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Accounting For Mortgage Banking Enterprise [MBE]



Mortgage banking enterprise [MBE] comprises two activities: (1) The origination or purchase of mortgage loans and subsequent sale to permanent investors, and (2) Long-term servicing of the mortgage loan.

To the extent that mortgage banking activities discussed in this post may be under-taken by subsidiaries or divisions of commercial banks or savings institutions, the same accounting and reporting standards apply.  Normal, non-mortgage lending of those enterprises, however, is accounted for in accordance with the lender’s normal accounting policies for such activities. Follow on…


Mortgage loans held for sale are valued at the lower of cost or market.  Mortgage backed-securities are reported under ASC 320 as held-to-maturity, trading, or available-for-sale, depending on the entity’s intent and ability to hold the securities. 

Loan origination fees and related direct costs for loans held for sale are capitalized as part of the related loan and amortized, using the effective yield method.  However, fees and costs associated with commitments to originate, sell, or purchase loans are treated as part of the commitment, which is a derivative accounted for under ASC 815. Loan origination fees and costs for loans held for investment are deferred and recognized as an adjustment to the yield.

ASC 942, Financial Services—Depository and Lending, provides uniform and consistent guidance for the accounting and reporting practices for similar transactions by various types of depository and lending institutions, and has now been incorporated in a unified AAG.  The standard includes in its scope, corporate credit unions and mortgage companies and, in fact, affects disclosure practices for any entity that extends credit to customers. In addition, the standard prescribes required disclosures for mortgage banking enterprises regarding their regulatory capital and net worth requirements.


Mortgage Banking Activities

A mortgage banking enterprise (MBE) acts as an intermediary between borrowers (mortgagors) and lenders (mortgagees).  MBE activities include purchasing and originating mortgage loans for sale to permanent investors and performing servicing activities during the period that the loans are outstanding.

The mortgage loans offered for sale to permanent investors may be originated by the MBE (in-house originations); purchased from realtors, brokers, or investors; or converted from short-term, interim credit facilities to permanent financing.  The common technique used by the MBE to market and sell the loans is referred to as securitization because the mortgage loans receivable are pooled and converted to mortgage-backed securities and sold in that form.

MBE’s customarily retain the rights to service the loans that they sell to permanent investors in exchange for a servicing fee.  The servicing fee, normally a percentage of the mortgage’s outstanding principal balance, compensates the MBE for processing of mortgagor payments of principal, interest and escrow deposits, disbursing funds from the escrow accounts to pay property taxes and insurance on behalf of the mortgagor, and remitting net proceeds to the permanent investor along with relevant accounting reports.
Mortgage loans – The MBE is required to classify mortgage loans that it holds as either (1) held-for-sale, or (2) held for long-term investment.

Loans held-for-sale – mortgage loans held for sale are reported at the lower of cost or market as of the balance sheet date.  Any excess of cost over market is accounted for as a valuation allowance, changes in which are to be included in income in the period of change.


Determination Of Cost Basis

The following matters must be considered with respect to the cost basis used for the purposes of the lower of cost or market value determination:

  • If a mortgage loan has been identified as a hedged item in a fair value hedge under ASC 815, the cost basis used reflects adjustments to the loan’s carrying amount for changes in the loan’s fair value attributable to the risk being hedged.
  • Purchase discounts on mortgage loans reduce the cost basis and are not amortized as interest revenue during the period that the loans are held for sale.
  • Capitalized costs attributable to the acquisition of mortgage servicing rights associated with the purchase or origination of mortgage loans are excluded from the cost basis of the mortgage loans.


Determination Of Market Value

The market value of mortgage loans held for sale is determined by type of loan; at a minimum, separate determinations are made for residential and commercial loans.  Either an aggregate or individual loan basis may be used in determining the lower of cost or market for each type of loan.

Market values for loans subject to investor purchase commitments (committed loans) and loans held for speculative purposes (uncommitted loans) must be determined separately as follows:

[1].  For committed loans, market value is defined as fair value.

[2].  For uncommitted loans, market value is based on quotations from the market in which the MBE normally operates, considering:

  • Market prices and yields sought by the MBE’s normal market outlets;
  • Quoted Government National Mortgage Association (GNMA) security prices or other public market quotations of rates for long-term mortgage loans; and
  • Federal Home Loan Mortgage Corporation (FHLMC) and Federal National Mortgage Association (FNMA) current delivery prices.


Loans Held For Long-Term Investment

Mortgage loans may be transferred from the held-for-sale classification to the held-for-long-term investment classification only if the MBE has both the intent and ability to hold the loan for the foreseeable future or until maturity.  The transfer to  the long-term investment classification is recorded at the lower of cost or market value on the date of transfer.  Any difference between the loan’s adjusted carrying amount and its outstanding principal balance (e.g., purchase discounts as discussed above) is recognized as a yield adjustment using the interest method.

