APPLICABILITY OF FAS 125 FOR REPORTING PURPOSES IN 1997 AND THE
TREATMENT OF SERVICING ASSETS FOR REGULATORY CAPITAL PURPOSES
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. A
discussion of the appropriate regulatory reporting treatment and the
recommended interim capital guidance is attached.
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
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.
Interim Guidance for Purposes of Reporting and Regulatory Capital
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
(1)Purchased servicing rights are servicing rights purchased from others. Originated servicing rights
generally arise when an institution originates and subsequently sells financial assets but retains the rights to
service those assets.
(2) Excess servicing fees receivable represent the right to receive servicing cash flows that exceed
the fee rate that is representative of rates most commonly used in comparable servicing agreements
covering similar types of assets.
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."
Applicability of Statement No. 125 for Regulatory Reporting Purposes.
For purposes of the bank Reports of Condition and Income (Call Report) and the Thrift Financial
Report (TFR), all insured banks and savings associations must adopt the provisions of FAS 125 for transfers
and servicing of financial assets and extinguishments of liabilities occurring after December 31, 1996, with
the exception of any provisions deferred for implementation by FASB. Banking organizations must also
apply the provisions of FAS 125 governing the accounting and reporting for servicing contracts in existence
before January 1, 1997, and certain other financial assets held on January 1, 1997, that are subject to
substantial prepayment risk. FAS 125 does not permit early adoption. The March 31, 1997, Call Report
and TFR will be the first regulatory reports to be completed in accordance with the provisions of FAS 125
for which FASB has not delayed implementation.
Regulatory Reporting Treatment for 1997
In the Call Report, banks should report the carrying value of all mortgage servicing assets
(MSAs) in Schedule RC-M, item 6.a, which will be renamed "Mortgage servicing assets," and on the
balance sheet in Schedule RC, item 10, "Intangible assets." The fair value of mortgage servicing assets
would be reported in a proposed new item in Schedule RC-M, item 6.a (1), "Fair value of mortgage
servicing assets." In addition, banks should report the carrying value of servicing assets related to financial
assets other than mortgages in Schedule RC-M, item 6.b.(2), "All other identifiable intangible assets." The
characterization of servicing assets as intangible assets for bank regulatory reporting purposes will remain
in effect until any change occurs in their characterization for regulatory capital purposes. Any interest-only
strips receivable not in security form that arise out of transfers of financial assets will be reported on the
balance sheet in Schedule RC, item 11, "Other assets." In Schedule RC-F -- Other Assets, two proposed
new items would provide further information on interest-only strips receivable in nonsecurity form
recognized pursuant to FAS 125 and an existing item in this schedule on "Excess residential mortgage
servicing fees receivable" would be eliminated.
In the TFR, savings associations should report servicing assets on mortgage loans on Schedule SC,
line SC642, "Servicing assets on mortgage loans," and should report servicing assets related to financial
assets other than mortgages (non-mortgage loans) on Schedule SC, line SC644, "Servicing assets on
non-mortgage loans." In addition, certain nonsecurity financial instruments should be reported on Schedule
SC, line SC655, "Interest-only strip receivables and certain other instruments." These certain nonsecurity
financial instruments include interest-only strip receivables, loans receivable, other receivables, or retained
interests in securitizations that can contractually be prepaid or otherwise settled in such a way that the holder
would not recover substantially all of its recorded investment.
Interim Guidance on the Regulatory Capital Treatment
The FFIEC's Task Force on Supervision, acting under delegated authority, is recommending that
the Agencies issue interim guidance that will specify the appropriate regulatory capital treatment of servicing
assets and any related interest-only strips receivable under the current capital framework. This interim
guidance is intended to address the Agencies' concerns regarding excessive concentrations in these newly
reported and created assets until the Agencies issue their final rules. This guidance reflects the Agencies'
general view of what would constitute safe and sound banking practice.
Under the interim guidance, the aggregate amount of mortgage servicing assets (MSAs) and PCCRs
that may be recognized for regulatory capital purposes (i.e., not deducted from assets and capital) by
institutions would be limited to no more than 50 percent of Tier 1 (core) capital (Tier 1 capital). Institutions
will continue to be subject to the restriction limiting the amount of MSAs and PCCRs that may be
recognized for Tier 1 capital purposes to the lesser of 90 percent of fair value or 100 percent of book value
(net of any valuation allowance), commonly referred to as the 10 percent haircut.(3)
Purchased servicing assets related to financial assets other than mortgages that were previously
capitalized under generally accepted accounting principles (GAAP) should continue to be treated as "all
other identifiable intangible assets" by banks and deducted when calculating banks' Tier 1 capital. With
the adoption of FAS 125, institutions must also capitalize originated servicing assets related to such financial
assets. Therefore, under the interim guidance, all servicing assets related to financial assets other than
mortgages should also be treated by banks as "all other identifiable intangible assets" and deducted in
computing Tier 1 capital.(4) The Agencies, in an upcoming proposal, will solicit industry comment on
whether non-mortgage servicing assets should be subject to this dollar-for-dollar deduction in computing a
banking organization's Tier 1 capital.
(3)For purposes of determining the amount of MSAs (or non-mortgage servicing assets) that would
be deducted (or disallowed) in computing Tier 1 capital, institutions may choose to reduce the otherwise
disallowed MSAs (or non-mortgage servicing assets) by the amount of any associated deferred tax liability.
(4)See footnote 3.
For savings associations, ESFRs on loans other than mortgages (i.e., non-mortgage loans) recognized
under GAAP are reported as assets on the balance sheet and are not deducted in computing Tier 1 capital
under current and prior practice. Under this interim guidance, savings associations may include non-
mortgage servicing assets in regulatory capital, but should subject them to the same 25 percent of Tier 1
capital sublimit and 90 percent of fair value limitation as PCCRs in the interim period. Furthermore, the
50 percent of Tier 1 capital limitation and the 90 percent of fair value limitation should apply in the
aggregate to all servicing assets -- both mortgage and non-mortgage loans. The Office of Thrift Supervision,
however, can provide no assurance of the capital treatment of such assets under any final interagency rule
on servicing assets.(5)
Prior to implementation of FAS No. 125, the rights to future interest income from serviced assets
in excess of the contractually specified fees (i.e., interest-only strips receivable arising out of servicing
activities) were a component of either servicing rights or ESFRs under GAAP, but were not categorized
as a separate financial asset. Until a final rule amending the Agencies' capital guidelines is issued, interest-
only strip receivables, which will be reported as "other assets" in the bank Call Report and the TFR,
generally will not be deducted in computing Tier 1 capital. At this time, however, the Agencies can provide
no assurance regarding what the capital treatment of such assets will be under any final capital rule on