Accounting for Servicing Rights
By Kris Hoefler
Community Bank Advisor, 2007 Winter 

FAS 156, Accounting for Servicing of Financial Assets — an Amendment of FAS 140, was issued in March 2006 and amends FAS 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities. FAS 156 affects all entities with servicing rights and is effective at the beginning of the first fiscal year after September 15, 2006, which is January 1, 2007 for calendar year ends. Earlier adoption was permitted as of the first quarter of 2006.

FAS 156 was issued to simplify the accounting for servicing rights (i.e., servicing assets and servicing liabilities) and reduce the volatility that results from the use of different measurement attributes for servicing rights and, where applicable, the related financial instruments used to economically hedge risks associated with those servicing rights. FAS 156 clarifies when to separately account for servicing rights, requires separately recognized servicing rights to be initially measured at fair value, and provides the option to subsequently account for those servicing rights (by class) either under the amortization method previously required under FAS 140 or at fair value.

Prior to the amendment of FAS 140, recognized servicing assets were initially measured (i.e., on “day 1”) by allocating the previous carrying amount of the loans between the loans that are sold and the retained servicing asset based on their relative fair values at the date of the sale. Under FAS 156, each separately recognized servicing asset or servicing liability is required to be initially recognized at its fair value, if practicable. Fair value is presumptively the price paid or received if the servicing asset or servicing liability were purchased or assumed. It is expected that the value of initial servicing rights under FAS 156 will be greater than previous accounting methods as the full fair value will be recognized on day 1.

This Statement provides two alternatives for the accounting for servicing rights during their life:

• Amortization Method — Amortize servicing assets/liabilities over the period of estimated net servicing income/loss and assess assets/liabilities for impairment or increased obligation based on fair value at each reporting date. This is the method previously required under FAS 140.
• Fair-Value Measurement Method — Measure servicing assets/liabilities at fair value at each reporting date and report changes in fair value in earnings in the period in which the change occurs. This method will result in volatility—both increases and decreases in value—in the income statement and is expected to be used by those entities that are hedging risks associated with the servicing rights.

Entities must elect and apply one of the above methods for subsequent measurement for each “class” of servicing rights. Different elections can be made for different classes of servicing rights. The election is irrevocable and can be made at the beginning of any fiscal year after the effective date of the Statement. If the fair-value option is elected, changes in the fair value of servicing rights should be recognized through earnings at each reporting date.

FAS 156 amends the disclosure requirements of FAS 140 by requiring different disclosures for servicing assets and servicing liabilities subsequently measured utilizing the amortization method and those measured at fair value.

The initial recognition and measurement provisions of FAS 156 should be applied prospectively to servicing rights resulting from transactions consummated after adopting the Statement. Additionally, the related disclosure requirements for servicing assets and servicing liabilities should be applied prospectively to financial statements issued after adopting the Standard. There are no changes in the amortization for those entities that continue under the amortization method. For those entities that chose the fair-value measurement method, FAS 156 addresses the transition methods for subsequent measurement at fair value upon adoption and after adoption of FAS 156.