Andy SchellCertified Public AccountantCertified Mortgage BankerCertified in Financial Forensics
Advanced Mortgage Accounting amp Mortgage Finance
AHACPALenderrsquos Update
December 3 2018
Andy Schell CPACFF CMB
Managing PartnerMortgage Banking Solutions
ldquoThe Profit Doctorrdquoon Lykken on Lending
Brief Biobull 35 years in Mortgage Financebull PhD Thesis (2020)
Economic Value of Financial Derivatives
bull Public Accounting in Texas amp Texas CPAbull Built Security Trading amp Valuation Modelsbull Ran Loan Accounting for Bank of Americabull Help CFOs Present Variance Analysisbull Manage Accounting System Installations
Margin Compression is RealMortgage Companies are facing
Insolvency Going Concern Risk and Qualified Opinions
Today We Explore hellipMortgage Finance
Advanced Mortgage Accounting
Presentation OutlineAdvanced Mortgage Accounting amp Hedging1 Hedging Overview amp Hedge Position Adjustment2 Market Value Change amp The Perfect Hedge3 Hedge Accounting amp Hedge Journal Entries4 More About the Derivative Asset 5 Transformational Costs Best Practices6 AICPA Market Value of Intangible Asset
Accountants must understand Hedgingbull to confirm that the activity is reasonable and bull to explain the results to management
Hedging Activity and Derivative Reporting are the most complicated aspect of Mortgage Banking
Purpose of Hedging
Preserving the Secondary Margin
Key Pointsbull Volatility - Interest rates fluctuate on a moment by moment basis
bull Value Sensitivity - The locked pipeline and warehouse are exposed to interest rate risk from the time a lock commitment is issued to a customer until the loan is sold
bull Hedge - The purpose of a hedge transaction is to create an offsetting financial event that has the direct inverse reaction to the value change of the underlying hedged asset
bull Loans go up Hedge goes down ndash Rates downbull Loans go down Hedge goes up ndash Rates up
2) Loan is Closed IRLC is FulfilledLender owns LHFS
3) Closed Loan Sold to BankBank Pays for Loans
Hedging Works when the
Past Predicts the Future
Multi-Variant Correlation
r2
r2 = Correlation Coefficient
BE
US Markets
World Markets
Borrower ldquoPUTrdquo
Pipeline
r2
TBA (hedge) MandatoryAOT
Price
Price Price Volume
Hedging Off-Setbull The hedge transaction
bull Establish a financial transaction that possess the same sensitivity to changes in the interest rate environment
bull But behaves with the opposite impact from rate changes
bull The LONG position or originating a loan behaves with an inverse relationship to the changes in interest rates
bull The SHORT position or selling an MBS has a positive correlation to changes in interest rates If rates go up the value of the short position goes up
bull Being Long and Short in the same transaction offsets or cancels the impact of changes in value from changes in the interest rate environment
bull This results in preserving the value of the underlying asset
Value of the loan and hedge react inversely to changes in rates
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
Objective is Recognition of Future Cash-Flows
PV of Discounted NET Future Cash-flows
Amortization Method or Fair Value MethodASC 860-50-35-9
IRLC under ASC 815An IRLC (Interest Rate Lock Commitment)
bull is an off balance sheet financial commitment bull subject to market risk and a bull derivative under SFAS 149 ASC 815 andbull subject MTM under SFAS 159 ASC 825
bull All IRLC are Derivatives (except for cost to complete)bull An IRLC hedged with Best Efforts is a derivativebull An IRLC hedged with a short MBS is a derivativebull The hedge strategy does not change the derivative
bull Derivatives under GAAPbull Recorded at Fair Value
bull Best Efforts Commitmentsbull Do not have a penalty for legitimate cancelationbull If loan is not closed the BE is canceled without costbull Avoidance of pair-off risk is not a derivative (most agree)bull Optional derivative under ASC 825-10-25
bull If IRLC is MTM and BE locks are not MTM bull Potential misrepresentation of gain positionbull Recommend all commitments are DerivativesMTM