If recoverability of the carrying amount of a mortgage loan held for long-term investment is doubtful and the impairment is judged to be other than temporary, the loan’s carrying amount is reduced by the amount of the impairment to the amount expected to be collected with the related charge recognized as a loss.  The adjusted carrying value becomes the loan’s new cost basis and any eventual gain on recovery may only be recognized upon the loan’s sale, maturity, or other disposition.


Mortgage-Backed Securities

The securitization of mortgage loans held-for-sale is accounted for as a sale of the mortgage loans and purchase of mortgage-backed securities.


Mortgage Banking Classification and Valuation

After the securitization of a held-for-sale mortgage loan, any mortgage-backed securities retained by  the MBE are classified as (1) trading, (2) available-for-sale, or (3) held-to-maturity under the provisions of ASC 320.  As is the case with the MBE’s mortgage loans held for investment, the MBE must have both the intent and ability to hold the mortgage-backed securities for the foreseeable future or until maturity in order to classify them as held-to-maturity.

 If the MBE had committed to sell the securities before or during the securitization process, the securities are required to be classified under the trading category.

Mortgage-backed securities held by a not-for-profit organization are stated at fair value under ASC 958-320.


The fair value of uncommitted mortgage-backed securities collateralized by the MBE’s own loans is ordinarily based on the market value of the securities.  If the trust holding the loans may be readily terminated and the loans sold directly, fair value of the securities is based on the market value of either the loans or the securities, depending on the entity’s intentions.  Fair value for other uncommitted mortgage-backed securities is based on published yield data.

Repurchase Agreements In Mortgage Banking

Mortgage loans or mortgage-backed securities held for sale may be temporarily transferred by an MBE to another financial institution under a formal or informal agreement which serves as a means of financing these assets.  Such agreements are accounted for as collateralized financing arrangements; the loans and securities transferred under the agreements are still reported by the MBE as held for sale.

A formal repurchase agreement specifies that the MBE retains control over future economic benefits and also the risk of loss relating to the loans or securities transferred.  These assets are subsequently reacquired from the financial institution upon the sale of the assets by the mortgage banking enterprise to permanent investors.

An informal repurchase agreement exists when no formal agreement has been executed but loans or securities are transferred by an MBE that does all of the following:

  • Is the sole marketer of the assets
  • Retains any interest spread on the assets
  • Retains risk of loss in market value
  • Reacquires uncollectible loans
  • Regularly reacquires most or all of the assets and sells them to permanent investors


When mortgage loans held for sale are transferred under a repurchase arrangement, they continue to be reported by the transferor as loans held for sale.  Mortgage-backed securities sold under agreements to repurchase are reported as trading securities as defined in ASC 320.


Servicing Mortgage Loans

Rights to service mortgage loans for others are recognized as separate assets by an MBE:

  • If the enterprise acquires such rights through purchase or origination of mortgage loans and retains them upon sale or securitization, the total cost of the mortgage loans must be allocated between the rights and the loans (without the rights) based on their relative fair values.
  • If it is impossible to determine the fair value of the mortgage servicing rights apart from the mortgage, the MBE/transferor records the mortgage servicing rights at zero value (ASC 860).
  • Otherwise, mortgage servicing rights are capitalized at their fair value and recognized as a net asset if the benefits of servicing the mortgage are expected to be more than adequate compensation to the servicer for performing the duties.  If the benefits of servicing the mortgage are not expected to adequately compensate the servicer, the servicer recognizes a liability.  The asset Mortgage Servicing Contract Rights is initially measured at its fair value.


Subsequent impairment is recognized as follows:

  • The mortgage servicing assets are stratified based on predominant risk characteristics.
  • Impairment is recognized through a valuation allowance for an individual stratum. The amount of impairment equals the carrying amount for a particular stratum minus its fair value.
  • The valuation allowance is adjusted to  reflect changes in the measurement of impairment after the initial measurement of impairment.


Servicing fees are usually based  on a percentage of the outstanding principal balance of the mortgage loan.  When a mortgage loan is sold with servicing rights retained, the sales price must be adjusted if the stated rate is materially different from the current (normal) servicing fee rate so that the gain or loss on the sale can be determined.  The adjustment is:

Adjustment = Actual Sales Price – Estimated sales price obtainable if normal servicing fee rate had been used

This adjustment allows for recognition of normal servicing fees in subsequent years. The adjustment and any recognized gain or loss is determined as of the sale date.  If estimated normal servicing fees are less than total expected servicing costs, then this loss is accrued on the sale date as well.


