Mortgage Bankers Association 2004 National Secondary Market Conference

1
Mortgage Bankers Association 2004 National
Secondary Market Conference

• Understanding the Business Implications of New
  and Proposed Accounting Rules
  
• April 19, 2004

2
Presenters

• Timothy Kviz
• PricewaterhouseCoopers LLP
• Michael Sperger
• GMAC Commercial Holding Corp.
• Thomas Ramm
• First Horizon Home Loans
• Bob Reynolds
• SunTrust Mortgage

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Agenda

• SAB 105
• Beneficial Interests in Securitized Financial
  Assets
  
• Mortgage Servicing Rights at Fair Value
• Three Company Perspectives

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SAB 105 - Overview

• FASB adds Loan Commitments project to agenda in
  October 2003
  
• MBA and industry representatives deliver overview
  of issues in an educational session to FASB Board
  in December 2003
  
• AICPA National Conference on Current SEC
  Developments
  
• SEC states loan commitments are written options
• Value of loan commitments must be a liability,
  since they are written options
  
• Substantial efforts made to address SEC position
  
  

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SAB 105 - Scope

• Applies to loan commitments for mortgage loans
  held for sale within the scope of FAS 149 and DIG
  Issue C-13
  
• Retail originations and Wholesale commitments
  broker and table funding
  
• Applies to all mortgage loans held for sale
  discussed in FAS 65
  
• Residential AND commercial
• Wholesale commitments - closed loans from
  correspondents
  
• If they meet the definition of a derivative under
  FAS 133, apply SAB 105 by analogy

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SAB 105 - Effective Date

• Effective for all loan commitments entered into
  on or after April 1, 2004
  
• Loan commitments entered into prior to effective
  date
  
• SEC will not object to accounting treatment that
  differs from guidance in SAB 105

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SAB 105 - Key Provisions

• Initial recognition (i.e., Day 1 accounting)
• Cannot consider cash flows related to servicing
  in value
  
• Cannot consider internally-developed intangible
  assets in value
  
• Disclosures
• No new requirements
• APB 22, FAS 107, FAS 133, MDA

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SAB 105 Other Considerations

• Implementation issues
• EITF 02-3 no value on Day 1
• Day 2 accounting not specifically addressed
• Changes in fair value recorded in the income
  statement
  
• Commitment can have an asset value
• Fair value excludes normal servicing and
  internally developed intangible assets
  
• FIN 39 implications
• Cannot net asset and liability positions

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SAB 105 Other Considerations

• Components of Value

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SAB 105 Other Considerations

• Once a loan has closed
• Value of commitment rolled into the basis of the
  loan
  
• Basis adjustment not amortized held until loan
  is sold
  
• Loan value for LOCOM or FAS 133 Fair Value hedge
  accounting includes ALL components of value
  
• Servicing NOT excluded
• FAS 133 FV hedging full change in fair value
  cannot exclude servicing component
  
• FAS 65 full change in fair value for market the
  company operates
  
• FAS 141 full value of loan until servicing is
  contractually separated

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Beneficial Interests in Securitized Financial
Assets

• Current guidance
• Beneficial interests exempt from FAS 133
• Classified as AFS or trading if its possible the
  investor may not recover substantially all the
  recorded investment
  
• Other interests may be classified as HTM

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Beneficial Interests in Securitized Financial
Assets

• Proposed Guidance
• Beneficial interests NOT exempt from FAS 133
• Framework for accounting for the interests being
  debated
  
• Trading classification
• Give the holder of the beneficial interest an
  election to either
  
• account for their interest as a trading
  security or
  
• bifurcate an embedded derivative from the host
  instrument and (a) account for the embedded
  derivative under Statement 133 and (b) the host
  instrument under Statement 115 (e.g.
  available-for-sale).

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Mortgage Servicing Rights at Fair Value

• FAS 122, 125, 140 provided accounting guidance
  for recognition, amortization, and impairment of
  MSRs
  
• FAS 133 hedge accounting guidance
• DIG Issues F1 and F8 address MSR specific hedging
  issues
  
• Proposed Amendment to FAS 140 issued in June
  2003
  
• Comment letters from several organizations
  include a call for MSRs at fair value
  
• FASB receives numerous requests from constituents
  requesting fair value treatment for MSRs
  
• Complexity in dealing with hedge accounting,
  comparability, and transparency issued cited as
  reasons in favor of FV
  

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Mortgage Servicing Rights at Fair Value

• LOCOM Accounting Model
• Diversity in applying current GAAP may sometimes
  lead to transparency and comparability issues
  
• Stratification
• Amortization
• Valuation allowance
• Other than temporary impairment
• The application of FAS133 and LOCOM creates an
  accounting model that is too complex
  
• Lack of comparability and transparency

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Mortgage Servicing Rights at Fair Value

• Fair Value Accounting Model
• industry employs fair value methods in the
  current accounting model
  
• has proven methods in place to derive fair value
  estimates
  
• operational and systems concerns that were once
  problematic for the industry are less of a
  concern today
  
• elimination of certain LOCOM and FAS133
  requirements would further alleviate accounting,
  operational and systems risks
  

