The jury is still out on the long-term implications of FAS 122, an accounting rule that changed the way mortgage servicing rights are to be valued on a company's balance sheets.
But some lenders are already steaming about the broad leeway the rule gives to companies in valuing their servicing assets. They say the rule leads to difficulties in comparing earnings from company to company and also leads to distortions of pricing.
The rule was established last year by the Financial Accounting Standards Board to replace FAS 65, the previous rule regarding servicing rights.
Under FAS 122, mortgage servicers must include on their balance sheets the value of servicing rights on loans they originated. Previously, only purchased servicing had to be on the balance sheet.
Many companies, especially the larger servicers, began to implement the FAS 122 guidelines as early as last year. All servicers will have to do so by the end of this year.
Though the rule has not been universally implemented, some effects have been felt already.
Kevin Race, chief financial officer of Jacksonville, Fla.-based HomeSide Lending Inc., said many lenders had been demanding higher rates to compensate for the increased interest rate risks brought about since the implementation of FAS 122.
Mr. Race said that FAS 122 "gave the industry a new weapon to aim at itself," but he added that in the long run the pricing environment would stabilize, since companies would begin to see the impact that aggressive pricing has on earnings.
Some lenders are more skeptical. Terrance G. Hodel, president of North American Mortgage Co., said he opposed FAS 122 from the beginning.
"The rule is allowing people to overvalue servicing and create profits that don't exist," Mr. Hodel said.
Santa Rosa, Calif.-based North American has been selling much of its originated servicing and has not made many purchases in the last few years.
Mr. Hodel added that unless there are changes made in the rule to limit how a company can value its servicing, there will not be an elimination of what he deemed "fantasy pricing" any time soon and that this level of aggressive pricing is not good for the industry.
"If you consistently overprice servicing, you'll have impairment problems," he said. "Impairment" refers to the requirement that declines in servicing value be deducted from earnings.
At a panel discussion about FAS 122 at the Mortgage Bankers Association of America's annual convention last month, Timothy Breedlove, chief accounting officer of Woodland Hills, Calif.-based Weyerhaeuser Mortgage Co., said that one of the major effects of FAS 122 was that it brought the risk factors associated with interest rate volatility to the forefront.
Mr. Breedlove added that midsize and smaller servicers now have to decide whether or not they are willing to retain their servicing rights because of the interest rate risk.
In fact, Weyerhaeuser Mortgage sold about $5 billion in servicing rights earlier this year and is now looking for a buyer for the entire company.
And larger players, Mr. Breedlove said, will probably seek to bolster their origination assets in order to continue fueling their "servicing machines," since substantial production capabilities act as a natural hedge to prepayment risk in a servicing portfolio.
Mr. Race said that consolidation in the industry will continue as smaller servicers will have to either grow their portfolios to stay efficient or exit the business if they find the growth option too expensive.
"All the cards are on the table. FAS 122 forced a strategic discussion," Mr. Race said. "This is a tough business to make any money in."
Mr. Hodel said he didn't think FAS 122 has forced anyone to actually leave the servicing business, but it has affected how companies hedge their portfolios, and in some cases made it necessary for companies that had been reluctant to hedge to start hedging.
There is also dispute about whether or not FAS 122 has been successful in making it easier to compare balance sheets of different companies.
"FAS 122 has not accomplished the goal of making people's financial statements understandable," Mr. Hodel said.
