6.3 Initial Measurement
6.3.1 General
ASC 860-50
30-1 An entity shall initially
measure at fair value, a servicing asset or servicing
liability that qualifies for separate recognition
regardless of whether explicit consideration was
exchanged.
Recognition of Servicing Upon Sale of a Participating
Interest
55-4 If the
entity that transfers a portion of a loan under a
participation agreement that meets the definition of a
participating interest and qualifies for sale accounting
under Subtopic 860-10 obtains the right to receive
benefits of servicing that more than adequately
compensate it for servicing the loan, and the entity
would continue to service the loan regardless of the
transfer because it retains part of the participated
loan, the entity shall record a servicing asset for the
portion of the loan it sold. The assumption that the
entity would service the loan because it retains part of
the participated loan does not affect the requirement to
recognize a servicing asset. Conversely, an entity could
not avoid recording a servicing liability if the
benefits of servicing are not expected to adequately
compensate the servicer for performing the servicing.
However, if the benefits of servicing are significantly
above an amount that would fairly compensate a
substitute service provider, should one be required, the
transferred portion does not meet the definition of a
participating interest, and, therefore, the transfer
does not qualify for sale accounting (see paragraph
860-10-40-6A(b)).
ASC 860-50 requires entities to initially measure recognized servicing assets or
servicing liabilities at fair value. See Section
6.3.2 for further discussion of determining the fair value of a
servicing asset or servicing liability. See below for an illustration of the
initial accounting upon a securitization of financial assets that is accounted
for as a sale.
Connecting the Dots
The requirement to recognize a servicing asset or
servicing liability at fair value in a sale of financial assets is
consistent with the guidance in ASC 860-20-30-1, under which a
transferor must recognize any asset obtained or liability incurred in a
transfer accounted for as a sale. Note that when an entity recognizes a
servicing asset in conjunction with the sale of a participating interest
in a financial asset, the fair value of the servicing asset is limited
to the servicing right related to the participating interest sold (i.e.,
a servicing asset is not recognized for the portion of the financial
asset that is retained). See Section 6.3.3.1 for discussion of
the accounting when an entity transfers a participating interest and
services that transferred interest without receiving any servicing
fees.
ASC 860-50-55-21 and 55-22 below provide an example illustrating
the initial measurement of a servicing asset in a transfer of financial assets
for which the proceeds include cash, a beneficial interest, and a servicing
right. See Section
4.2.2 for an additional example.
ASC 860-50
Example 1: Sale of Receivables With Servicing
Obtained by the Transferor
55-21 Entity
A originates $1,000 of loans that yield 10 percent
interest income for their estimated lives of 9 years.
Entity A transfers the entire loans to an unconsolidated
entity and the transfer is accounted for as a sale.
Case A: Transferor Continues to Service the Loans
55-22 Entity
A receives as proceeds $1,000 cash, a beneficial
interest to receive 1 percent of the contractual
interest on the loans (an interest-only strip
receivable), and an additional 1 percent of the
contractual interest as compensation for servicing the
loans. The fair values of the servicing asset and the
interest-only strip receivable are $40 and $60,
respectively. This Case illustrates Entity A’s (the
transferor’s) accounting for a sale with the servicing
obtained by Entity A (the transferor), as follows.
6.3.2 Measuring Fair Value
ASC 860-50
30-2 Typically, the benefits of
servicing are expected to be more than adequate
compensation to a servicer for performing the servicing,
and the contract results in a servicing asset. However,
if the benefits of servicing are not expected to
adequately compensate a servicer for performing the
servicing, the contract results in a servicing
liability. Paragraph 860-50-35-1A states that a
servicing asset may become a servicing liability, or
vice versa, if circumstances change. The initial measure
for servicing may be zero if the benefits of servicing
are just adequate to compensate the servicer for its
servicing responsibilities. A servicing contract that
entitles the servicer to receive benefits of servicing
just equal to adequate compensation, regardless of the
servicer’s own servicing costs, does not result in
recognizing a servicing asset or a servicing liability.
A purchaser would neither pay nor receive payment to
obtain the right to service for a rate just equal to
adequate compensation.
30-3 The
determination of whether the servicer is adequately
compensated for servicing specified assets is based on
the amount demanded by the marketplace, not the
contractual amount to be paid to a replacement servicer.
However, that contractual provision would be relevant
for determining the amount of contractually specified
servicing fees. Therefore, the amount that would be paid
to a replacement servicer under the terms of the
servicing contract can be more or less than adequate
compensation.
30-4 Whether
a servicing asset or servicing liability is recorded is
a function of the marketplace, not the servicer’s cost
of servicing. For example, a loss shall not be
recognized if a servicing fee that is equal to or
greater than adequate compensation is to be received but
the servicer’s anticipated cost of servicing would
exceed the fee.
