Accounting and Regulatory Guidance for the Federal Home Loan Banks MPF Program

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1 Federal Home Loan Bank of Des Moines Charting Your Course Member Conference Mortgage Partnership Finance Program MPF Accounting and Regulatory Guidance Mortgage Partnership Finance, MPF and MPF Xtra are registered trademarks of the Federal Home Loan Bank of Chicago. 1

2 1) Product Descriptions Today s Topics 2) Valuation of Mortgage Servicing Rights, Credit Enhancement Fees Receivable and Credit Enhancement Recourse Liabilities 3) Journal entries for recording the loan sale, including MSR, CE Fees Receivable and CE Recourse Liability 4) Regulatory Reporting Requirements 2

3 1. Original MPF MPF Closed Loan Product Descriptions FHLB provides the first loss account (FLA) which increases at 4 basis points per year PFI provides a Credit Enhancement (CE) Recourse Obligation to the FHLB PFI is paid a fixed Credit Enhancement Fee (CE Fee) for providing the CE Recourse Obligation 2. MPF 125 FHLB provides the FLA which is equal to 100 basis points of the delivered amount PFI provides a minimum CE Recourse Obligation of 25 basis points based on the delivered amount PFI receives a performance based CE Fee for providing the CE Recourse Obligation 3

4 MPF Closed Loan Product Descriptions - Continued 3. MPF Xtra Loans sold to the FHLBs are concurrently sold to a third party investor No CE Recourse Obligation or CE Fees 4. MPF Government Loans Includes FHA, VA, HUD 184 and RHS Section 502 loans No CE Recourse Obligation or CE Fees 4

5 How to Determine if an MSR Asset exists? Transfer of loan that meets sales accounting requirements Sales accounting is a very complex topic discussed in FAS ASC

6 Criteria for a Sale* 1) The transferred financial assets have been isolated from the transferor put presumptively beyond the read of the transferor and its creditors, even in bankruptcy or other receivership. 2) No condition both constrains the transferee (or third party holder of its beneficial interests) from taking advantage of its right to pledge or exchange and provides more than a trivial benefit to the transferor continuing involvement 3) The transferor, its consolidated affiliates included in the financial statements being presented, or its agents do not maintain effective control over the transferred financial assets or third-party beneficial interests related to those transferred assets. *ASC

7 Continuing Involvement Characteristics of the MPF Program could be construed as continuing involvement: 1. The servicing contract safe harbor for servicing ASC A 2. The credit enhancement fee is an ongoing and could be construed as an interest only strip 3. The CE Recourse Obligation is a form of recourse or guarantee arrangement 4. Agreements to purchase or redeem transferred financial assets involves normal representations and warranties again a safe harbor ASC A 7

8 Cannot Divide the Financial Asset Unless You Create a Participating Interest Participating Interest must meet three criteria: 1. Proportionate ownership rights with equal priority to each participating interest holder 2. Involves no recourse (other than standard representations and warranties) to, or subordination by, any participating interest holder 3. Does not entitle any participating interest holder to receive cash before any other participating interest holder Wilary Winn does not believe the Credit Enhancement fee would meet the participating interest criteria. 8

9 Unit of Account* A PFI can receive an interest only strip in a transfer provided the transfer of the loan meets the sales accounting test essentially that the PFI has sold its entire interest in the loan. The PFI then enters into a separate transaction in which it receives the credit enhancement fee in consideration of assuming the CE Recourse Obligation. The PFI records and accounts for the credit enhancement fee receivable as a separate entire financial asset. GAAP does not also preclude entering into a separate recourse obligation such as the CE Recourse Obligation Amount. A PFI records a liability for the recourse obligation. The case for recording a separate liability is reinforced in situations in which the transferor could be obliged to write a check in excess of the fees received as is the case under the MPF program. (FAS 166 response to questions 67 and 68) *ASC F 9

10 Accounting for Servicing of Financial Assets Must initially recognize MSRs at their fair value PFI can elect either the amortization method or the fair value method for future reporting of their MSRs 10

11 Mortgage Servicing Right (MSR) Primary Valuation Components 1. The loan amount 2. Servicing fee percentage 3. Ancillary income 4. Expected loan life prepayment 5. Discount rate 6. Costs to service market costs 7. Delinquency rate and foreclosure losses 8. Remittance methodology single vs. multiple 9. Escrow Payment (Tax & Insurance) 11