Repurchase Financing

A repurchase financing involves the transfer of a previously transferred financial asset back to the lender as collateral for a financing between the borrower and the lender.  The lender usually returns the financial asset to the borrower when the financing is repaid.  The borrower and lender cannot separately account for an asset transfer and related repurchase financing unless the two transactions have a valid business purpose for being entered into separately, and the repurchase financing does not result in the lender retaining control over the financial asset.  If a transaction meets these criteria, then evaluate the initial transfer without the repurchase financing to see if it meets the requirements for sale accounting (ASC 860).  If the transaction does not meet these criteria, then the arrangement is probably a forward contract.


Sales to Affiliated Enterprises

When mortgage loans or mortgage-backed securities are sold to an affiliated enterprise, the carrying amount of the assets must be adjusted to lower of cost or market as of the date that management decides that the sale will occur.  This date is evidenced by formal approval by a representative of the affiliated enterprise (purchaser), issuance of a purchase commitment, and acceptance of the purchase commitment by the seller.

Any adjustment is charged to income.


If a group of (or all) mortgage loans are originated specifically for an affiliate, then the originator is an agent of the affiliated enterprise.  In this case, the loans are transferred at the originator’s cost of acquisition.  This treatment does not apply to “right of first refusal” or similar contracts in which the originator retains all risks of ownership.


Issuance of GNMA Securities

An issuer of GNMA securities who elects the internal reserve method must pay one month’s interest cost to a trustee.  This cost is capitalized (at no greater than the present value of net future servicing income) and amortized.


Loan and Commitment Fees and Costs

Mortgage bankers may pay or receive loan  and commitment fees as compensation for various loan administration services.

These fees and costs are accounted for as described in the following paragraphs. Read on… 

Loan origination fees received –  Loan origination fees and related direct costs are deferred and amortized, using the effective yield method.  Fees and costs associated with commitments to originate, sell, or purchase loans, however, must be considered part of the commitments, which are deemed to be derivatives under ASC 815.  If the loan is held for investment, loan origination fees and costs are recognized as an adjustment of yield using the effective interest method.

Services rendered –  Fees for specific services rendered by third parties as part of a loan origination (e.g., appraisal fees) are recognized when the services are performed.

Commitment fees paid to investors on loans held for sale –  Residential or commercial loan commitment fees paid to permanent investors are recognized as expense when the loans are sold or when it is determined that the commitment will not be used.  Since residential loan commitment fees typically cover groups of loans, the amount of fees recognized as revenue or expense relating to an individual transaction is calculated as:

Revenue or expense recognized on individual transaction = Total residential loan commitment fee × [Amount of individual loan / Total commitment amount]


Loan placement fees (fees for arranging a commitment directly between investor and borrower) are recognized as revenue once all significant services have been performed by the MBE.  In some cases, an MBE secures a commitment from a permanent investor before or at the same time a commitment is made to a borrower and the latter commitment requires:

  • Simultaneous assignment to the investor; and
  • Simultaneous transfer to the borrower of amounts paid by the investor.

Note: The fees related to such transactions are also accounted for as loan placement fees.

Expired commitments or early repayment of loans – At the time that a loan commitment expires unused or is repaid before repayment is due, any related fees that had been deferred are recognized as revenue or expense.


Reporting Mortgage Banking Enterprise

An MBE must, on its balance sheet, distinguish between mortgage loans and mortgage-backed securities that are held for sale and those that are held for long-term investment.  The notes to the financial statements are to disclose whether the MBE used the aggregate method or the individual-loan method to determine the lower of cost or market.

ASC 942, Financial Services—Depository and Lending, contains specific capital disclosure requirements including, at a minimum:

[1].  A description of the minimum net worth requirements related to:

  • Secondary market investors, and
  • State-imposed regulatory mandates.

[2].  The actual or possible material effects of noncompliance with those requirements.

[3].  Whether the entity is in compliance with the regulatory capital requirements including, as of the date of each balance sheet presented, the following measures:

  • The amount of the entity’s required and actual net worth
  • Factors that may significantly affect adequacy of net worth such as potentially volatile components of capital, qualitative factors, or regulatory mandates.

[4].  If the entity is not in compliance with capital adequacy requirements as of the most recent balance sheet date, the possible material effects of that condition on amounts and disclosures in the financial statements.

[5].  Loan servicers with net worth requirements imposed by more than one source are to disclose the new worth requirements of:

  • Significant servicing covenants with secondary market investors with commonly defined servicing requirements;
  • Any other secondary market investor where violation of the net worth requirement would have an adverse effect on the business; and
  • The most restrictive third-party agreement if not already included in the above disclosures.
  • The standard points out that non-compliance with minimum net worth requirements may trigger substantial doubt about the entity’s ability to continue as a going concern.

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