ASC 815 ndash Hedge Accounting
The Interest Rate Lock Commitments ndash IRLC ndashbull IRLCs are initially issued to generate a profitbull The imbedded profit is valued at each reporting period bull The resulting gain is recorded as a Derivative Asset
bull It is very unlikely an IRLC will be a Derivative Liability
Hedge Positionbull TBA-MBS can generate a gain or loss
bull depending upon price movement since the date of salebull gain is reported as a Derivative Assetbull loss is reported as a Derivative Liability
+25 IRLCDerivative Asset Margin
Preservation
-50 TBADerivative Liability
+130 TBADerivative Asset
+70 IRLCDerivative Asset
Always consider loan gain with hedge gain or loss
Hedging Journal Entries
Warehouse bull The warehouse is comprised of two segments
ndash Committed or Allocated to Mandatory Commitmentndash Uncommitted or Hedged with Short TBA-MBS
bull The month-end MTM of the LHFS adjusts the basis of the LHFS creating a gain or loss in the PampL
Pipeline Hedgebull The month-end open TBA position MTM gain or loss is
posted to a Derivative Asset or Derivative Liability and a MTM gain or loss in PampL
Allocated and Unallocated LHFS
Secondary Marketing Data
You must get this informationhellipbull Do you Believe the numbers
(Mandatory Commitment MTM off-setting LHFS excluded in example)
WH Committed not in TBA Hedge- Valued based on purchase priceWH Uncommitted is in TBA Hedge- Valued by hedge advisor
MTM JE
bull Reverse the prior month MTM
bull Post Pair-Off AP or ARbull Post current month MTM
bull Significant changes in volume can impact the PampL
bull If hedge was gain Derivative Asset
bull Confirm everything with your Auditorbull All external reports must be GAAP
Derivative Asset increases CapitalWe Create a Derivative Asset bybull DR Derivative Asset CR Income
bull What happens to IRLC Income ndash Becomes Capital
IMBs want more Capitalbull More IRLC means more Incomebull More Income means more Capitalbull More Capital means more Warehouse borrowingbull More Capital means qualifying for FHA amp Agencybull More IRLC means more Capital
Derivative Asset
Is Confusing to Business Ownersand leads to bad decisions
Capital Accounts with Derivative AssetThe Derivative Asset is not carried at Fair Value because the Derivative Asset cannot be sold for the carrying value
During 2018 several companies failed Capital = $2 million Derivative Asset = $2 million
The Owner did not understand why they were insolvent
Disclose the Impact of the Derivative Asset in Capital Accountsbull Common Stockbull Paid In Capitalbull Distributionsbull Retained Earnings (Move IRLC MTM impact from NI to Unrealized Gain)bull Unrealized Gain(Loss)
Thanks to Oystein Konsmo CFO at Nova Financial for implementing this practice
Derivative Asset Characteristics
What is the Locked Pipeline
bull IRLC is a lock commitments issued to borrowers bull They are ldquoApplications in Processrdquo bull IRLC are commitments ndash not Loans bull There is no active market for IRLCbull There is no Asset to basis adjust for MTM
bull Is a TBA-MBS tradeable in its current form YES
bull Is a IRLC tradeable in its current form NO
bull The IRLC must be Transformed into a loan then securitized to be valued as tradeable instrument
bull Transformational Costs are unavoidable and undeniable
bull IRLC is not pure derivative but is derivative under GAAP
bull Absorption Costing is a way to understand the basis for Transformational Costs = Work in Process but is it not perfect
bull I think MSR valuation of cash flow is a more accurate measure
Is an IRLC a Tradable Asset
How have CPAs Presented theDerivative Asset
INCONSISTANTLY
Derivative Asset vs Pipeline
Small Independent Large Public
Source ndash A Greer CPA
bull Warehouse Lenders Rely on CPA for GAAP Capitalbull Lenderrsquos Observe CPA Auditorshellip
ndash Overstate Capital with DAndash Under-apply Cost to Completendash Inconsistently apply Costs to Complete
bull Warehouse Lenders reduce Derivative Asset ndash Some arbitrarily reduce by 50ndash Some reduce based on Net Future Cash Flows
Warehouse Lenderrsquos Adjustment
What about GAAP