12 1.500% MSR Yield Curve and Convexity 30 Year Conforming Conventional Par Rate Servicing Fee Value 1.250% 1.000% 0.750% -200 bps -100 bps -50 bps Base +50 bps +100 bps +200 bps Change in Interest Rates Value 12

13 1.450% MSR Asset Volatility Value of MSR Asset % % % % % % % 100 Mar Jun Sept Dec Mar Jun Sept Dec Mar Jun Sept Dec Mar Jun Sept Dec Mar Jun Sept Dec Mar Jun MSR Value % Prepayment Speed 13

14 Accounting Mortgage and Regulatory Servicing Guidance Rights for the MPF Product Credit Structure Homeowner s Equity Private Mortgage Insurance First Loss Account FHLB Participating Financial Institution Credit Enhancement Oblicgation Increasing Mortgage Losses FHLB 14

15 MPF Credit Enhancement Fee 1. Paid to member for assuming credit risk (CE Recourse Obligation) on mortgage defaults 2. Determined by the quality of the loans at the pool level and the MPF program selected 3. Fee paid monthly over the life of the loans 4. Sensitive to prepayments 15

16 The Primary Valuation Factors of the CE Fees Receivable are: 1. The loan amount 2. The CE Fee percentage and whether or not it is performance based depends upon the program selected 3. The expected life of the loan sensitive to prepayments 4. The discount rate used to discount the cash flows 16

17 Example: $100,000 loan CE Fee Value 30 Yr. 20 Yr. 15 Yr. MPF Original CE Fee % 0.420% 0.387% 0.337% MPF Original CE Fee $ $ $ $ MPF 125 CE Fee % 0.218% 0.202% 0.175% MPF 125 CE Fee $ $ $ $

18 The Primary Valuation Factors of the CE Recourse Liability are: 1. The loan amount 2. The CE Recourse Obligation amount depends on quality of loans delivered 3. The expected life of the loan sensitive to prepayments 4. The expected default rate 5. The expected severity of actual foreclosure losses 6. The level of credit risk assumed depends on program selected 7. The discount rate used to discount the cash flows 8. The amount in the First Loss Account (FLA) depends on program selected 18

19 CE Recourse Liability vs. CE Recourse Obligation Amount There is a difference between the CE Recourse Liability and the CE Recourse Obligation Amount The CE Recourse Liability is related to properly accounting for the loans delivered under the program per Generally Accepted Accounting Principles The CE Recourse Obligation amount is related to the amount of risk based capital that a PFI must hold for regulatory purposes for loans delivered under the program 19

20 Example: $100,000 loan CE Obligation Liability 30 Yr. 20 Yr. 15 Yr. MPF Original CE Obligation % % % % MPF Original CE Obligation $ -$ $ $32.81 MPF 125 CE Obligation % 0.000% 0.000% 0.000% MPF 125 CE Obligation $ $0.00 $0.00 $

21 Accounting for Loans Sold Under the MPF Program The discussion which follows are based on general examples. PFIs are strongly encouraged to review the accounting for the program with their external auditors and primary regulators before implementing the accounting described in the presentation, because the facts and circumstances for a particular institution may lead to different accounting and regulatory interpretations. We further note that for purposes of simplicity, we have omitted the accounting requirements related to the Interest Rate Lock Commitments PFIs make to their borrowers and Forward Sales Commitments a PFI enters into with the FHLB, which are both derivatives. 21

22 Recording of the CE Recourse Liability Record the CE Recourse Liability and the CE Fee receivable at their fair values Record CE Recourse Liability equal to CE Fee receivable FIN 45 22

23 Example: $100,000 loan sold with an MSR of 1% Fair Values Cash proceeds 100,000 Servicing asset 1,000 CE Fees Receivable 400 Net Proceeds Cash proceeds 100,000 Servicing asset 1,000 Net proceeds 101,000 23

24 Example #1 Journal Entries CE Recourse Liability at Calculated Fair Value JE 1 Cash $ 100,000 CE Fees Receivable $ 400 CE Recourse Liability $ 40 Loan Receivable $ 100,000 Gain on Sale $ 360 Record Loan Sale with CE fees and CE obligation at fair value JE 2 Servicing Asset $ 1,000 Gain on Sale $ 1,000 Record fair value of MSR 24

