to hold unrecognized value off their balance sheets, even after the recent change in accounting rules, according to a study by Fitch Investors Service Inc. The bond rating agency tallied up that hidden value at the 30 largest bank mortgage servicers. It found that the unrecognized value equals about 5.4% of the total reported equity of the banks. Fitch looked at the banks' equity from debt holders' standpoint, and determined that the hidden equity is a cushion. "This represents comfort capital that is available to a bank to pay debt," said David R. Martin, a Fitch analyst, and gives bond holders a sense of security, knowing the bank has more equity available than is readily apparent. The Financial Accounting Standards Board has taken steps to treat almost all servicing alike, whether it is originated by the servicer or purchased from another lender. Formerly, only purchased servicing rights were recognized as balance-sheet assets. Under the new rule, FAS 122, both originated and purchased servicing rights will be recognized. Even with the new accounting standard, loans originated before FAS 122 goes into effect will not be recognized on servicers' balance sheets. Because the treatment of servicing rights will not be retroactive, servicers will still continue to have unrecognized value in their servicing assets from loans originated before this year. This is of particular concern to bank servicers because they tend to hold servicing rights in order to cross-sell other bank products to the borrowers, even if the loan is sold. To determine just how much bank servicers have in unrecognized equity, Mr. Martin and another analyst, Scott J. O'Donnell, evaluated the capital levels of the 30 largest bank servicers and looked at the off-balance-sheet servicing rights. The analysts concluded that if servicing rights for loans originated after FAS 122 was implemented are recognized on balance sheets, then all servicing rights, regardless of when the loans were originated, should be recognized. The different treatment leaves a significant portion of servicing unrecognized, the report said. The bank with the highest incidence of unrecognized equity in servicing rights is First Tennessee National Corp. The lender has unrecognized servicing rights that equal 13.7% of the bank's equity. Under FAS 122, servicers will have to disclose more information than is currently required. However, data on loans originated before the accounting change do not have to be released. FAS 122 was available for early adoption in June 1994, but is mandatory on all financial statements for periods after December 1995. "The current accounting doesn't reflect the current financial health of mortgage servicing operations," Mr. Martin said. "It is an artificial distinction that has been put into place by FAS 122." In the future, when Fitch analyzes a mortgage servicing portfolio, Mr. Martin said, analysts will look at the fair market value of the servicing asset, and discount it about 25% to account for potential changes in interest rates. Mr. Martin said it would be an oversimplification to assume that servicers at the top of the hidden-equity list are there solely because they service loans they originated before FAS 122. "It is also a reflection of what is on the balance sheet, at what level the loans were recorded on the balance sheet and the function of the total servicing rights relative to the equity base of the company," Mr. Martin said.

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