bull What does GAAP say about Transformation Costs
bull Direct Cost Deduction Method - direct costs only
bull Full Cost Absorption Method - direct and indirect costs
bull IRLC is a pure derivative - IRLC same as TBA-MBS
bull Net Future Cash Flow Valuation Method (discussed soon)
Transformation Costs or Cost to Completebull What is the value of the IRLC
bull Pull-thru adjusted MTM less Costs to Complete
bull What is the right amount of Transformation Costsbull Direct Cost Deduction Method - direct costs onlybull Full Cost Absorption Method - both direct and indirect costsbull IRLC is a pure derivative ndash no adjustment (IRLC = TBA-MBS)
bull Uncertainty Principalndash Exponential diminishing impact to closingndash You have it when you have it otherwise uncertainndash Day of Lock 99 uncertainty Day before closing 1 uncertainty
IMB Transformational Costs ndash Best PracticesDirect Expenses
bull LO commissions production commissionsbull Other Direct Production Costs
bull appraisals outsourcing courier credit reports other cosbull Other Direct Expenses
bull LO wages processors LOA bull underwriting funding disclosure and post closing
Indirect Expensesbull Allocated Production Rent Branch Rent Branch Overhead
Consequence of Ignoring Indirect Costs
Hawaii vs TexasHigh Balance vs Low Balance
Loan Size Matters
Loan Size Dynamics ndash One Loanbull ONE LOAN
bull High Balance low gainbull Low Balance high gain
bull Derivative Asset
bull Processing costs as of loan are different
bull Profit is same
Higher Gain
$50000000 Locked Pipeline
bull Texas lender is more than double Hawaii
bull Identical Cash Realization
bull Indirect Costs Matter
Direct Costs Only - Distort Results
Derivative Asset Value
View From Finance
Present Value of Net Future Cash Flow
Same as MSR
Derivative Asset OoopsMany CPAs firms have issued opinions on financial statements with derivative asset values I would challenge as not reasonable
Changing Presentation method now creates exposure to Opinion Risk
There is presently no consensus among CPA Auditors about how to apply GAAP
What is the Value of the IRLC - DA
Day of Lock Day Before Closing
High ProbabilityRevenue less Commission
Value is approaching Revenue
UnIncurred Costs Decrease as Percentage of Completion Increases
Low ProbabilityRevenue less all Costs
Value is approaching Zero
What is the value of an Intangible Asset
The Derivative Asset is an Intangible Asset
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
IRLC under ASC 815
ASC 815 ndash Commitments
ASC 815 ndash Hedge Accounting
Slide Number 41
Slide Number 42
Slide Number 43
Slide Number 44
Slide Number 45
Slide Number 46
Slide Number 47
Derivative Asset increases Capital
Slide Number 49
Slide Number 50
Slide Number 51
What is the Locked Pipeline
Slide Number 53
Slide Number 54
Slide Number 55
Slide Number 56
What about GAAP
Transformation Costs or Cost to Complete
IMB Transformational Costs ndash Best Practices
Slide Number 60
Slide Number 61
Slide Number 62
Slide Number 63
Derivative Asset Ooops
What is the Value of the IRLC - DA
Slide Number 66
AICPA Valuation Services
AICPA - Discounted Future Benefit
Hedging Data for DA Valuation
Percentage of Completion by Status
Net Cash Flow Valuation Data
IRLC-DA Grows in Value as Costs Incurred
Lock to LHFS DA Value Accretion
Revenue Potential vs Derivative Asset
GAAP Methods Only Right Once
Slide Number 76
IRLC Value is What You Negotiate
Slide Number 78
Slide Number 79
FASB Board Meeting ndash 32818
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
Slide Number 83
IRLC is Taxable when Recorded - BUT
Slide Number 85
Slide Number 86
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
PampL - with and without IRLC
IRLC Revenue is Confusing
Slide Number 91
Slide Number 92
Slide Number 93
Slide Number 94
Slide Number 95
Slide Number 96
Balance Sheet or Commitment
Gain or (Loss)
Warehouse - committed
$1000000000
$10000000
(1)
Pair-Off trades - closed not settled
($800000)
(2)
Locked Pipeline (net of pull-thru)
$3000000000
$30000000
(3)
Warehouse ndash not committed
$45000000
$450000
(4)
Hedge