25 Example #2 Original MPF: Journal Entries Liability = Receivable JE 1 Cash $ 100,000 CE Fees Receivable $ 400 CE Recourse Liability $ 400 Loan Receivable $ 100,000 Record Loan Sale JE 2 Servicing Asset $ 1,000 Gain on Sale $ 1,000 Record fair value of MSR JE 3 Cash $ 100 CE Fees Receivable $ 90 Other Income $ 10 Record year one CE fees and amortize discount on liability JE 4 CE Recourse Liability $ 90 Other Expense $ 10 Other Income $ 100 Recognize fee income and amortize discount on liability 25

26 How to account for the MSR after initial recording? FAS ASC paragraph allows the asset to be measured and reported in one of two ways: 1) Amortization Method 2) Fair Value Method A PFI may select either method, but cannot switch methodologies unless it moves to the Fair Value method at the beginning of the fiscal year before interim financial statements have been released. A PFI cannot go back to the amortization method after it has elected Fair Value. 26

27 Amortization Method Amortize the MSR in proportion and over the period of estimated net servicing income (level yield method) and assess servicing assets for impairment based on fair value at each reporting date. 27

28 Fair Value Method The fair value is determined at each reporting period The asset is adjusted to equal its fair value The difference is taken into income or expense for that reporting period PFIs that hedge their servicing rights portfolios can benefit from the fair value method because the accounting is less complex than under FAS ASC Topic 815 Derivatives and Hedging. PFIs that do not hedge their portfolios and that elect the fair value method could experience earnings volatility. 28

29 Regulatory Reporting Requirements FFIEC Federal Financial Institutions Examination Council NCUA National Credit Union Administration 29

30 Federal Home Loan Bank of Des Moines Active Master Commitments - Summary funded through 9/30/2013 PFI Number: XXXX ABC Bank MC Number: XXXX Totals for MC Number: XXXX Original (Contracted) C/E: $1,500, MC Pool Amount: $45,000, Pool (Total Used) C/E: $1,149, Delivery Commitment Amounts: Balance (Available) C/E: $350, Amount Funded to Date: $29,425, $28,332, Outstanding Delivery Commitment Amount Available: $0.00 Highest Zip Code Concentration XXXX % Number of Loans to Date: 186 Average Loan Level CE 4.056% Total PairOff Fees by MC: $5.01 Total Extension Fees by MC: $ MC Expiration Date: 12/31/2013 MC Program: Original Remaining MC Available: $5,575,

31 FFIEC Call Report Requirements for MPF Closed Loan Products Mortgage Servicing Rights 1) Total volume of loans sold - Schedule RC-S, item 11A and RC-S, Memoranda, item 2a (for MPF Xtra loans the only required entry is RC-S Memoranda, item 2b because there is no recourse) 2) Book value of retained servicing RC-M, Memoranda, item 2a 3) Estimated fair value of retained servicing RC-M, Memoranda, item 2a(1) 4) Gain or Loss on loan sales for the quarter should be reported on Schedule RI, item 5i 5) Servicing fees for the quarter should be reported on Schedule RI, item 5f 31

32 Basel III Impact on MSR Assets 1) Servicing assets are limited to 10% of total Common Equity Tier 1 2) Deduction phases in through the end of ) Eligible portion is risk weighted at 250% beginning January 1,

33 FFIEC Call Report Requirements for Mortgage Banking Activities Schedule RC-P 1-4 Family Residential Mortgage needs to be completed if the following is true: 1. The Bank has over $1 Billion in Total Assets. 2. The Bank has less than $1 Billion in Total Assets at which either 1-4 family residential mortgage loan originations and purchases for resale from all sources, loan sales, or quarter-end loans held for sale exceed $10 Million for two consecutive quarters. 33

34 FFIEC Call Report Requirements CE Recourse Obligation RC-R Line 50 vs. Line 51: A bank can elect to calculate its risk weighted assets based on the methodology that is most favorable to the bank s capital. The most favorable treatment is dependent on several factors including the dollar amount of the CE Obligation amount as a percentage of the outstanding principal balance of the loans in the master commitment and the bank s Tier 1 Capital percentage. Wilary Winn recommends that a bank calculate its risk weighted assets by first entering the outstanding principal balance of the loans on RC-R line 51 and multiplying the balance by a 50% risk weight. 34

