6.5 Transfers of Servicing Rights
6.5.1 General
ASC 860-50
Overall
40-2 The
following criteria shall be considered when evaluating
whether a transfer of servicing rights qualifies as a
sale:
-
Whether the transferor has received written approval from the investor if required.
-
Whether the transferee is a currently approved transferor-servicer and is not at risk of losing approved status.
-
If the transferor finances a portion of the sales price, whether an adequate nonrefundable down payment has been received (necessary to demonstrate the transferee’s commitment to pay the remaining sales price) and whether the note receivable from the transferee provides full recourse to the transferee. Nonrecourse notes or notes with limited recourse (such as to the servicing) do not satisfy this criterion.
-
Temporary servicing performed by the transferor for a short period of time shall be compensated in accordance with a subservicing contract that provides adequate compensation.
40-3 Also,
the following additional criteria shall be considered
when evaluating whether a transfer of servicing rights
qualifies as a sale:
-
Title has passed.
-
Substantially all risks and rewards of ownership have irrevocably passed to the buyer.
-
Any protective provisions retained by the seller are minor and can be reasonably estimated.
40-4 If a
sale is recognized and minor protection provisions
exist, a liability shall be accrued for the estimated
obligation associated with those provisions. The seller
retains only minor protection provisions if both of the
following conditions are met:
-
The obligation associated with those provisions is estimated to be no more than 10 percent of the sales price.
-
Risk of prepayment is retained for no longer than 120 days.
40-5 A temporary subservicing
contract in which the subservicing will be performed by
the transferor for a short period of time would not
necessarily preclude recognizing a sale at the closing
date.
40-6 The
criteria in paragraphs 860-50-40-2 through 40-4 apply to
transfers of servicing rights relating to loans
previously sold and to transfers of servicing rights
relating to loans that are retained by the transferor.
The carrying amount of servicing rights sold relating to
loans that have been retained shall be allocated at the
date of sale between the servicing rights and the loans
retained using relative fair values.
Sales of Servicing
Rights With a Subservicing Contract
40-7 A sale of mortgage
servicing rights with a subservicing contract shall be
treated as a sale with gain deferred if substantially
all the risks and rewards inherent in owning the
mortgage servicing rights have been effectively
transferred to the transferee, as discussed in paragraph
860-50-40-3. Attributes of the transferee (for example,
ability to perform servicing) would not be significant
to the accounting for the transaction. The risks and
rewards associated with a transferor performing purely
administrative functions under a subservicing contract
would not necessarily preclude sales treatment. A loss
shall be recognized currently if the transferor
determines that prepayments of the underlying mortgage
loans may result in performing the future servicing at a
loss.
40-8
Substantially all the risks and rewards inherent in
owning the mortgage servicing rights have not been
transferred to the transferee and, therefore, the
transaction shall be accounted for as a financing if any
of the following factors are present:
-
The transferor-subservicer directly or indirectly guarantees a yield to the transferee. For example, the transferor-subservicer guarantees prepayment speeds or maximum loan default ratios to the buyer.
-
The transferor-subservicer is obligated to advance a portion or all of the servicing fees on a nonrecoverable basis to the transferee before receipt of the loan payment from the mortgagor.
-
The transferor-subservicer indemnifies the transferee for damages due to causes other than failure to perform its duties under the terms of the subservicing contract.
-
The transferor-subservicer absorbs losses on mortgage loan foreclosures not covered by the Federal Housing Administration, Department of Veterans Affairs, or other guarantors, if any, including absorption of foreclosure costs and costs of managing foreclosed property.
-
Title to the servicing rights is retained by the transferor-subservicer.
40-9 The
presence of any of the following factors creates a
rebuttable presumption that substantially all the risks
and rewards inherent in owning the mortgage servicing
rights have not been transferred to the transferee and
that the transaction shall be accounted for as a
financing:
-
The transferor-subservicer directly or indirectly provides financing or guarantees the transferee’s financing. Nonrecourse financing, for example, would indicate that risks have not been transferred to the transferee. Topic 450 requires a guarantor to recognize, at inception of the guarantee, a liability for the obligation undertaken in issuing the guarantee.