$2700000000
($27000000)
(5)
Balance Sheet amp Income Statement Accounts
Assets
Cash
$1000000
Loans Held for Sale
$10000000
Loans Held for Sale
$450000
Loans Held for Sale
$100000
(1)
Loans Held for Sale
$4500
(4)
AR Loan Sales (not GAAP)
AR Pair Off
Derivative Asset (MTM gains)
$300000
(3)
Liabilities
Warehouse loan
$10000000
AP Commission
AP Pair-Off
$8000
(2)
Borrower Escrow
$450000
Derivative Liability (MTM losses)
$270000
(5)
Capital
MTM valuation
Retained Earning
$1000000
Revenue
MTM Gain or Loss (gain)
$100000
(1)
MTM Gain or Loss (gain)
$300000
(3)
MTM Gain or Loss (gain)
$4500
(4)
Expense
Pair-Off Gain or Loss (loss)
$8000
(2)
MTM Gain or Loss (loss)
$270000
(5)
$12132500
$12132500
Journal Entries
Warehouse Loans with Purchase Commitment (value based on purchase commitment)
If gain
Debit Loans Held For Sale
$10000000
Credit MTM Gain or Loss
$10000000
If loss
Debit MTM Gain of Loss
$10000000
Credit Loans Held For Sale
$10000000
Pair-Offs (value based on closed trade)
If gain
Debit Pair-Off Receivable
$800000
Credit Pair-Off Gain or Loss
$800000
If loss
Debit Pair-Off Gain or Loss
$800000
Credit Pair-Off Payable
$800000
Warehouse Loans without Purchase Commitment MTM (value at month-end)
If gain
Debit Loans Held for Sale
$450000
Credit MTM Gain or Loss^
$450000
If loss
Debit MTM Gain or Loss^
$450000
Credit Loans Held for Sale
$450000
Locked Pipeline MTM (pull-thru adjusted)
If gain
Debit Derivative Asset
$30000000
Credit MTM Gain or Loss^
$30000000
If loss
Debit MTM Gain or Loss^
$30000000
Credit Derivative Liability
$30000000
Hedge MTM
If gain
Debit Derivative Asset
$27000000
Credit MTM Gain or Loss^
$27000000
If loss
Debit MTM Gain or Loss^
$27000000
Credit Derivative Liability
$27000000
or Gain on Sale for mgmt reporting (not GAAP)
^ or MTM valuation in Capital for mgmt reporting (not GAAP)
Andy Schell CPACFF CMB
Managing PartnerMortgage Banking Solutions
ldquoThe Profit Doctorrdquoon Lykken on Lending
Brief Biobull 35 years in Mortgage Financebull PhD Thesis (2020)
Economic Value of Financial Derivatives
bull Public Accounting in Texas amp Texas CPAbull Built Security Trading amp Valuation Modelsbull Ran Loan Accounting for Bank of Americabull Help CFOs Present Variance Analysisbull Manage Accounting System Installations
Margin Compression is RealMortgage Companies are facing
Insolvency Going Concern Risk and Qualified Opinions
Today We Explore hellipMortgage Finance
Advanced Mortgage Accounting
Presentation OutlineAdvanced Mortgage Accounting amp Hedging1 Hedging Overview amp Hedge Position Adjustment2 Market Value Change amp The Perfect Hedge3 Hedge Accounting amp Hedge Journal Entries4 More About the Derivative Asset 5 Transformational Costs Best Practices6 AICPA Market Value of Intangible Asset
Accountants must understand Hedgingbull to confirm that the activity is reasonable and bull to explain the results to management
Hedging Activity and Derivative Reporting are the most complicated aspect of Mortgage Banking
Purpose of Hedging
Preserving the Secondary Margin
Key Pointsbull Volatility - Interest rates fluctuate on a moment by moment basis
bull Value Sensitivity - The locked pipeline and warehouse are exposed to interest rate risk from the time a lock commitment is issued to a customer until the loan is sold
bull Hedge - The purpose of a hedge transaction is to create an offsetting financial event that has the direct inverse reaction to the value change of the underlying hedged asset
bull Loans go up Hedge goes down ndash Rates downbull Loans go down Hedge goes up ndash Rates up
2) Loan is Closed IRLC is FulfilledLender owns LHFS
3) Closed Loan Sold to BankBank Pays for Loans
Hedging Works when the
Past Predicts the Future
Multi-Variant Correlation
r2
r2 = Correlation Coefficient
BE
US Markets
World Markets
Borrower ldquoPUTrdquo
Pipeline
r2
TBA (hedge) MandatoryAOT
Price
Price Price Volume
Hedging Off-Setbull The hedge transaction
bull Establish a financial transaction that possess the same sensitivity to changes in the interest rate environment
bull But behaves with the opposite impact from rate changes
