Chapter 6 — Servicing Assets and Liabilities

6.2 Recognition of Servicing Assets or Liabilities

6.2.1 General

ASC 860-50

25-1 An entity shall recognize a servicing asset or servicing liability each time it undertakes an obligation to service a financial asset by entering into a servicing contract in any of the following situations:

A servicer’s transfer of any of the following, if that transfer meets the requirements for sale accounting:
1. An entire financial asset
2. A group of entire financial assets
3. A participating interest in an entire financial asset, in which circumstance the transferor shall recognize a servicing asset or a servicing liability only related to the participating interest sold.
Subparagraph superseded by Accounting Standards Update No. 2009-16.
An acquisition or assumption of a servicing obligation that does not relate to financial assets of the servicer or its consolidated affiliates included in the financial statements being presented.

Example 1 (see paragraph 860-50-55-20) illustrates accounting for a sale of receivables with servicing obtained by the transferor.

25-2 A servicer that transfers or securitizes financial assets in a transaction that does not meet the requirements for sale accounting and is accounted for as a secured borrowing with the underlying financial assets remaining on the transferor’s balance sheet shall not recognize a servicing asset or a servicing liability.

25-3 A servicer that recognizes a servicing asset or servicing liability shall account for the contract to service financial assets separately from those financial assets.

A servicing asset or liability is recognized separately to reflect an entity’s rights (obligations) to service financial assets only when both of the following conditions are met:

The benefits of servicing do not equal adequate compensation.
An entity (1) retains the servicing responsibility in a transfer of financial assets that meets the conditions for sale accounting in ASC 860-10 or (2) enters into a contract to acquire a servicing asset or assume a servicing liability that is not related to the entity’s financial assets.

Connecting the Dots

The accounting for a contract to service financial assets is the same regardless of whether the servicing right results from an outright sale or securitization of transferred financial assets or from a purchase or assumption of the rights to service financial assets that the entity or its consolidated affiliates do not own. It is never appropriate to recognize a servicing asset or servicing liability in (1) a transfer of financial assets that is not accounted for as a sale and (2) an acquisition of loan receivables with the rights to service them.

The examples below illustrate when it is appropriate to recognize a servicing asset or servicing liability.

Example 6-1

Sale of Mortgage Loans

Entity A transfers mortgage loans to an unconsolidated securitization entity and retains the rights to service the transferred mortgage loans. The transfer of the mortgage loans meets the sale accounting conditions in ASC 860-10-40-5. The benefits of servicing the transferred mortgage loans exceed adequate compensation. Entity A should recognize a servicing asset as part of the proceeds received on the transfer of the mortgage loans.

Example 6-2

Purchase of Mortgage Loans

Entity B purchases mortgage loans in a whole-loan purchase transaction. As part of the purchase, B obtains the rights to service the acquired mortgage loans. Entity B should not separately recognize a servicing asset or servicing liability because ASC 860-50-25-1(c) prohibits an entity from recognizing a servicing asset or servicing liability on financial assets that it owns.

That is, when an entity acquires the servicing rights on loans that it recognizes on its balance sheet, a servicing asset or servicing liability cannot be recorded because the servicing is related to financial assets owned by the servicer.

6.2.2 Special Considerations

6.2.2.1 Securitization Transaction in Which the Transferor Obtains the Resulting Securities

ASC 860-50

25-4 An entity that transfers its financial assets to an unconsolidated entity in a transfer that qualifies as a sale in which the transferor obtains the resulting securities and classifies them as debt securities held to maturity in accordance with Topic 320 may either separately recognize its servicing assets or servicing liabilities or report those servicing assets or servicing liabilities together with the asset being serviced.

As discussed in Section 3.6.1, an entity may transfer mortgage loans to an unconsolidated securitization entity and meet the conditions in ASC 860-10 for sale accounting even though the entity retains all the securities issued by the unconsolidated securitization entity. This type of transaction would generally qualify as a sale under ASC 860-10 only if a third party provides a guarantee on the transferred mortgage loans. The accounting for the MSRs in such a transaction depends on how the entity accounts for the debt securities received in the transfer.

