Insight into FASB Statements
Financial Accounting Standards Board (FASB) Statements

FAS 156 – Fair Value for MSRs
Day One Accounting – Fair Value, NOT Relative Fair Value

Making sense of the standard

This is a big development that has not been adequately discussed by the industry as a whole.

Bankers are instructed to elect Fair Value or LOCOM after the asset is on the books. MIAC expects that only the top 25 MSR investors will initially elect Fair Value treatment, but this could change once the industry becomes more aware of the ramifications of booking the initial asset at fair value.

Important timing considerations

This Statement is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006.

Important issues to bear in mind

Prior to FASB 155, when a mortgage company booked an MSR, relative fair value was the accounting method employed. This meant that even if the market value was 140 bps, the asset might be booked at 100 bps because relative fair value capped the total value of the securitized portion of the loan and the MSR to be no more than the original cost. This provided a substantial cushion between initial fair value and the initial book value. Consequently, most smaller mortgage companies elected not to hedge their MSRs, finding it unlikely that these assets would be impaired.

By requiring the mortgage company to book at fair value, the cushion is removed and the asset now becomes a very volatile asset on their balance sheet.

What will the ramifications for the industry be? Certainly, we’ll see increased earnings volatility. But there are other question marks. Will there be more consolidation among larger players that believe they can hedge the risk involved in acquiring these assets? Will we see more flow sales to realize the benefit of creating the asset without the balance sheet risk? What about more players interested in exiting the business due to the accounting risk? MIAC will continue to monitor this issue.

FAS 157 – New Clarity on Fair Value
The New Fair Value Standard will make it more explicit that Fair Value is based upon a market price discovery process and less on a mark-to-model process.

Important timing considerations

This Statement is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006.

Important issues to bear in mind

This may sound simple, but MIAC believes that the ‘OAS-model-to-price’ camp within the MSR industry could be seriously challenged by their auditors. MIAC has strived to be as close to a market execution as possible and has a rigorous method for regular MSR price discovery. MIAC utilizes its Generic Servicing Assets, GSAs, as the benchmark instruments for reference pricing of particular MSR portfolios.

For more information about any of these issues or other important issues relating to the valuation or hedging of all types of mortgage-related assets, contact us at Products@MIACAnalytics.com. MIAC Analytics provides third-party fair valuations of all CMO classes, residual interests, and interest rate derivative products.