bull The LONG position or originating a loan behaves with an inverse relationship to the changes in interest rates
bull The SHORT position or selling an MBS has a positive correlation to changes in interest rates If rates go up the value of the short position goes up
bull Being Long and Short in the same transaction offsets or cancels the impact of changes in value from changes in the interest rate environment
bull This results in preserving the value of the underlying asset
Value of the loan and hedge react inversely to changes in rates
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
Objective is Recognition of Future Cash-Flows
PV of Discounted NET Future Cash-flows
Amortization Method or Fair Value MethodASC 860-50-35-9
IRLC under ASC 815An IRLC (Interest Rate Lock Commitment)
bull is an off balance sheet financial commitment bull subject to market risk and a bull derivative under SFAS 149 ASC 815 andbull subject MTM under SFAS 159 ASC 825
bull All IRLC are Derivatives (except for cost to complete)bull An IRLC hedged with Best Efforts is a derivativebull An IRLC hedged with a short MBS is a derivativebull The hedge strategy does not change the derivative
bull Derivatives under GAAPbull Recorded at Fair Value
bull Best Efforts Commitmentsbull Do not have a penalty for legitimate cancelationbull If loan is not closed the BE is canceled without costbull Avoidance of pair-off risk is not a derivative (most agree)bull Optional derivative under ASC 825-10-25
bull If IRLC is MTM and BE locks are not MTM bull Potential misrepresentation of gain positionbull Recommend all commitments are DerivativesMTM
ASC 815 ndash Hedge Accounting
The Interest Rate Lock Commitments ndash IRLC ndashbull IRLCs are initially issued to generate a profitbull The imbedded profit is valued at each reporting period bull The resulting gain is recorded as a Derivative Asset
bull It is very unlikely an IRLC will be a Derivative Liability
Hedge Positionbull TBA-MBS can generate a gain or loss
bull depending upon price movement since the date of salebull gain is reported as a Derivative Assetbull loss is reported as a Derivative Liability
+25 IRLCDerivative Asset Margin
Preservation
-50 TBADerivative Liability
+130 TBADerivative Asset
+70 IRLCDerivative Asset
Always consider loan gain with hedge gain or loss
Hedging Journal Entries
Warehouse bull The warehouse is comprised of two segments
ndash Committed or Allocated to Mandatory Commitmentndash Uncommitted or Hedged with Short TBA-MBS
bull The month-end MTM of the LHFS adjusts the basis of the LHFS creating a gain or loss in the PampL
Pipeline Hedgebull The month-end open TBA position MTM gain or loss is
posted to a Derivative Asset or Derivative Liability and a MTM gain or loss in PampL
Allocated and Unallocated LHFS
Secondary Marketing Data
You must get this informationhellipbull Do you Believe the numbers
(Mandatory Commitment MTM off-setting LHFS excluded in example)
WH Committed not in TBA Hedge- Valued based on purchase priceWH Uncommitted is in TBA Hedge- Valued by hedge advisor
MTM JE
bull Reverse the prior month MTM
bull Post Pair-Off AP or ARbull Post current month MTM
bull Significant changes in volume can impact the PampL
bull If hedge was gain Derivative Asset
bull Confirm everything with your Auditorbull All external reports must be GAAP
Derivative Asset increases CapitalWe Create a Derivative Asset bybull DR Derivative Asset CR Income
bull What happens to IRLC Income ndash Becomes Capital
IMBs want more Capitalbull More IRLC means more Incomebull More Income means more Capitalbull More Capital means more Warehouse borrowingbull More Capital means qualifying for FHA amp Agencybull More IRLC means more Capital
Derivative Asset
Is Confusing to Business Ownersand leads to bad decisions
Capital Accounts with Derivative AssetThe Derivative Asset is not carried at Fair Value because the Derivative Asset cannot be sold for the carrying value
During 2018 several companies failed Capital = $2 million Derivative Asset = $2 million
The Owner did not understand why they were insolvent
