Recent Developments in Mortgage Servicing Rights

Recent Developments in Mortgage Servicing Rights


Recent changes to the regulatory treatment of mortgage servicing rights ("MSR"s) for financial institutions subject to Basel III, together with political and prosecutorial pressures, have resulted in a substantial increase in incentives for financial institutions to transfer their residential MSRs. While MSRs have traded frequently in the past, the following highlights some of the current issues related to the sale and financing of MSRs in the current environment.

What is an MSR?

The term "MSR" is commonly used by market participants to describe all or some of a party's contractual rights with respect to servicing or controlling the servicing of a pool of mortgage loans, including the entitlement to receive servicing compensation. In addition, there are specific regulatory and accounting uses (discussed below). MSRs, however, are usually contingent rights that may be lost entirely if the servicer is terminated. In addition, the ability to transfer MSRs may be prohibited, severely limited or conditioned on the assumption of certain risks and liabilities. Anyone evaluating an MSR should carefully review the relevant servicing contract, which may vary considerably depending on numerous factors, including whether the loan is included in a securitization or held in portfolio.

Valuation of MSRs

It is our understanding that under GAAP, an entity is required to recognize a servicing asset (or servicing liability) "each time it undertakes an obligation to service a financial asset by entering into a servicing contract," unless such contract relates to servicing of financial assets sold by such entity in a transaction that does not qualify for sale accounting. FASB ASC 860-50-25-1. Such asset (or liability) must initially be measured at "fair value." FASB ASC 860-50-30-1. Whether servicing constitutes an asset or liability (or nothing) depends on whether "the benefits of servicing are expected to be more than adequate compensation to a servicer for performing the servicing." FASB ASC 860-50-30-2. While such conclusion may change if the applicable assumptions change, the asset or liability must be based on the compensation demanded by the marketplace, not the entity's own cost of servicing or even the amount that would be paid to a replacement servicer. FASB ASC 860-50-30-3 and -4. After initial measurement at fair value, an entity may elect to either amortize the servicing asset (or liability) or continue to measure at fair value. FASB ASC 860-50-35-1.

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