8/12/2019 FASB Looks at CMBS Servicing 2006

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FASB Looks Hard At CMBS ServicingTotal Securitization -- Institutional Investor News (January 27, 2006)

The Financial Accounting Standards Board is taking a close look at thefunctions performed by commercial mortgage-backed securities servicersregarding 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 openeda formal project to address QSPE and excess servicer discretion issues.Industry representatives acting under the umbrella of the Capital Consortiumare 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 purposeentities (QSPEs) to which sellers transfer loans in securitizations may onlyengage in activities which are significantly limited and entirely specified inthe legal documents that establish the QSPE. The issue is whether thetraditional servicing functions of securitization vehicles meet this standard. Ifthe servicer exceeds the QSPE guidelines set out in FAS 140, loan sellersmay be prohibited from booking the transactions as sales for GAAPpurposes, Jones said. "If sellers don't achieve true sales treatment, CMBSsecuritization programs will not contribute to earnings and the loanspurported to have been sold will remain on the sellers' books. Thetransactions would be treated as if the sellers borrowed money and did notsell 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 theassets and liabilities of the purchased pool on its books, ballooning balancesheets 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 andcorporate finance also has become aware of the debate and last yearrequested a meeting to better understand the issue. "We told them how theindustry conducted itself with regard to FAS 140 and that we firmly believedour structures meet the requirements for sale treatment. However, the SECapparently thought the auditors had raised issues which needed furtherconsideration," Jones said. A few weeks after the meeting, the SEC formallyrequested 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 aproperty is sold. Mortgages are often assumed by new buyers

* Substitution of collateral. In some limited circumstances, when permitted bythe loan documents, borrowers can replace one piece of collateral with asimilar piece of collateral.

* The process by which a servicer, after a property has become REO, sellsthe property. Under the REMIC statutes that govern CMBS, the property hasto be sold within three years.

The worst possible outcome, which Jones said is unlikely, is that manyCMBS sellers might have to revise audited financials for years beginning in2000, reversing gains on sales and adding billions in assets and liabilities tobalance sheets, while B piece buyers would be obliged to consolidate thesame billions of dollars of loans and attendant debt onto their balancesheets. "This would be bad," he said. Jones is hopeful that new guidance willaddress the concerns and permit the CMBS business to continue to operateefficiently. So far, audits have been going through and business is going on

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