Banks that have gotten drunk on the servicing boom in recent years may have a bit of a hangover New Year's Day, courtesy of a new regulatory accounting rule.
On Jan. 1, a complicated Federal Financial Institutions Examination Council interim rule kicks in that will change the way financial institutions report loan servicing rights.
The regulation is meant to implement Financial Accounting Standards Board rule 125, but the exam council's interpretation of FAS 125's effect on capital is proving contentious.
Bankers are upset over a provision that could limit the amount of servicing rights that count toward an institution's Tier 1 capital requirements.
The exam council last week said banks must record on their balance sheets all nonmortgage servicing rights as "intangible" assets. That means they do not count toward the capital requirement.
Banking industry representatives said that this will cause headaches for credit card and auto loan servicers. Under the exam council's rule, even if a servicer adds millions of dollars worth of servicing rights, their balance sheets won't reflect the value of these lucrative assets, said Marti Sworobuk, president of Financial Standards Inc. This means mortgage servicers must hold additional capital to meet their reserve requirements.
"FASB has said you can recognize servicing rights as an asset and capital, but the regulators have thumbed their nose at FASB and said these things are intangible," Ms. Sworobuk said.
The exam council said the interim rule will remain in effect until banking regulators issue a final rule amending their capital regulations in light of FAS 125. But regulators haven't even issued a proposal yet, and the final rule isn't expected until next summer at the earliest.
Mortgage servicers don't get off scot-free, either. Another provision in the exam council's rules could create problems for them.
Currently, banks recognize servicing rights for loans they originate and purchase as assets. But there is a restriction: Mortgage servicing rights may not add up to more than half of a bank's Tier 1 capital.
Now, to make matters more complicated for mortgage servicers, the exam council is going to count so-called excess servicing fees toward the capital limit. Banks earn excess servicing fees whenever they profit from the sale of a mortgage.
The problem is that many mortgage servicers are already nearing the 50% cap. Requiring them to count excess servicing fees toward the limit could send them over the edge. This means they would be holding assets that would not count toward their capital requirements.
"The markets for servicing rights have gotten bigger. These are real and true assets, so these capital limitations are far too stringent," said Donna Fisher, the American Bankers Association's manager of tax and accounting.
"It is good that FASB wants servicers to recognize excess servicing rights, because they are an income producer," added Ms. Sworobuk. "But the exam council is taking this rule and distorting the way it should be implemented."