35 FFIEC Call Report Requirements CE Recourse Obligation RC-R Line 50 vs. Line 51 (Cont.): We then recommend that a bank calculate its risk weighted assets by calculating their risk weighted assets that would result from reporting the CE Obligation amount on RC-R line 50. We encourage banks with more than 8% Tier 1 capital to calculate their institution specific multiplier on line 50 because it will most likely be less than the default factor of The bank can then report the CE Obligation according to the method which results in the lower amount of risk weighted assets. 35

36 FFIEC Call Report Requirements Direct Reduction Method Direct Reduction Method In general, PFIs with total risk based capital in excess of 8 percent will generally benefit from the use of the direct reduction method when calculating the Credit Conversion Factor because it will result in a factor lower than 12.5, and thus less total risk weighted assets. Contact Wilary Winn and we can provide a spreadsheet that can assist you with the calculation of the direct reduction Credit Conversion Factor or refer to our MPF Accounting manual (pages 32-33) located on our website for details of how to calculate your institution specific Credit Conversion Factor. 36

37 FFIEC Call Report Requirements for CE Fees Receivable and CE Recourse Liabilities Line 50 Example 1) The CE Recourse Obligation amount (less any CE recourse liability recorded) is reported in Schedule RC-S, item 12A and RC-R, item 50A 2) The amount in RC-R, 50A is multiplied by the Credit Conversion Factor of 12.5 (gross-up method) or the institution-specific factor for the PFI (direct reduction method) 3) The resulting multiplicand is reported as the Credit Equivalent Amount in RC-R, Item 50F 4) The CE Fees receivable is to be reported on RC-F, item 3a as an interest only strip (and for MPF 125 only on RC-S 2a column A) 5) The CE recourse liability is reported on RC-G, item 3 37

38 FFIEC Call Report Requirements for CE Fees Receivable and CE Recourse Liabilities Line 51 Example 1) The unpaid principal balance of the loans is reported on RC-R item 51A 2) The amount in RC-R, 51A is risk weighted at 50 percent in Column E 3) The CE Fees receivable is to be reported on RC-F, item 3a as an interest only strip (and for MPF 125 only on RC-S 2a column A) 4) The CE recourse liability is reported on RC-G, item 3 38

39 Regulatory Reporting Example FFIEC Line 50 Example ABC Bank - FFIEC Call Report Summary 9/30/2013 Valuation - Client Uses Amortization Method Item Amount to Report Location to Report Outstanding Prin. Bal. of Sold Loans 37,165, Schedule RC-S, item 11A Outstanding Prin. Bal. of Sold Loans 37,165, Schedule RC-S, Memoranda, item 2a Book Value of Retained Servicing 329, Schedule RC-M, Memoranda, item 2a Estimated Fair Value of Retained Servicing 334, Schedule RC-M, Memoranda, item 2a (1) CE Recourse Obligation Amount Net of Recourse Liability 1,024, Schedule RC-S, item 12A CE Recourse Obligation Amount Net of Recourse Liability 1,024, Schedule RC-R, item 50A CE Recourse Obligation Amount* 12.5 (gross up method) 12,807, Schedule RC-R, item 50F CE Fees Receivable 124, Schedule RC-F, item 3a Gain or Loss on Sale (for the quarter) 27, Schedule RI, item 5i Servicing Fees (for the quarter) N/A Schedule RI, item 5f Recourse Liability (actual liability reported on G/L) 124, Schedule RC-G, item 4 39

40 Regulatory Reporting Example FFIEC Line 51 Example ABC Bank - FFIEC Call Report Summary 9/30/2013 Valuation - Client Uses Amortization Method Item Amount to Report Location to Report Outstanding Prin. Bal. of Sold Loans 37,165, Schedule RC-S, item 11A Outstanding Prin. Bal. of Sold Loans 37,165, Schedule RC-S, Memoranda, item 2a Book Value of Retained Servicing 329, Schedule RC-M, Memoranda, item 2a Estimated Fair Value of Retained Servicing 334, Schedule RC-M, Memoranda, item 2a (1) CE Recourse Obligation Amount Net of Recourse Liability 1,522, Schedule RC-S, item 12A Outstanding Loan Balance of Master Commitment 37,165, Schedule RC-R, item 51A Outstanding Loan Balance of Master Commitment * 50% 18,582, Schedule RC-R, item 51E CE Fees Receivable 124, Schedule RC-F, item 3a Gain or Loss on Sale (for the quarter) 27, Schedule RI, item 5i Servicing Fees (for the quarter) N/A Schedule RI, item 5f Recourse Liability (actual liability reported on G/L) 124, Schedule RC-G, item 4 40

