With a little over a month to go, mortgage lenders are scrambling to bring their accounting into compliance with a standard that will go into effect Jan. 1.
FAS 133, formulated by the Financial Accounting Standards Board, will make it harder for mortgage companies to qualify for the highly valued hedge accounting method, which allows them to offset gains or losses in the value of loans or servicing rights. The change was postponed to the current deadline late last year, giving lenders more time to prepare. Yet with the new deadline approaching, observers say that many lenders have simply avoided the issue and are not ready to make the changes.
Mel Steele, senior vice president for capital markets at PNC Mortgage Corporation of America in Vernon Hills, Ill., took an informal poll in July of capital markets officials, who manage pipeline risk, one of the two key elements in FAS 133.
During a speech to a group of such officials "I asked if I could see the hands of those present who had completed their accounting policy or at least had begun their accounting policy for FAS 133," Mr. Steele said in an interview.
"In that room full of people, I and one other executive were the only two that raised our hands," he said. Executives representing 16 of the top 20 servicers were in attendance, and "two of them raised their hands - so 50% of the top 20 hadn't even begun."
FAS 133 sets guidelines for mortgage companies to determine a market value for their assets - such as pipeline commitments, loans held in warehouse, and mortgage servicing rights - and the derivatives used for hedging these assets. The values must be tallied for the date on the company's earnings statement.
Mortgage companies must comply with the standard if they use hedge accounting, which allows businesses to offset any rise or fall in the value of an asset, such as servicing rights, by a corresponding rise or fall in the value of a hedge investment. Without this benefit, their earnings could become more volatile.
For example, a hedge against fluctuating interest rates, which would cut or add to the value of servicing rights, would be purchasing options on Treasury securities or Treasury futures, or an interest rate floor or swap.
The standard also directs lenders to treat as derivatives their forward loan commitments - that is, their pipeline of loans - as well as the hedges used against a rise or fall in the value of these commitments.
But the new standard threatens to create major hurdles and complications in calculating earnings.
For example, lenders that want to qualify for hedge accounting under the new standard must make substantial investments in new risk management strategies, analytical tools, software, and personnel.
The standard also dictates that the market value of the hedges used to offset the rise or fall in the value of servicing rights be marked to market, and that the movement in the market values of servicing rights and the hedges remain correlated.
Gerald Baker, president of First Horizon Home Loans of Irving, Tex., the mortgage subsidiary of First Tennessee Corp. of Memphis, said that because FAS 133 increases banks' exposure to unanticipated gains or losses, the banks will need to have very strong hedging strategies, which are complicated and require a lot of resources.
Another issue with the new standard is that it requires companies to apply hedges that almost perfectly mimic the changes in value of servicing. However, it is very difficult to mimic how servicing values respond to fluctuations in interest rates, because the rate of change in servicing values can increase as interest rates rise or fall.
Despite the approaching change, mortgage lenders seemed unusually reluctant to discuss the subject for this article. Calls to 14 of the top 25 servicers found officials of only three willing to do so.
One chief financial officer from a top-10 servicer agreed to comment for the article, but backed off at the behest of a spokeswoman. The reason, she said, was that proprietary information might be jeopardized.
Robert Husted, a principal with Mortgage Industry Advisory Co., a New York company that helps mortgage companies formulate risk management strategies that comply with the new standard, said that getting ready for the standard has been difficult, but firms that are willing to put in the time and money to do so can get it done.
The Financial Accounting Standards Board has been slow to make decisions on the details of the standard, and that appears to have made preparing to comply far more difficult and costly for lenders.
Marangal Domingo, senior vice president and treasurer at Washington Mutual Inc. in Seattle, said two weeks ago that mortgage bankers could only comply with the standard to the extent that the board has provided guidance. At that time there were still a number of questions the board had to answer, he said.
The board took until last month to rule out a hedge coverage strategy for mortgage servicing rights that many in the industry had hoped it would support. In addition, only two weeks ago the board reversed itself on a key point and told mortgage bankers they must mark their forward loan commitments to market as derivatives.
Bankers like Mr. Steele, who have spent most of the year preparing not to treat forward commitments as derivatives, were upset at the loss of time and money involved in the change.
The delays and reversal have also given headaches to the Mortgage Bankers Association, which has had to delay publication of a question-and-answer booklet for mortgage lenders on FAS 133 until the end of this month.
Tim Lucas, a spokesman for the board, said that while the hashing out of the details has taken a long time, the board is dealing with difficult issues that it wants to investigate fully and give reasoned answers to.
"There is kind of a joke that circulates among some of the people in the standard-setting business that says, 'If you need an answer really quickly, the answer is no.' We didn't do that here," he said.
The board recognized that the industry had to make certain preparations to comply with the standard, which is why the effective date of the standard was delayed, Mr. Lucas said. However, "we can't realistically wait until all the questions anybody can come up with have been addressed."
Mr. Lucas predicted that the board will continue to have questions about the standard after the effective date. "We still have questions on other standards that have been out even 20 or 30 years."