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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