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Mortgage Servicing Rights at Fair Value

• January 2004 FASB adds project to agenda
• March 2004 Educational session and meeting to
  discuss the project
  
• Summary of Decisions Reached
• Fair value is the appropriate measurement
  attribute
  
• Other servicing rights to be considered for the
  scope of the standard
  
• Staff to investigate feasibility of a separate
  project to permit, but not require, entities to
  account for financial instruments and similar
  instruments at fair value (similar to IAS 39)

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Mortgage Servicing Rights at Fair Value

• Key decisions to be addressed in future
  meetings
  
• Scope of the project
• Just MSRs
• All servicing rights
• All residual and beneficial interests
• When should fair value be applied
• At inception and subsequent to inception
• Subsequent to inception only
• Potential impacts on FAS 140
• Additional disclosure requirements

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Mortgage Servicing Rights at Fair Value

• Issues if fair value is elective, or if MSRs are
  accounted for like available for sale investment
  securities
  
• Comparability issues would still exist
• Reported amounts
• Disclosures
• Complexity of an AFS accounting model
• Applicability of EITF 99-20
• Potential inconsistencies with IFRS
• Potential for future changes with convergence

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REPORTING MORTGAGE SERVICING RIGHTS AT FAIR VALUE

• Three Company Perspectives
• GMAC Commercial Mortgage Holding Corp.
• First Horizon Home Loans
• SunTrust Mortgage

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Mortgage Bankers Association 2004 National
Secondary Market Conference
Fair Value Accounting for MSRs

• Michael Sperger
• GMAC Commercial Holding Corp.
• April 19, 2004

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Commercial Mortgage Servicing Rights

• Valuation Background
• Call Protection
• Defeasance
• Lockouts
• Yield Maintenance
• Prepayment Penalties
• Escrows Reserves
• Portfolio Characteristics
• Loans Balances
• Float Values
• Cost to Service

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Commercial Mortgage Servicing Rights

• Fair Value Accounting
• Hedging
• Volatility
• Market Liquidity
• Transition Provisions
• Elective Approach

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Mortgage Bankers Association 2004 National
Secondary Market Conference Fair Value
Accounting for MSRs

• April 19, 2004
• Washington, DC

Thomas Ramm, CFA First Horizon Home Loans tramm_at_
firsthorizon.com
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Overview

• Fair Value Accounting for Mortgage Servicing
  Rights
  
• First Horizon Perspective
• Industry Perspective
• Investor Perspective

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First Horizon Perspective

• Stratification of MSR asset
• Temporary vs. Permanent Impairment
• ? No consensus or industry-best practice
  available
  
• ? Issues of concern mentioned in Interagency
  Advisory on Mortgage Banking
  

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First Horizon Perspective

• FAS 133 hurdles (headaches)
• Similar Asset Test
• Effectiveness Test
• Single Coverage Ratio
• ? Lower Hedge Cost (combine negatively and
  positively convex Similar Asset tranches)
  

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Industry Perspective

• No more earnings-driven MSR sales
• Accounting process does not match economic
  reality when hedging MSRs
  
• There is a need for fair value information as
  evidenced by all the peer surveys

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Investor Perspective

• Complex Asset (MSR)
• Complex Accounting (FAS 133, etc)
• I dont understand !
• Complex Asset (MSR)
• Straight-forward Accounting (Fair Value)
• I get it !

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Investor Perspective

• Increased comparability of financial statements
• Focus can be on Fair Value assumptions instead of
  accounting treatment
  
• ? Clear the smoke screen from financial
  statements
  

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Mortgage Bankers Association 2004 National
Secondary Market Conference
Fair Value Accounting for MSRs

• Bob Reynolds
• SunTrust Mortgage
• April 19, 2004

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Cons of Fair Value of MSRs

• Piece Meal Approach to Fair Value Accounting
• Today only some financial instruments and overall
  a very small portion of our balance sheets are
  held at fair value
  
• MSRs are not pure financial instruments
• Accuracy of Financial Presentation
• Would distort financial results of non-hedgers or
  hedgers not using derivatives
  
• Intent is to hold asset
• Operational function to service a customer Not
  a trading security
  
• Increased Costs for Non-Hedgers
• Would force hedging or different business models

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Risks of Fair Value of MSRs

• Scope Creep
• Which servicing is affected?
• Agencies Sub-Prime Portfolio Loans Commercial
  Home Equity Loans/Lines
  
• Odds FASB maintains this narrow scope?
• Determination Of Fair Value
• Mark to model versus Mark to market
• Comparability across the industry
• Similar portfolios vs impairment tranches
• Currently a wide range of multiples
• Disclosure requirements
• Determination of values by
• Regulators Audit firms SEC

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Complexities of Fair Value of MSRs

• Fair Value Is Not Necessary
• FAS 133 effectively allows hedgers to have fair
  value
  
• Is 133 cumbersome? Yes
• It is elective
• Shouldnt force industry to change to alleviate
  this burden for some
  
• Increases Volatility and Costs
• Many companies do not hedge with derivatives
• Negates natural hedges within an institution