DALLAS – Credit unions that sell mortgages on the secondary market increasingly choose to retain servicing rights as a way to maintain the member relationship. But that option also comes with credit unions' responsibility of having to value the income they derive from the servicing to provide auditors and regulators. For most of them it's a time consuming but necessary responsibility, and they may have found some assistance with ALM First's Mortgage Servicing Rights Valuation Service. “In today's environment, it's important that credit unions not only meet their regulatory requirements as mortgage servicers, but that they stay current with market changes that impact their balance sheets,” said ALM First's David Montgomery, ALM manager. The Mortgage Servicing Rights Valuation Service was designed to help credit unions determine the value of their income stream from servicing mortgage loans, and Montgomery said the program helps credit unions meet their GAAP requirements. Last May, the NCUA and the four other federal financial regulatory agencies released accounting guidance for credit unions and other institutions. In its Accounting Bulletin No. 05-01, the agency emphasized that the guidance “does not apply to the majority of credit unions that simply originate loans to members to hold in portfolio.” Instead, the guidance is relevant to CUs that originate mortgage loans to members that they intend to resell; and enters into commitments to sell the originated loans. The “Interagency Advisory on Accounting and Reporting for Commitments to Originate and Sell Mortgage Loans” reminds credit unions of the requirements under GAAP to: * report interest rate lock commitments with members on loans originated for sale as derivatives; and * derivatives must be carried at fair value in the financial statements. In addition certain forward sales commitments can also be derivatives requiring fair value measurement. Montgomery said that by GAAP requirements, ALM First is referring mainly to Financial Accounting Standards Board Statements 140. Related to servicing valuation and accounting, he explained that it states in general that 1) institutions must amortize servicing assets in proportion to and over the period of net servicing income, and 2) institutions must stratify servicing assets based on risk characteristics and test for impairment based on these classifications. “Amortizing servicing assets in proportion to net servicing income is best achieved by projecting net servicing income,” said Montgomery, adding, “Our system provides this capability.” Testing for impairment, he further explained, involves comparing book value to market value for categories of servicing assets based on risk characteristics. “Our Mortgage Servicing Rights Valuation Service provides the market value piece of this test, and our accounting service provides the book value piece,” Montgomery said pointing out that ALM First can establish the risk categories – “tranches” – for the credit union. The Mortgage Servicing Rights Valuation Service program can be tailored to an individual credit union's profile, whether the CU needs valuation only, service on demand, or periodic valuation combined with monthly accounting. It can also be customized to what assumptions are fed into the program and the value of the assumptions. Valuations are performed at the loan-level using IPS-Sendero's DecisionServ software. The program's accounting service includes loan-level accounting, tranche-level impairment testing, and monthly amortization entries. The product, Montgomery says, is set up to take the technology and manpower burden off of credit unions they would otherwise have to deal with if they conducted their own valuations on a pool-by-pool basis and had to compare those to generic mortgage pools in the market. From his experience working with credit unions, Montgomery said he's observed credit unions typically take one of two approaches to do valuations. Usually, he said, they have to hire someone who has mortgage servicing experience or train them to set up a system. The alternative – and this “short-cut method” Montgomery said is usually taken by credit unions with small amounts of servicing – is to do a pool level of evaluation that involves taking a bunch of loans, getting an average term and valuing many loans as one instead of individually. “Sometimes auditors and regulators are okay with that and sign off on it, but sometimes they want a credit union to do a more comprehensive valuation,” Montgomery said. That's what St. Anne's of Fall River Credit Union, Fall River, Mass. used to do, and Senior Vice President/CFO Ross Upton said the process was very time and labor intensive. The credit union worked with ALM First for about a year during the pilot phase of the new program while the company worked out certain refinements. The $650 million CU sells the majority of its fixed rate mortgage products on the secondary market to Fannie Mae. It keeps Adjustable Rate Mortgages in its portfolio and retains the servicing rights. In 2005 the 60,000-member CU did $154 million in mortgage volume. “The Mortgage Servicing Rights Valuation Service has taken the guess work out of the valuation process,” said Upton. “Now I can download the Fannie Mae servicing report and compare what we have on our ledger to the general market. That way the servicing rights on the balance sheet don't get away from you. Doing it on a loan-by-loan basis now, as the loan gets paid down, then the related servicing right gets paid down too. There's always a balance,” Upton explained. “The service is so easy, all that's required to get started is a download from the loan system. It provides a basis for the valuation of our servicing rights and allows us to test for impairment over time.” Montgomery said during the pilot phase, ALM First tested the product with credit unions that had high mortgage volumes and those with smaller volumes. He said the user response was typically that the program wasn't “unbearably expensive” and gave them the information they need. “That's what we're trying to provide, a cost effective and reliable solution,” he said. -

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