-
The terms of the subservicing contract unduly limit the transferee’s ability to exercise ownership control over the servicing rights or result in the seller’s retaining some of the risks and rewards of ownership. For example, if the transferee cannot cancel or decline to renew the subservicing contract after a reasonable period of time, the transferee is precluded from exercising certain rights of ownership. Conversely, if the transferor cannot cancel the subservicing contract after a reasonable period of time, the transferor has not transferred substantially all of the risks of ownership.
-
The transferee is a special-purpose entity without substantive capital at risk.
Sales of Servicing
Rights for Participation in an Income Stream
40-10 The following addresses a
situation in which an entity sells the right to service
mortgage loans that are owned by other parties. The
related mortgage loans have been previously sold, with
servicing retained, in a separate transaction. Because
of the ability to invest the float that results from
payments received from borrowers but not yet passed to
the owners of the mortgages, the mortgage servicing
rights can be sold for immediate cash or for a
participation in the future interest stream of the
loans.
40-11 If a transfer of mortgage
servicing rights qualifies as a sale under the criteria
beginning in paragraph 860-50-40-2 and the sale is for a
participation in the future interest income stream, gain
recognition is appropriate at the sale date. There are
difficulties in measuring the amount of the gain if the
sales price is based on a participation in future
payments and there is no specified upper limit on the
computed sales price. The transferor of mortgage
servicing rights shall consider all available
information, including the amount of gain that would be
recognized if the servicing rights were to be sold
outright for a fixed cash price.
ASC 860-10 — SEC Materials — SEC Staff Guidance
SEC Observer Comment: Balance Sheet Treatment of a Sale
of Mortgage Servicing Rights With a Subservicing
Agreement
S99-1 The
following is the text of SEC Observer Comment: Balance
Sheet Treatment of a Sale of Mortgage Servicing Rights
with a Subservicing Agreement.
In accordance with paragraph
860-50-40-7, a sale of mortgage servicing rights with a
subservicing contract could be treated as a sale with
the gain deferred if substantially all of the risks and
rewards have been transferred to the transferree. In the
view of the SEC staff, a transaction that, in substance,
transfers only a portion of the servicing revenues does
not result in transfer of substantially all of the risks
and rewards of ownership and the accounting for those
transactions should be guided by the guidance in
paragraph 470-10-25-1.
ASC 860-50-40-2 through 40-9 provide guidance on when rights to
service financial assets should be derecognized. This derecognition guidance
differs from the guidance in ASC 860-10 that applies to the derecognition of
financial assets. While the derecognition model in ASC 860-10-40 focuses on
control, the derecognition guidance related to servicing rights in ASC 860-50-40
focuses primarily on risks and rewards.
6.5.1.1 Scope of Guidance on Transfers of Servicing Rights
The guidance in ASC 860-50-40 on transfers of servicing rights applies to the
following:
-
A transfer of separately recognized servicing assets and servicing liabilities.
-
A transfer of servicing rights on financial assets owned by the transferor.
Connecting the Dots
An entity can recognize a sale of servicing rights
that are attached to the related loans (i.e., the servicing rights
are not separately recognized) if the conditions in ASC 860-10-40-5
for recognizing a sale of financial assets are met. We do not
believe that an entity must apply the guidance in ASC 860-50-40 on
transfers of servicing rights. In addition, when an entity transfers
servicing rights on financial assets that it owns but does not
transfer the financial assets themselves, the guidance in ASC
860-50-40 applies. In these circumstances, the guidance in ASC
860-10 on participating interests is not relevant.
ASC 860-50-40 does not apply to transfers of
financial assets that include the rights to service those
transferred financial assets unless the servicing rights have been
separately recognized as a servicing asset or servicing liability.
Rather, only ASC 860-10-40-5 applies to the transfers of those
financial assets. See Examples 6-3 through 6-5.
ASC 860-50-40 also does not apply to a sale of a
legal entity that meets the definition of a business (i.e., ASC
860-50-40 would not apply to any servicing rights included in the
legal entity). However, if an entity sells a group of assets that
does not constitute a legal entity, it would generally need to apply
ASC 860-50-40 to any servicing rights that are included in this sale
regardless of whether the group of assets meets the definition of a
business.
6.5.1.2 Accounting for a Transfer of Servicing Rights by the Transferor
There are three possible accounting outcomes when rights to service loans are
transferred:
-
Sales treatment with immediate gain recognition.
