The Financial Accounting Standards Board has released its exposure draft proposing an amendment to its Rule 65, "Accounting for Certain Mortgage Banking Activities."
While all mortgage banking companies are expected to benefit, companies with lower levels of capitalized servicing on the balance sheet and a high proportion of retail business, such as Fleet Mortgage, will benefit the most.
The net effect of these proposals should be a more accurate representation of accounting income generated and economic value created in a given period.
There are three fundamental changes proposed:
* Servicing rights will no longer be considered intangible assets.
* Once on the balance sheet, the assets will be measured on a discounted, disaggregated basis, in which each company's total servicing portfolio is broken down into smaller portfolios and the present value of future cash flows are compared with the asset's carrying value.
* Gains from the sale of loans on correspondent transactions will be recognized through the income statement, also enhancing the bottom line.
On the surface, the amendments will improve the profitability of mortgage lending and eliminate the need of strong retail players to sell servicing.
We believe that the proposed amendments will create an opportunity for mortgage banks to make aggressive assumptions when calculating the fair value of each servicing right.
While the proposed changes likely will benefit every player in the mortgage banking industry in some way, we believe that Fleet Mortgage Group will benefit the most, for these reasons:
* Of the company's 1993 total production, 45% derived from retail sources, a number we expect to continue rising.
* Fleet already disaggregates and discounts its servicing portfolio when comparing the carrying value of servicing assets on the balance sheet to their market value, eliminating the risk of an impairment upon adoption.
* In 1993 alone, Fleet Mortgage Group used about $35 million, or 43 cents per share after tax, in gains from the sale of correspondent-generated loans to offset servicing assets on the balance sheet. This type of gain is expected to flow through the income statement in the future.
Although Countrywide Credit Industries also is expected to benefit from the proposed changes, we do not know if there will be any negative effects of the proposed changes on currently capitalized assets.
The comment period will probably last 90 days. A standard Will probably be issued by mid-October. Once passed, the standard must be adopted in the first fiscal year beginning after Dec. 15, 1995, but earlier adoption is encouraged. Based on the current timing of the draft, the earliest that mortgage banking companies can adopt this amendment will be the fourth quarter of this calendar year.
While the accounting amendments are expected to have a positive impact on the ongoing profitability of mortgage bankers, there is a possibility that some companies may have to recognize a charge for impairment of existing asset in the first period after adoption.
Some companies may postpone the adoption of the amended rule for the simple reason that in a rising interest rate environment, the longer they wait the stronger the value of their servicing portfolio will become.
After taking a closer look, these proposed accounting changes actually may reshape the mortgage banking industry in the following ways:
The loss of the accounting-generated competitive advantage in certain wholesale transactions may cause that source of production to contract
* Activity in the bulk servicing market may decline as retail mortgage bankers actually experience a cash-tax incentive by holding onto servicing.
* The initial improvement to production margins may cause mortgage banking companies to tighten pricing
* Industry consolidation may increase as the improved profitability of mortgage banks begins to attract more interest in the mortgage banking industry.