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Applicability of OF FAS 125
January 27, 1997
|Circular No. 10917|
To All State Member Banks and Bank Holding Companies in the Second Federal Reserve District:
The following are excerpts from a statement issued by the Federal Financial Institutions Examination Council:
The Reports Task Force of the Federal Financial Institutions Examination Council (FFIEC) is reminding banks and savings associations (collectively, banking organizations) about the applicability for regulatory reporting purposes of a new financial accounting standard governing servicing assets and any related interest-only strips receivable that takes effect in 1997. In addition, the FFIEC's Task Force on Supervision, acting under delegated authority, is announcing its recommendations to the Federal Deposit Insurance Corporation, the Board of Governors of the Federal Reserve System, the Office of the Comptroller of the Currency, and the Office of Thrift Supervision (the Agencies) regarding appropriate interim guidance for the regulatory capital treatment of servicing assets and any related interest-only strips receivable....
The need for this guidance arises because the Financial Accounting Standards Board's (FASB) Statement No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" (FAS 125), becomes effective January 1, 1997. FAS 125 supersedes Statement No. 122, "Accounting for Mortgage Servicing Rights" (FAS 122), which was effective prospectively for fiscal years beginning after December 15, 1995. FAS 125 applies an accounting treatment similar to that outlined in FAS 122 for mortgage servicing rights and extends it to servicing assets on all financial assets.
The Task Force on Supervision is also recommending that this interim capital guidance remain in effect until a final rule amending the Agencies capital guidelines becomes effective.
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Servicing rights are the contractual obligations undertaken by an institution to provide servicing for loans and other financial assets owned by others, typically for a fee. Over the last two years, the accounting treatment for servicing rights has changed significantly.
The Financial Accounting Standards Board's (FASB) Statement No. 122, "Accounting for Mortgage Servicing Rights" (FAS 122), eliminated the distinction between purchased mortgage servicing rights (PMSRs) and originated mortgage servicing rights (OMSRs) and required that these assets, together known as mortgage servicing rights (MSRs), be treated as a single asset for financial statement purposes, regardless of how the servicing right was acquired.¹ Under FAS 122, MSRs reflected only normal servicing fees. Excess servicing fees receivable (ESFRs) continued to be recognized separately from MSRs.² On August 1, 1995, the Federal Deposit Insurance Corporation, the Board of Governors of the Federal Reserve System, the Office of the Comptroller of the Currency, and the Office of Thrift Supervision (the Agencies) issued an interim capital rule and request for comments that amended the Agencies' capital adequacy guidelines. The interim rule limits the total of all MSRs and purchased credit card relationships (PCCRs) that may be recognized for regulatory capital purposes to no more than 50 percent of Tier 1 capital. In addition, the interim rule applies a 90 percent of fair value limitation (that is, a 10 percent haircut) to all MSRs and PCCRs.
FASB Statement No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" (FAS 125), effective January 1, 1997, will apply an accounting recognition of MSRs similar to that outlined in FAS 122 and extend it to servicing rights on all kinds of financial assets. In addition, FAS 125 will eliminate the distinction between servicing rights based on normal servicing fees and ESFRs and will generally reclassify the cash flows associated with those assets into two new types of assets: (1) servicing assets and (2) certain related interest-only financial assets in non-security form, referred to as "interest-only (I/O) strips receivable." Servicing assets will represent the cash flows from the contractually specified fees received for the actual servicing of the financial assets. The I/O strips receivable will represent the cash flows, if any, received by the servicer on the serviced assets in excess of the contractually specified servicing fees. These I/O cash flows would be retained by the servicer even if the related servicing asset is sold. Under FAS 125, these I/Os are not treated as servicing assets. Rather, they are treated as separate financial assets and are subsequently measured at fair value in a manner similar to investments in debt securities classified as available-for-sale or trading under FAS 115, "Accounting for Certain Investments in Debt and Equity Securities."
The ruling by the Board of Governors of the Federal Reserve System containing interim guidance for state member banks and consolidated bank holding companies is available as a text document. Questions on this matter may be directed to Sarah Dahlgren or Michael Tursi.