-
Sales treatment with gain deferral.
-
Secured borrowing.
Generally, a transfer of servicing rights should be accounted for as a sale
only when all of the substantive risks and rewards of ownership have been
transferred. Agreements to sell or transfer servicing rights may contain
complex provisions designed to protect the buyer. For example, in addition
to standard eligibility representations and warranties, agreements may
include subsequent adjustments to the sales price depending on higher than
agreed-to levels of prepayments or defaults on the underlying loans that
occur within a specified time frame. ASC 460 addresses the accounting for
guarantees.
Frequently, sellers transfer servicing rights but continue to service the
underlying loans under a subservicing agreement. The terms of subservicing
arrangements vary widely; sometimes they are temporary and provide for a
period after closing during which the parties coordinate systems and
controls in anticipation of the actual transfer of data. However, in some
situations, the existence of a subservicing agreement may indicate that the
original seller/subservicer continues to bear the substantive risks and
rewards of ownership.
The table below summarizes the guidance in ASC 860-50-40 on the transferor’s
accounting for a transfer of servicing rights.2
Table
6-3
Transfers of Servicing Rights
|
Guidance
| Discussion |
---|---|---|
Subservicing is not performed by the seller, or
subservicing is short-term.(a)
|
ASC 860-50-40-2 through 40-6
|
Provided that the conditions in ASC 860-50-40-2 are
met, the sale is recognized when (1) title has
passed, (2) substantially all risks and rewards have
irrevocably passed to the buyer, and (3) protection
provisions are minor and can be reasonably
estimated(b) (see Examples 6-7 and 6-8).
See Section
6.5.1.2.1 for guidance on the
transferor’s accounting when the transaction meets
the conditions for recognition as a sale.
See Section
6.5.1.2.2 for guidance on the
transferor’s accounting when the transaction does
not qualify as a sale.
|
Subservicing is not performed by the seller; loans
are retained by the seller.
|
ASC 860-50-40-2
|
Provided that the conditions in ASC 860-50-40-2 are
met, the sale is recognized when (1) title has
passed, (2) substantially all risks and rewards have
irrevocably passed to the buyer, and (3) protection
provisions are minor and can be reasonably
estimated(b) (see Examples 6-7 and 6-8).
See Section
6.5.1.2.1 for guidance on the
transferor’s accounting when the transaction meets
the conditions for recognition as a sale. See
Section
6.5.1.2.2 for guidance on the
transferor’s accounting when the transaction does
not qualify as a sale.
|
Subservicing is performed by the seller, and
subservicing is not short-term.
|
ASC 860-50-40-7 through 40-9
|
Sales with subservicing agreements should be treated
as a sale with a deferred gain if substantially all
risks and rewards have been effectively transferred.
When certain factors are present, either financing
treatment is required or there is a rebuttable
presumption that financing treatment is
appropriate.(c)
See Section
6.5.1.2.1 for guidance on the
transferor’s accounting when the transaction meets
the conditions for recognition as a sale. See
Section
6.5.1.2.2 for guidance on the
transferor’s accounting when the transaction does
not qualify as a sale.
|
Notes to Table:
(a) An entity generally
determines whether the period of subservicing is
short-term on the basis of time. Qualitative factors
may be relevant to this evaluation, such as the
length of time necessary to set up systems and
controls (e.g., for an extremely large portfolio or
a complex portfolio of commercial loans with unique
contractual terms).