ASC 860-50 requires an entity to recognize a servicing asset or servicing liability for MSRs that are acquired or obtained in a mortgage securitization involving an unconsolidated securitization entity in which the transferor retains all of the resulting securities and classifies them as either available for sale or trading. However, ASC 860-50-25-4 indicates that if the securities retained are classified as held to maturity, the entity may choose to separately recognize a servicing asset or servicing liability or recognize the MSR together with the asset being serviced (i.e., the held-to-maturity securities). ASC 860-50-30-1 requires entities to initially measure servicing assets and servicing liabilities at fair value; therefore, MSRs that are recognized in a transfer of financial assets to an unconsolidated securitization entity in which the transferor retains all the underlying securities issued by the securitization entity should be initially measured at fair value.

6.2.2.2 Distinguishing Servicing Assets From IO Strips

ASC 860-50

Distinguishing Servicing From an Interest-Only Strip

25-6 A servicer shall account separately for rights to future interest income from the serviced assets that exceed contractually specified servicing fees. Those rights are not servicing assets; they are financial assets, effectively interest-only strips to be accounted for in accordance with paragraph 860-20-35-2.

25-7 Whether a right to future interest income from serviced assets should be accounted for as an interest-only strip, a servicing asset, or a combination thereof, depends on whether a servicer would continue to receive that amount (that is, the value of the right to future interest income) if a substitute servicer began servicing the assets. Therefore, any portion of the right to future interest income from the serviced assets that would continue to be received even if the servicing were shifted to another servicer would be reported separately as a financial asset in accordance with paragraph 860-20-35-2. For guidance on why an interest-only strip precludes a portion of a financial asset from meeting the definition of a participating interest, see paragraph 860-10-55-17K.

25-8 The value of the right to receive future cash flows from ancillary sources such as late fees shall be included in the measurement of the servicing asset, not the interest-only strip, if retention of the right to receive the cash flows from those fees depends on servicing being performed satisfactorily, as is generally the case.

ASC 860-50-25-6 through 25-8 discuss the importance of distinguishing servicing assets from IO strips. The table below summarizes the significant accounting differences between servicing assets and IO strips (in this table, it is assumed that the assets were retained in a sale or securitization and not purchased separately).

Table 6-1

	Servicing Asset	IO Strip
Definition	The amount by which — on the basis of marketplace conditions — the contractually specified servicing fee exceeds adequate compensation for servicing. See Section 6.1.	Rights to any remaining portion of the interest spread beyond the contractually specified servicing rate.
Initial recorded amount	Fair value. See Section 6.3.	Fair value.
Immediate adjustment required after initial recording	No adjustment.	No adjustment.
Income recognition	An entity may either (1) amortize servicing assets or servicing liabilities in proportion to, and over the period of, estimated net servicing income or (2) measure servicing assets or servicing liabilities at fair value as of each reporting date and report changes in fair value in earnings. See Section 6.4.	Trading and available for sale — Level yield; prospective adjustments are made for changes in estimated income under ASC 325-40. In addition, IO strips often contain an embedded derivative that must be bifurcated under ASC 815-15. In lieu of bifurcation, entities often elect the FVO. IO strips cannot generally be accounted for as held-to-maturity securities (see ASC 860-20-35-2 and ASC 310-10-35-45).
Balance sheet carrying value	Amortized cost or fair value, depending on the method selected. See Section 6.4.	Fair value.
Recognition of impairment	If the amortization method is selected, a valuation allowance is established for an individual stratum of servicing assets when its carrying amount exceeds its fair value. Changes to a valuation allowance are recognized in earnings; however, an entity cannot recognize a fair value amount that is above the stratum’s carrying amount (see ASC 860-50-35-9(c)). See Section 6.4.2.2.4 for discussion of direct write-downs of servicing assets.	Trading — Fair value with periodic changes recorded through earnings. Available for sale — Written down to fair value in accordance with ASC 325-40, ASC 320, and ASC 958-325, if impaired.

Connecting the Dots

The determination of whether a right to receive a strip of cash flows (often referred to in practice as “excess cash flows” or “excess servicing”) is a component of a servicing asset or represents an IO strip depends on whether the holder of such a right can transfer that right independently of the servicing contract. If such a transfer is allowed, the right to the excess cash flows does not depend on servicing and reflects an IO strip. If such a transfer is not allowed, the right to excess cash flows reflects servicing benefits in excess of adequate compensation since the holder cannot receive such cash flows without servicing the related financial assets.