41 Basel III Impact on Credit Enhancement 1) Under Basel III the CE Obligation is treated as a securitization (see page 346 of the Basel III rules). 2) A bank can use the Simplified Supervisory Formula Approach ( SSFA ) or a gross up method under the general risk-based capital rules. 3) The SSFA formula is: K A A D A X 1,250% + D - K A D - A X 1,250% X K SSFA 4) The (simplified) gross up method formula is: 1) (Outstanding UPB Remaining FLA) * 50% Risk Weight 41

42 NCUA Call Report Requirements for Mortgage Servicing Rights 1) Servicing fees are included in Non-Interest Income Page 5, line 12 2) Loan servicing expenses are included in Non-Interest Expense Page 5, line 24 3) Total amount of 1 st mortgage loans sold into the secondary market year-to-date is reported on Schedule A, line 16 4) Amount of real estate loans sold but serviced by the credit union (dollar amount of servicing) is reported on Schedule A, line 18 5) The MSR book value is reported on Schedule A, line 19 42

43 NCUA Call Report Requirements for CE Fees Receivable and CE Recourse Liabilities 1) The CE Fees receivable is reported on Page 2, line 32C 2) The CE Recourse liability is reported on Page 3, line 8 3) The outstanding principal amount of loans sold is reported on Page 10, line 5 in the Contingent Liabilities section. The principal amount sold is then subject to the Risk Based Net Worth requirement equal to six percent (NCUA (d)). Complex credit unions (defined as those having more than $10M in total assets and a standard risk based net worth of over 6%) may benefit from calculating the capital charge under In this way, the capital charge is limited to the actual CE Obligation percentage. 43

44 Regulatory Reporting Example - NCUA ABC Credit Union - NCUA Call Report Summary 3/31/2012 Valuation - Client Uses Amortization Method Item Amount to Report Location to Report Loan Servicing Fees (for the quarter) N/A * Page 5, Line 12 Loan Servicing Costs (for the quarter) N/A * Page 5, Line 24 Total amount of loans sold in secondary market Year-to-Date 5,897, Schedule A, Line 16 Total amount of first mortgage loans sold but serviced by the credit union 37,165, Schedule A, Line 18 CE Fees Receivable 124, Page 2, Line 32C Recourse Liability 124, Page 3, Line 8 Book Value of Mortgage Servicing Assets 329, Schedule A, Line 19 Outstanding Principal Amount of Loans Sold 37,165, ** Page 10, Line 5 * This information is internal to the credit union and can not be provided by Wilary Winn. ** The principal amount sold is then subject to the Risk Based Net Worth requirement, equal to the lesser of the actual CE Recourse Obligation percent or 6 percent (NCUA (d)). 44

45 How Wilary Winn Can Help 1. Wilary Winn can perform a valuation of your entire mortgage servicing portfolio. The valuation will include determining the values of the MSR, the CE Fees Receivable, the CE Recourse Liability at the Loan Level and assist with any questions related to the accounting for the portfolio. 2. For those electing the amortization method for MSRs, Wilary Winn will incorporate the MSR into a loan level basis roll forward file, which will provide information necessary to produce the amortization journal entries going forward. The file will also include a section where newly sold loans can be added and the amount of the new MSR will be calculated; the amortization for these loans will also be calculated. 45

46 Services and Contact Information Mortgage Servicing Rights and Mortgage Banking Derivatives: Eric Nokken Private Label MBS/CMOs and Asset Liability Management: Frank Wilary Mergers and Acquisitions, Fair Value Footnotes, and TDRs: Brenda Lidke Pooled Trust Preferred CDOs: Gregg Johnson 46

47 Wilary Winn LLC Alliance Bank Center 55 East 5 th Street, Suite 1020 St. Paul, MN