(b) ASC 860-50-20 defines
“protection provisions” as follows:
Provisions in some contracts to
sell or transfer mortgage servicing rights that
could affect the amount ultimately paid to the
transferor. For example, the transferor may agree
to adjust the sales price for loan prepayments,
defaults, or foreclosures that occur within a
specified period of time. Provisions that must be evaluated
under ASC 860-50-40-3(c) and 40-4 are those designed
to (1) reflect a purchase price adjustment or (2)
protect a purchaser against losses associated with
the servicing rights acquired. That is, protective
provisions are contract terms that are intended to
adjust the sales price as a result of events that
subsequently affect the purchaser’s acquired rights
to service loans. Not all contingent payment
provisions specified in a sale agreement represent
protection provisions. For example, standard
eligibility representations and warranties are not
protection provisions. In addition, the following
reimbursement provisions would generally not
constitute protection provisions:
However, reimbursement provisions
related to risks that should be absorbed by the
buyer or other third parties constitute protection
provisions that must be included in the 10 percent
test described in ASC 860-50-40-4. These types of
payment provisions differ from the reimbursement
provisions discussed above because the seller of
servicing rights is taking on a risk that should be
absorbed by the buyer. Examples include amounts
payable by the seller to the buyer for adverse
changes in prepayment speeds, discount rates, or
servicing costs. An entity must consider the
specific facts and circumstances associated with
reimbursement provisions in determining whether they
represent protection provisions. For example, some
payment provisions that are triggered by actions of
the servicer before the sale of the servicing rights
could represent protective provisions if the amount
payable is not commensurate with the loss incurred
by the buyer.
(c) The presence of one
or more of the following factors would indicate that
substantially all the risks and rewards inherent in
owning the MSRs have not been transferred to the
buyer and that the transaction should therefore be
accounted for as a financing:
In addition, the presence of the
following factors creates a rebuttable presumption
that substantially all the risks and rewards
inherent in owning the MSRs have not been
transferred to the buyer and that the transaction
should be accounted for as a financing:
|
6.5.1.2.1 Recognition if Transfer Meets the Conditions for a Sale
The transferor’s accounting for a sale of servicing
rights depends on whether the servicing rights were previously (1)
separately recognized or (2) included in the carrying amount of the
related financial assets.
If a transfer involves separately recognized servicing assets or
servicing liabilities and subservicing is not performed by the seller,
the transferor should recognize the sale as follows:
- Recognize:
-
An asset (liability) for the proceeds received (paid) in accordance with other U.S. GAAP.
-
A liability for any minor protection provisions.
-
- Derecognize the carrying amount of the servicing assets or servicing liabilities sold.
- Recognize a gain or loss on sale for the difference between (1) and (2).
If the transfer involves separately recognized servicing assets or
servicing liabilities, and subservicing is performed by the seller on a
short-term basis, the transferor should recognize the sale as follows:
- Recognize:
-
An asset (liability) for the proceeds received (paid) in accordance with other U.S. GAAP.
-
A liability for any minor protection provisions.
-
An asset (liability) if the short-term subservicing agreement involves benefits of servicing that are greater than (less than) adequate compensation
-
- Derecognize the carrying amount of the servicing assets or servicing liabilities sold.
- Recognize a gain or loss on sale for the difference between (1) and (2).
If the transfer involves separately recognized servicing
assets or servicing liabilities and the transferor performs subservicing
on other than a short-term basis, the transferor should recognize the
transaction in a manner similar to that when subservicing is performed
by the seller on a short-term basis, except that any gain on sale must
be deferred in accordance with ASC 860-50-40-7. Any loss on sale would
generally be recognized immediately.
If the transfer involves the sale of servicing rights on financial assets
that continue to be owned by the transferor and subservicing is not
performed by the seller, or subservicing is performed on a short-term
basis, the transferor should recognize the sale as follows:
- Recognize:
-
An asset (liability) for the proceeds received (paid) in accordance with other U.S. GAAP.
-
A liability for any minor protection provisions.
-
An asset (liability) if the transaction involves a short-term subservicing agreement in which the benefits of servicing are greater than (less than) adequate compensation.
-
- Adjust the carrying amount of the loans in accordance with ASC 860-50-40-6 (i.e., allocate the carrying amount of the loans between the loans that have been retained and the servicing rights that have been sold on a relative fair value basis). (See Example 6-6 for an illustration that involves the derecognition of a servicing liability.)
- Recognize a gain or loss on sale for the difference between (1) and (2).
If the transferor performs subservicing on other than a
short-term basis, the transferor is precluded from recognizing any gain
on sale (a loss on sale would be immediately recognized). We generally
believe that, in these situations, it is unnecessary for the transferor
to derecognize any portion of the carrying amounts of the loans.
ASC 860-50-40-10 and 40-11 address a transaction involving a sale of MSRs
in return for a participation in the income stream from the sold
servicing rights. This guidance highlights the potential difficulty with
measuring the amount of gain if the transfer qualifies as a sale.
