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.