30-6 When
valuing the right to receive future cash flows from
ancillary sources such as late fees, an entity shall
estimate the value of the right to benefit from the cash
flows of potential future transactions, not the value of
the expected cash flows to be derived from future
transactions.
30-7 Entities shall consider
the nature of the assets being serviced as a factor in
determining the fair value of a servicing asset or
servicing liability. The types of assets being serviced
affect the amount required to adequately compensate the
servicer. Several variables, including the nature of the
underlying assets, shall be considered in determining
whether a servicer is adequately compensated. For
example, the amount of effort required to service a home
equity loan likely would be different from the amount of
effort required to service a credit card receivable or a
small business administration loan.
In initially recognizing the fair value of an asset for a
servicing right (or a liability for a servicing obligation), an entity must
compare the (1) estimated future revenues from contractually specified servicing
fees, late charges, and other ancillary revenues (benefits of servicing) with
(2) adequate compensation. The concept of “adequate compensation” focuses on the
benefits that fairly compensate a substitute servicer if one is required,
including the profit that would be demanded in the marketplace. Since adequate
compensation is determined in the marketplace, a servicer’s internal costs of
servicing financial assets do not factor into the determination of the fair
value of servicing assets or servicing liabilities.
In estimating future revenues from the benefits of servicing,
entities must take into account, among other considerations, expected
prepayments on the underlying financial assets. If a third party has the
unilateral right to remove the entity as servicer (i.e., a kick-out right that
may be exercised without cause), the entity would also take this into account in
estimating the expected future revenues from servicing. The impact of a kick-out
right on expected future cash flows must be considered from a market
participant’s perspective.
The cost of servicing financial assets varies among servicers and depends on
factors such as the volume of financial assets serviced, the geographic location
of the servicer, and the efficiency of the servicer. Accordingly, a servicer’s
own cost of servicing financial assets is not relevant to the determination of
adequate compensation. The determination of adequate compensation in an illiquid
market often involves significant analysis and should be well documented.
Adequate compensation is also discussed in ASC 860-50-30-2 through 30-7.
The approach in ASC 860-50 is consistent with the guidance in
ASC 820, which emphasizes that fair value is a market-based rather than an
entity-specific measurement. Therefore, a fair value measurement is determined
on the basis of the assumptions that market participants would use in pricing a
servicing asset or servicing liability. In practice, entities generally use an
income approach to measure the fair value of servicing assets and servicing
liabilities. One of the more sensitive assumptions in an income approach is the
discount rate. In accordance with ASC 820, the inputs to a valuation technique
(e.g., the discount rate) must reflect the assumptions of marketplace
participants. Although servicing rights are not actively traded, sales of
servicing assets do occur. Therefore, entities must consider relevant observable
transactions involving sales of servicing rights. That is, observable
transactions should be considered under the market approach regardless of
whether that approach is used to value the servicing rights or is merely used to
calibrate the results of an income approach. For more information about fair
value measurements and disclosures, see Section 6.4.2.2 and Deloitte’s Roadmap
Fair Value Measurements
and Disclosures (Including the Fair Value Option).
6.3.3 Special Considerations
6.3.3.1 Servicer Is Not Entitled to Receive a Contractually Specified Servicing Fee
ASC 860-50
Servicer Is Not Entitled to Receive a Contractually
Specified Servicing Fee
55-5 The
following guidance addresses whether an entity
should recognize a servicing liability if it
transfers all or some of a financial asset that
meets the definition of a participating interest
that is accounted for as a sale and undertakes an
obligation to service the asset but is not entitled
to receive a contractually specified servicing fee.
In the circumstances described, the
transferor-servicer would be required to recognize a
servicing liability at fair value if the benefits of
servicing are less than adequate compensation. The
requirements in paragraph 860-50-25-1 apply even if
it is not customary to charge a contractually
specified servicing fee. Example 1, Case C
(paragraph 860-50-55-25) illustrates a transaction
in which a transferor agrees to service loans
without explicit compensation.
Case C: Future Benefits of Servicing Do Not Provide
Adequate Compensation
55-25 Transferors sometimes
agree to take on servicing responsibilities when the
future benefits of servicing are not expected to
adequately compensate them for performing that
servicing. In that circumstance, the result is a
servicing liability rather than a servicing
asset.
55-26 For example, if in the
transaction illustrated in paragraphs 860-20-55-43
through 55-45, the transferor (Entity A) had agreed
to service the loans without explicit compensation
and it estimated the fair value of that servicing
obligation at $50, net proceeds would be reduced to
$980, gain on sale would become a loss on sale of
$20, and the transferor would report a servicing
liability of $50.