6.5.1.2.2 Recognition if Transfer Fails to Meet the Conditions for a Sale
If a transfer of servicing rights does not meet the
conditions for sale accounting, the transferor should not derecognize
the servicing assets or servicing liabilities but should recognize a
secured borrowing (lending) equal to the amount of proceeds received
(paid). The servicing assets or servicing liabilities involved in the
transfer would continue to be subsequently recognized in accordance with
ASC 860-50. The entity would account for any liability (asset) for the
secured borrowing (lending) in accordance with other U.S. GAAP. See
Chapter
5 for further discussion of secured borrowing
accounting.
6.5.1.3 Transferee’s Accounting for a Transfer of Servicing Rights
As with the accounting under ASC 860-10, the transferee’s
accounting is symmetrical with the transferor’s accounting for a transfer of
servicing rights.3 That is, if the transferor recognizes a sale of servicing assets, the
transferee recognizes an acquisition of servicing assets. If, however, the
transferor recognizes the transfer of servicing assets as a secured
borrowing, the transferee must account for the transaction as a receivable
from the transferor. The transferee cannot recognize the acquisition of a
servicing asset in this situation because the conditions for recognition of
a servicing asset in ASC 860-50-25-1(c) are not met. The same symmetrical
accounting applies to a transfer of servicing liabilities.
Note that when a transferee recognizes a receivable from, or
payable to, a transferor in a transfer of servicing rights that does not
qualify for sale accounting, the transferee must apply other U.S. GAAP to
subsequently measure the receivable or payable, unless the transferee elects
the FVO.
6.5.2 Examples
Example 6-3
Transfer of Financial Assets on a Servicing-Released
Basis — Servicing Rights Were Not Separately
Recognized
Entity C enters into a whole-loan sale
transaction that involves the sale of a portfolio of
mortgage loans to a third party. Assume that the
transfer (1) meets the conditions for sale accounting in
ASC 860-10-40-5 and (2) occurs on a “servicing-released”
basis (i.e., the buyer acquires both the transferred
mortgage loans and the rights to service those mortgage
loans). Entity C recognizes only the mortgage loan
receivables on its balance sheet (i.e., the servicing
rights are not separately recognized).
Entity C is not required to apply ASC
860-50-40 to determine the accounting for this transfer.
Only ASC 860-10-40 applies. Since the conditions for
sale accounting in ASC 860-10-40-5 are met, C should
derecognize the mortgage loans.
Example 6-4
Transfer of
Financial Assets on a Servicing-Released Basis —
Servicing Rights Were Separately Recognized
In 20X1, Entity D transfers mortgage
loans on a “servicing-retained” basis (i.e., D retains
the rights to service those mortgage loans). This
transfer qualifies for sale accounting under ASC
860-10-40-5; therefore, D derecognizes the mortgage
loans and recognizes an MSR asset as part of the
proceeds of the transfer.
In 20X3, D is required to rerecognize
the transferred mortgage loans. In accordance with ASC
860-20-25-10(b), D continues to recognize the MSR asset
related to those rerecognized mortgage loans.
In 20X4, D enters into an agreement with
a third party to transfer the mortgage loans on a
“servicing-released” basis (i.e., D transfers the
mortgage loans and the rights to service those mortgage
loans to the third party).
Entity D is required to apply both ASC
860-10-40 and ASC 860-50-40 to the transfer that occurs
in 20X4. ASC 860-10-40 applies to D’s accounting for the
transfer of the mortgage loans, and ASC 860-50-40
applies to D’s accounting for the transfer of the MSR
asset. Unlike Example 6-3, this example addresses a
situation in which ASC 860-50-40 pertains to the
transfer of the servicing rights because they were
separately recognized as a servicing asset on the date
of the transfer.
Example 6-5
Coissue
Transaction
Entity E enters into the following transactions at the
same time:
-
A transfer of mortgage loans to the FNMA without transferring the servicing rights (i.e., servicing-retained).
-
A transfer of the MSRs to X, a third-party FNMA-approved servicer.
-
A subservicing contract with X under which E will service the transferred mortgage loans for a period of time in return for a fee that equals adequate compensation.