Disclose the Impact of the Derivative Asset in Capital Accountsbull Common Stockbull Paid In Capitalbull Distributionsbull Retained Earnings (Move IRLC MTM impact from NI to Unrealized Gain)bull Unrealized Gain(Loss)
Thanks to Oystein Konsmo CFO at Nova Financial for implementing this practice
Derivative Asset Characteristics
What is the Locked Pipeline
bull IRLC is a lock commitments issued to borrowers bull They are ldquoApplications in Processrdquo bull IRLC are commitments ndash not Loans bull There is no active market for IRLCbull There is no Asset to basis adjust for MTM
bull Is a TBA-MBS tradeable in its current form YES
bull Is a IRLC tradeable in its current form NO
bull The IRLC must be Transformed into a loan then securitized to be valued as tradeable instrument
bull Transformational Costs are unavoidable and undeniable
bull IRLC is not pure derivative but is derivative under GAAP
bull Absorption Costing is a way to understand the basis for Transformational Costs = Work in Process but is it not perfect
bull I think MSR valuation of cash flow is a more accurate measure
Is an IRLC a Tradable Asset
How have CPAs Presented theDerivative Asset
INCONSISTANTLY
Derivative Asset vs Pipeline
Small Independent Large Public
Source ndash A Greer CPA
bull Warehouse Lenders Rely on CPA for GAAP Capitalbull Lenderrsquos Observe CPA Auditorshellip
ndash Overstate Capital with DAndash Under-apply Cost to Completendash Inconsistently apply Costs to Complete
bull Warehouse Lenders reduce Derivative Asset ndash Some arbitrarily reduce by 50ndash Some reduce based on Net Future Cash Flows
Warehouse Lenderrsquos Adjustment
What about GAAP
bull What does GAAP say about Transformation Costs
bull Direct Cost Deduction Method - direct costs only
bull Full Cost Absorption Method - direct and indirect costs
bull IRLC is a pure derivative - IRLC same as TBA-MBS
bull Net Future Cash Flow Valuation Method (discussed soon)
Transformation Costs or Cost to Completebull What is the value of the IRLC
bull Pull-thru adjusted MTM less Costs to Complete
bull What is the right amount of Transformation Costsbull Direct Cost Deduction Method - direct costs onlybull Full Cost Absorption Method - both direct and indirect costsbull IRLC is a pure derivative ndash no adjustment (IRLC = TBA-MBS)
bull Uncertainty Principalndash Exponential diminishing impact to closingndash You have it when you have it otherwise uncertainndash Day of Lock 99 uncertainty Day before closing 1 uncertainty
IMB Transformational Costs ndash Best PracticesDirect Expenses
bull LO commissions production commissionsbull Other Direct Production Costs
bull appraisals outsourcing courier credit reports other cosbull Other Direct Expenses
bull LO wages processors LOA bull underwriting funding disclosure and post closing
Indirect Expensesbull Allocated Production Rent Branch Rent Branch Overhead
Consequence of Ignoring Indirect Costs
Hawaii vs TexasHigh Balance vs Low Balance
Loan Size Matters
Loan Size Dynamics ndash One Loanbull ONE LOAN
bull High Balance low gainbull Low Balance high gain
bull Derivative Asset
bull Processing costs as of loan are different
bull Profit is same
Higher Gain
$50000000 Locked Pipeline
bull Texas lender is more than double Hawaii
bull Identical Cash Realization
bull Indirect Costs Matter
Direct Costs Only - Distort Results
Derivative Asset Value
View From Finance
Present Value of Net Future Cash Flow
Same as MSR
Derivative Asset OoopsMany CPAs firms have issued opinions on financial statements with derivative asset values I would challenge as not reasonable
Changing Presentation method now creates exposure to Opinion Risk
There is presently no consensus among CPA Auditors about how to apply GAAP
What is the Value of the IRLC - DA
Day of Lock Day Before Closing
High ProbabilityRevenue less Commission
Value is approaching Revenue
UnIncurred Costs Decrease as Percentage of Completion Increases
Low ProbabilityRevenue less all Costs
Value is approaching Zero
What is the value of an Intangible Asset
The Derivative Asset is an Intangible Asset
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
