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FASB Looks Hard At CMBS Servicing
Total Securitization -- Institutional Investor News (January 27, 2006)
The Financial Accounting Standards Board is taking a close look at the functions performed by commercial mortgage-backed securities servicers regarding FAS 140. The issue first came into focus last year when Ernst & Young held up the audits of several b-piece buyers. FASB has now opened a formal project to address QSPE and excess servicer discretion issues. Industry representatives acting under the umbrella of the Capital Consortium are set to meet with FASB officials on Feb. 9 to try to forge a solution, said Rick Jones, a partner at Dechert, who leads the effort.
The issue is a serious one. FAS 140 provides that qualified special purpose entities (QSPEs) to which sellers transfer loans in securitizations may only engage in activities which are significantly limited and entirely specified in the legal documents that establish the QSPE. The issue is whether the traditional servicing functions of securitization vehicles meet this standard. If the servicer exceeds the QSPE guidelines set out in FAS 140, loan sellers may be prohibited from booking the transactions as sales for GAAP purposes, Jones said. "If sellers don't achieve true sales treatment, CMBS securitization programs will not contribute to earnings and the loans purported to have been sold will remain on the sellers' books. The transactions would be treated as if the sellers borrowed money and did not sell loans," he said. Moreover, if the securitization vehicles are not QSPEs, the B piece buyer for each pool may be required to consolidate all of the assets and liabilities of the purchased pool on its books, ballooning balance sheets with assets not actually owned and liabilities for which the B buyer has no legal responsibility.
The Securities and Exchange Commission's staff for accounting policy and corporate finance also has become aware of the debate and last year requested a meeting to better understand the issue. "We told them how the industry conducted itself with regard to FAS 140 and that we firmly believed our structures meet the requirements for sale treatment. However, the SEC apparently thought the auditors had raised issues which needed further consideration," Jones said. A few weeks after the meeting, the SEC formally requested that FASB reconsider these issues.
The specific servicing functions which have attracted attention are:
* Due on sale provision, which governs what happens to a mortgage when a property is sold. Mortgages are often assumed by new buyers
* Substitution of collateral. In some limited circumstances, when permitted by the loan documents, borrowers can replace one piece of collateral with a similar piece of collateral.
* The process by which a servicer, after a property has become REO, sells the property. Under the REMIC statutes that govern CMBS, the property has to be sold within three years.
The worst possible outcome, which Jones said is unlikely, is that many CMBS sellers might have to revise audited financials for years beginning in 2000, reversing gains on sales and adding billions in assets and liabilities to balance sheets, while B piece buyers would be obliged to consolidate the same billions of dollars of loans and attendant debt onto their balance sheets. "This would be bad," he said. Jones is hopeful that new guidance will address the concerns and permit the CMBS business to continue to operate efficiently. So far, audits have been going through and business is going on as usual in the CMBS market. "Such an analysis is a horror show in the real world," Jones said.
Lisa Filomia-Aktas, a partner and practice leader of Ernst & Young's On-Call Advisory Services Group, noted that the FASB project on servicer discretion could have an impact on other sectors. "Although these issues are much more prevalent and arose from CMBS, they may also be troublesome in other asset classes, such as RMBS," she said. But CMBS servicers have more discretion than servicers in other asset classes, she added