In this tri-party arrangement, the FNMA
pays the purchase price for the mortgage loans and X
pays E the purchase price for the acquisition of the
servicing rights. Both payments equal fair value
individually, and E is paid, in total, an aggregate
amount equal to the fair value of the mortgage loans
sold with servicing rights (i.e., on a
servicing-released basis).
In this transaction, it would be acceptable for the
transferor-seller (i.e., E) to apply either of the
following views:
-
View A — Apply only ASC 860-10-40-5 to the transfer of the mortgage loans (i.e., assume that the servicing was a component of the mortgage loans transferred).
-
View B — Apply ASC 860-10-40-5 to the transfer of the mortgage loans (i.e., assume that the mortgage loans were sold with servicing retained) and apply ASC 860-50-40 to the transfer of the MSRs.
Our conclusion that these two views are
acceptable is premised on the ambiguity in ASC 860-10
and ASC 860-50 with respect to how to account for such a
transaction as well as on the assumption that the three
parties had no prior relationships with respect to the
mortgage loans transferred. An entity should elect one
of the two views as an accounting policy and apply it
consistently.
Example 6-6
Separation and
Transfer of Servicing Obligation
Entity F is a bank that services
GNMA-eligible mortgage loans (“GNMA loans”) that are
held in off-balance-sheet securitization entities. The
GNMA loans were originated by F, and the transfers of
such loans to the securitization entities qualified for
sale accounting. Entity F has the option of purchasing
delinquent GNMA loans owned by the securitization
entities at par under an EBO with the GNMA. The
delinquent GNMA loans that may be purchased under the
EBO are loans that are in the early stages of
foreclosure. Entity F purchases such delinquent GNMA
loans because the interest income that accrues on these
loans and is paid by another government entity, such as
the Department of Housing, offsets some of the
foreclosure costs that F incurs to service the loans.
Although F services the GNMA loans held in the
securitization entities, F did not initially recognize
any MSR assets or liabilities because the benefits of
servicing initially equaled adequate compensation.
Although some GNMA loans have become delinquent, the
delinquencies have not exceeded the estimated amounts
initially expected; therefore, F has not recognized any
servicing liability related to this servicing activity
(i.e., overall, the benefits of servicing still equal or
exceed adequate compensation).
The EBO is not accounted for as a
derivative instrument (therefore, for simplicity, assume
that F has not recognized any asset for the EBO). When
the GNMA loans become delinquent (i.e., when they become
eligible for repurchase), F has regained effective
control over these loans and therefore records them on
its balance sheet, with an offsetting obligation for the
purchase price in accordance with ASC 860-20-25-10(a).
When F purchases the GNMA loans in accordance with the
EBO, it extinguishes the obligation and recognizes a
loss. Over time, F has accumulated a $100 million
portfolio of such GNMA loans, which are recognized as
receivables on F’s balance sheet. Assume that, in all
cases, F has exercised its EBO; therefore, all GNMA
loans that were eligible to be purchased by F have been
purchased. Entity F previously recognized the following
journal entry for the EBO feature and related purchases
of GNMA loans:
Entity F had EBOs triggered that allowed
for the purchase of $100 million of GNMA loans. In
accordance with ASC 860-20-30-3, F recognized at fair
value the GNMA loans over which it regained effective
control. The fair value equals 98 percent of the total
$100 million purchase price. The 2 percent excess of the
purchase price over fair value results entirely from the
fact that a servicing obligation is embedded in these
GNMA loans. The fair value of the GNMA loans is not
affected by credit risk because the repayment of
principal and interest on these loans is guaranteed by
another government entity. It is assumed that the fair
value of these GNMA loans has not been affected by
changes in interest rates and that recognition of an
allowance for credit losses is unnecessary.
Entity F pays par to purchase the GNMA
loans under the EBO and therefore recognizes a loss on
extinguishment of its obligation for the purchase price.
Note that although ASC 860-20 prevents an entity from
recognizing a loss when it initially recognizes
financial assets upon regaining control, ASC
860-20-25-12 does not preclude the recognition of a loss
when the purchase price is paid and the loans are
repurchased.