6.2.2.3 Subservicing Contracts

ASC 860-50

Subservicing Contracts

55-10 A transferor may transfer mortgage loans in their entirety to a third party in a transfer that is accounted for as a sale and undertake an obligation to service the loans. After the transfer, the transferor enters into a subservicing arrangement with a third party.

55-11 If the transferor’s benefits of servicing exceed its obligation under the subservicing contract, that differential shall not be accounted for as an interest-only strip. Rather, the transferor should account for the two transactions separately. First, the transferor should account for the transfer of mortgage loans in accordance with Subtopic 860-20. The obligation to service the loans should be initially recognized and measured at fair value according to paragraph 860-50-30-1 as proceeds obtained from the sale of the mortgage loans. Second, the transferor should account for the subcontract with the subservicer.

ASC 860-50-55-10 and 55-11 address when an entity transfers mortgage loans, retains the right to service the mortgage loans, and enters into a contract with a third party to service the mortgage loans (i.e., a subservicing contract). That guidance stipulates that if the transfer of the mortgage loans is accounted for as a sale, the transferor has two separate transactions to account for: (1) the transfer of the mortgage loans and recognition of the servicing asset or servicing liability as part of the proceeds on transfer and (2) the subcontract with the subservicer. Because the transferor has the primary obligation to service the transferred mortgage loans, it would recognize a servicing asset or servicing liability, and not an IO strip, related to that servicing right. The subservicing contract would be accounted for separately.

6.2.2.4 Revolving-Period Securitizations

ASC 860-50

Revolving-Period Securitizations

25-9 Recognition of servicing assets or servicing liabilities for revolving-period receivables shall be limited to the servicing for the receivables that exist and have been sold. As new receivables are sold, rights to service them may become assets or liabilities that are recognized. Therefore, additional transfers under revolving-period securitizations (for example, home equity loans or credit card receivables) may result in the recognition of additional servicing assets or servicing liabilities.

ASC 860-50-25-9 clarifies that servicing assets and servicing liabilities may only be recognized for recognized receivables. Entities may not separately recognize a servicing asset or servicing liability for receivables to be originated in the future. This guidance is consistent with ASC 860-20-55-31, which indicates that the fair value measurement of a beneficial interest in a securitization entity may not include the estimated cash flows associated with receivables that do not yet exist but that will be originated and transferred during the revolving period (e.g., in securitizations with revolving features or prefunding provisions).

6.2.2.5 Regaining Control of Financial Assets Sold

ASC 860-50

Regaining Control of Financial Assets Sold

25-10 Paragraph 860-20-25-10(b) explains that, after a paragraph 860-10-40-41 change, the transferor shall not change, the accounting for the servicing asset related to the previously sold financial assets and provides related guidance.

Entities may be required to rerecognize financial assets that were previously considered sold for many different reasons. Upon such rerecognition, entities do not subsume any previously recognized servicing asset or servicing liability into the carrying amount of the rerecognized financial assets. For more information, see Section 4.3.

6.2.2.6 Acquisition of Rights to Service an Entity’s Owned Financial Assets

Entities may obtain the servicing rights on financial assets that are owned by the entity or its consolidated affiliates. For example, an entity may purchase financial assets with the servicing retained by the seller and then later acquire those servicing rights. In accounting for an acquisition or assumption of servicing rights, an entity should consider the guidance in ASC 860-50-25-1(c), which addresses the recognition of a servicing asset or servicing liability in situations in which an entity acquires or assumes an obligation to service financial assets that it owns. We believe that if, in a manner consistent with this guidance, an entity acquires the servicing rights to financial assets that it owns, it should account for the servicing rights and related financial assets on a combined basis. That is, the offsetting entry for the consideration paid or received for the servicing rights should be recognized as an adjustment to the related receivables. In such circumstances, an entity may be required to make an allocation to each receivable within a larger group by using a systematic and reasonable allocation method.

We understand that recognizing acquired servicing rights as a basis adjustment to the carrying amounts of the related receivables could be considered inconsistent with the guidance in ASC 860-50-25-10 (see Section 6.2.2.5). However, ASC 860-50-25-1(c) prohibits the recognition of a separate servicing asset or servicing liability in this situation.

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This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.