ASC 860-50-55-5 discusses the requirement in ASC 860-50-30-1
to recognize a servicing liability at fair value when an entity transfers a
participating interest in a transaction that is accounted for as a sale and
does not receive any contractually specified servicing fees for the
obligation to service the interest sold. ASC 860-50-55-26 illustrates that
the initial fair value of the servicing liability will affect the
calculation of the gain or loss on a sale of a financial asset.
6.3.3.2 Servicing Rights Acquired or Assumed for No Cash Payment
6.3.3.2.1 General
ASC 860-50
Servicing Assets Assumed Without Cash Payment
55-6 The
following guidance addresses transactions in which
servicing assets are assumed without cash payment,
and the appropriate offsetting entry by the
transferee.
55-7 The offsetting entry
depends on whether an exchange or capital
transaction has occurred. If an exchange has
occurred, then the transaction should be recorded
based on the facts and circumstances. For example,
the servicing asset may represent consideration
for goods or services provided by the transferee
to the transferor of the servicing. In that case,
the offsetting entry by the transferee would be
the same as if cash was received in exchange for
the goods and services (that is, revenue or a
liability as appropriate).
55-8 The servicing assets
also might be received in full or partial
satisfaction of a receivable from the transferor
of the servicing. In those cases, the offsetting
entry by the transferee would be to derecognize
all or part of the receivable satisfied in the
exchange. Another possibility is that an investor
is in substance making a capital contribution to
the investee (the party receiving the servicing
asset, that is, the transferee) in exchange for an
increased ownership interest. In that case, the
investee should recognize an increase in equity
from a contribution by owner.
When an entity obtains a servicing right without making
or receiving a cash payment, the offsetting entry depends on whether an
exchange or capital transaction has occurred. That is, although no cash
was exchanged for the servicing right, there is either other
consideration exchanged (e.g., noncash financial assets) or the
transaction is of a capital nature. An entity could enter into a
contract to service financial assets, with no consideration exchanged,
that does not represent a capital transaction (see Section
6.3.3.2.2); however, such contracts are expected to be
infrequent.
6.3.3.2.2 Servicing Right Acquired or Assumed for No Consideration
An entity may enter into a contract with a third party to service
financial assets without paying or receiving any consideration for
taking on the servicing responsibility. That is, there is no other
transaction or arrangement involved as of the date the entity is hired
to service financial assets (i.e., the contract to service the financial
assets is not entered into contemporaneously or in conjunction with any
other arrangement). In evaluating the accounting for a stand-alone
exchange contract to service financial assets that is entered into with
an unrelated party without any consideration exchanged by the parties,
an entity should consider the following:
-
Whether the benefits of servicing differ from adequate compensation.
-
The offsetting entry upon any recognition of a servicing asset or servicing liability.
When an entity enters into a contract with a third party
to service financial assets and no consideration is exchanged, the fair
value of the servicing right should equal or approximate zero. ASC
860-50-30-2 states, in part, that “a purchaser would neither pay nor
receive payment to obtain the right to service for a rate just equal to
adequate compensation.” Therefore, a transaction price of zero indicates
that the fair value of servicing is zero because the benefits of
servicing equal adequate compensation. This is consistent with the
guidance in ASC 820-10-30-3A, which indicates that the initial fair
value of an asset or liability equals its transaction price unless
certain conditions are met.
If an entity believes that the transaction price of zero
differs from the fair value of the servicing right as of the date the
contract is executed, it should consider whether one of the four
conditions in ASC 820-10-30-3A is met. (Note that ASC 820-10-30-3A
addresses situations for which the transaction price of an asset’s or
liability’s fair value differs at initial recognition.) In evaluating
these conditions, an entity should take into account the objective of
the initial fair value measurement of a servicing asset or servicing
liability, as discussed in ASC 860-50-30-3 and 30-4. If none of the
conditions in ASC 820-10-30-3A are met, the fair value of servicing at
initial recognition would be expected to equal or approximate the
transaction price (i.e., zero).
If, after considering ASC 820-10-30-3A, the entity
appropriately concludes that the benefits of servicing are more or less
than adequate compensation, it should recognize a servicing asset or a
servicing liability in accordance with ASC 860-50-30-1. If a servicing
liability is recognized, the entity should make the offsetting entry to
expense because it would be difficult for it to conclude that it is
allowed to recognize an asset under other U.S. GAAP. If, however, a
servicing asset is recognized, we generally believe that the offsetting
entry should be recognized as deferred income since the entity has not
yet performed the requisite services to obtain the benefits of
servicing.