After purchasing these GNMA loans, F
enters into an agreement with Y, a third party, to
assume the servicing obligation related to these GNMA
loans. As of the date of this agreement, the carrying
amount of the GNMA loans on F’s balance sheet has not
changed. Because the costs of servicing these delinquent
loans exceeds adequate compensation, F pays Y $2 million
to assume this servicing obligation. Entity F retains
the right to service the performing GNMA loans that
remain in the securitization entities (i.e., only the
MSRs related to the GNMA loans recognized on F’s balance
sheet are assumed by Y). Note that the $2 million
payment to Y does not represent a prepayment of all
future servicing fees; rather, this payment is the
amount Y demands to service these loans after taking
into account the portion of the interest coupon on the
loans that Y is entitled to in return for servicing
them.
Assume that the transfer of the MSRs on these GNMA loans
meets the conditions for sale accounting. Therefore, F
is evaluating how to account for the $2 million payment
made to Y to assume this servicing obligation. Entity F
considers the following views regarding the recognition
of the offsetting entry for the $2 million cash paid to Y:
-
View A — Recognize as a prepaid servicing cost (i.e., an asset).
-
View B — Recognize as an increase in the carrying amount of the GNMA loan receivables.
-
View C — Recognize immediately as a loss.
On the basis of the facts, View B is
appropriate. Application of this view is consistent with
ASC 860-50-40-6. Note that when the servicing obligation
is assumed, a gain or loss could arise if the amount
paid differs from the adjustment to the carrying amount
of the recognized GNMA loans that is made in accordance
with ASC 860-50-40-6. However, there is no difference in
this example. Rather, the removal of the inherent
servicing obligation by using the allocation approach
described in ASC 860-50-40-6, which increases the
carrying amounts of the GNMA loans on F’s balance sheet,
equals the amount paid to Y to assume the servicing
obligation. Therefore, F recognizes the following
entry:
After this entry is recognized, the carrying amount of
the GNMA loans is $100 million, which equals the loans’
purchase price as well as their aggregate fair value
(excluding servicing) when they were initially
recognized. As discussed above, a gain or loss would
have been recognized if the amount paid to Y to assume
the servicing obligation had differed from the allocated
carrying amount of the servicing obligation.
View A is not appropriate in this case
because the offsetting entry should result in an
adjustment to the carrying amount of the GNMA loans.
View A and View B might not change total assets but
would result in a different presentation on the balance
sheet. In addition, the subsequent accounting may differ
under View A because the amortization method applied to
any prepaid asset may differ from the interest method
under ASC 310-20.
View C is not appropriate because the
economic loss resulting from the servicing obligation
was recognized when the GNMA loans were repurchased and
recognizing an additional loss on the transfer of the
servicing obligation would result in counting the same
loss twice.
Note that applying View B could result
in a carrying amount of the GNMA loan receivables that
exceeds the amounts for which the borrowers may prepay
such loans without penalty. However, ASC 310-20-35-18(a)
does not preclude recognition of this amount because it
merely represents a premium paid on purchased loans.
Example 6-7
Evaluation of
Reimbursement Provisions as Protective
Provisions
Entity G enters into a servicing rights purchase and sale
agreement (the “agreement”) with a third party to sell
G’s MSRs. The MSRs are related to loans originated and
sold by G and servicing rights previously acquired from
Z, a third party. In addition to standard eligibility
representations and warranties, the agreement contains
the following reimbursement provisions:
-
Breach of loan origination and servicing representations — If the purchaser receives any request to repurchase a loan because of (1) a breach of an origination representation or warranty on any mortgage loan that was originated by G or (2) any breach of a servicing obligation by G before the date of the agreement, G is required to indemnify the purchaser for any losses, costs, or expenses related to this repurchase. (Note that this provision is only related to any breach associated with G’s actions upon origination of a mortgage loan or servicing of any mortgage loan. That is, this loss reimbursement is related only to G’s actions that were taken during the loan origination process or servicing process before the date of the agreement.)
-
Breach of third-party origination representations — If the purchaser receives any request to repurchase a loan that was originated by Z because of a breach of an origination representation or warranty made by Z, as originator of the loan, G is required to indemnify the purchaser for any losses, costs, or expenses related to this repurchase in the event that the purchaser is unable to collect such amounts from Z within 60 days of the purchaser’s submission of a claim to Z. (Note that any payment by G under this provision does not relieve Z from its obligation to indemnify G. That is, G maintains the right to seek reimbursement from Z for any payment made to the purchaser.)
-
Assessment of compensatory fees — G is responsible and liable for any fees or penalties imposed by the FHLMC and FNMA related to any mortgage loan foreclosures that exceed the required timelines of the FHLMC and FNMA. Entity G is responsible only for such fees that pertain to the period before the date of the agreement (i.e., fees that result from actions of G as servicer).
In view of the definition of protection
provisions in ASC 860-50-20, provisions that must be
evaluated under ASC 860-50-40-3(c) and 40-4 are those
designed to (1) reflect a purchase price adjustment or
(2) protect a purchaser against losses associated with
the servicing rights acquired. That is, protective
provisions are contract terms that are intended to
adjust the sales price as a result of events that
subsequently affect the purchaser’s acquired rights to
service loans. Not all contingent payment provisions
specified in a sale agreement represent protection
provisions. An entity must use judgment to determine
whether a reimbursement provision affects the risks and
rewards of ownership of servicing rights.
Breach of Loan Origination and
Servicing
Representations
These contingent payments are related to G’s past
actions. Such obligations would be retained by G
regardless of whether G had sold the MSRs or
acknowledged such a liability in the agreement. That is,
the purchaser of MSRs may incur losses related to G’s
past actions and these reimbursement provisions merely
serve to acknowledge that any such losses are G’s
responsibility. Therefore, these reimbursement
provisions are not designed to provide any protection or
adjustment related to the purchaser’s rights to service
the mortgage loans (i.e., any such payments made by G
under these provisions do not result in an adjustment to
the sales price of the MSRs). The purchaser of the MSRs
is merely acting as a collection agent for the owners of
the underlying mortgage loans, and any payments made by
G under these reimbursement provisions reflect amounts
that ultimately are borne by the owners of the
underlying mortgage loans. The obligation of G to make
payments for these breaches either existed as of the
date the mortgage loans were sold to third-party
investors or result from actions of G as servicer (i.e.,
G’s obligation to make payments under these provisions
did not arise from the agreement, and the fact that the
purchaser of the MSRs is now servicing the loans does
not change G’s obligations). Since this reimbursement
provision is merely a mechanism to indemnify the new
servicer for obligations that G had before the
agreement, these payment provisions do not reflect
protection provisions under ASC 860-50. Note that in
reaching this conclusion, we determined that any
indemnification of the purchaser of the MSRs for damages
that result from G’s faulty servicing before the
agreement does not protect the purchaser of the MSRs for
risks of future changes in the fair value of the
MSRs.
Breach of
Third-Party Origination
Representations
This payment provision requires G to
retain a risk that is typically borne by a servicer of
mortgage loans. Before the agreement, G was exposed to
losses resulting from Z’s breach of origination
representations to the extent that G was unable to
collect amounts paid from Z. We would expect that, upon
the sale of MSRs, this risk would be transferred to the
purchaser as subsequent servicer. By agreeing to
reimburse the purchaser for any losses incurred as a
result of origination representations breached by Z that
Z does not reimburse to the purchaser within 60 days, G
is retaining a servicing risk associated with the MSRs.
In other words, G is effectively becoming obligated for
a risk for which only Z should be obligated. Therefore,
this reimbursement provision represents a protective
provision under ASC 860-50.
Assessment of
Compensatory Fees
This payment provision does not
represent a protective provision under ASC 860-50 for
the same reasons described above for indemnifications
that arise from G’s servicing of the mortgage loans
before the date of the agreement.
Example 6-8
Evaluation of
Repurchase Provision as a Protective
Provision
Entity H enters into an agreement to
sell MSRs to Entity W. As part of the sale agreement, H
has agreed that, for the next two years, it will not
solicit a refinancing of any mortgage loan that is being
serviced by W after the sale transaction. This
nonsolicitation obligation only precludes H from
soliciting refinancing transactions; H is permitted to
refinance any mortgage loan that is being serviced by W
as long as the borrower approaches H regarding the
refinancing. Entity H cannot, however, solicit the
refinancing unless its nonsolicitation obligation is
explicitly waived by W.
The nonsolicitation obligation does not
represent a protective provision. While this provision
does reduce, to some extent, the prepayment risk to W,
any payment arises from an action within the control of
H. Furthermore, this provision is akin to a standard
representation and warranty.