IRLC under ASC 815
ASC 815 ndash Commitments
ASC 815 ndash Hedge Accounting
Slide Number 41
Slide Number 42
Slide Number 43
Slide Number 44
Slide Number 45
Slide Number 46
Slide Number 47
Derivative Asset increases Capital
Slide Number 49
Slide Number 50
Slide Number 51
What is the Locked Pipeline
Slide Number 53
Slide Number 54
Slide Number 55
Slide Number 56
What about GAAP
Transformation Costs or Cost to Complete
IMB Transformational Costs ndash Best Practices
Slide Number 60
Slide Number 61
Slide Number 62
Slide Number 63
Derivative Asset Ooops
What is the Value of the IRLC - DA
Slide Number 66
AICPA Valuation Services
AICPA - Discounted Future Benefit
Hedging Data for DA Valuation
Percentage of Completion by Status
Net Cash Flow Valuation Data
IRLC-DA Grows in Value as Costs Incurred
Lock to LHFS DA Value Accretion
Revenue Potential vs Derivative Asset
GAAP Methods Only Right Once
Slide Number 76
IRLC Value is What You Negotiate
Slide Number 78
Slide Number 79
FASB Board Meeting ndash 32818
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
Slide Number 83
IRLC is Taxable when Recorded - BUT
Slide Number 85
Slide Number 86
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
PampL - with and without IRLC
IRLC Revenue is Confusing
Slide Number 91
Slide Number 92
Slide Number 93
Slide Number 94
Slide Number 95
Slide Number 96
Balance Sheet or Commitment
Gain or (Loss)
Warehouse - committed
$1000000000
$10000000
(1)
Pair-Off trades - closed not settled
($800000)
(2)
Locked Pipeline (net of pull-thru)
$3000000000
$30000000
(3)
Warehouse ndash not committed
$45000000
$450000
(4)
Hedge
$2700000000
($27000000)
(5)
Balance Sheet amp Income Statement Accounts
Assets
Cash
$1000000
Loans Held for Sale
$10000000
Loans Held for Sale
$450000
Loans Held for Sale
$100000
(1)
Loans Held for Sale
$4500
(4)
AR Loan Sales (not GAAP)
AR Pair Off
Derivative Asset (MTM gains)
$300000
(3)
Liabilities
Warehouse loan
$10000000
AP Commission
AP Pair-Off
$8000
(2)
Borrower Escrow
$450000
Derivative Liability (MTM losses)
$270000
(5)
Capital
MTM valuation
Retained Earning
$1000000
Revenue
MTM Gain or Loss (gain)
$100000
(1)
MTM Gain or Loss (gain)
$300000
(3)
MTM Gain or Loss (gain)
$4500
(4)
Expense
Pair-Off Gain or Loss (loss)
$8000
(2)
MTM Gain or Loss (loss)
$270000
(5)
$12132500
$12132500
Journal Entries
Warehouse Loans with Purchase Commitment (value based on purchase commitment)
If gain
Debit Loans Held For Sale
$10000000
Credit MTM Gain or Loss
$10000000
If loss
Debit MTM Gain of Loss
$10000000
Credit Loans Held For Sale
$10000000
Pair-Offs (value based on closed trade)
If gain
Debit Pair-Off Receivable
$800000
Credit Pair-Off Gain or Loss
$800000
If loss
Debit Pair-Off Gain or Loss
$800000
Credit Pair-Off Payable
$800000
Warehouse Loans without Purchase Commitment MTM (value at month-end)
If gain
Debit Loans Held for Sale
$450000
Credit MTM Gain or Loss^
$450000
If loss
Debit MTM Gain or Loss^
$450000
Credit Loans Held for Sale
$450000
Locked Pipeline MTM (pull-thru adjusted)
If gain
Debit Derivative Asset
$30000000
Credit MTM Gain or Loss^
$30000000
If loss
Debit MTM Gain or Loss^
$30000000
Credit Derivative Liability
$30000000
Hedge MTM
If gain
Debit Derivative Asset
$27000000
Credit MTM Gain or Loss^
$27000000
If loss
Debit MTM Gain or Loss^
$27000000
Credit Derivative Liability
$27000000
or Gain on Sale for mgmt reporting (not GAAP)
^ or MTM valuation in Capital for mgmt reporting (not GAAP)
Margin Compression is RealMortgage Companies are facing
Insolvency Going Concern Risk and Qualified Opinions
Today We Explore hellipMortgage Finance
Advanced Mortgage Accounting
Presentation OutlineAdvanced Mortgage Accounting amp Hedging1 Hedging Overview amp Hedge Position Adjustment2 Market Value Change amp The Perfect Hedge3 Hedge Accounting amp Hedge Journal Entries4 More About the Derivative Asset 5 Transformational Costs Best Practices6 AICPA Market Value of Intangible Asset
Accountants must understand Hedgingbull to confirm that the activity is reasonable and bull to explain the results to management
Hedging Activity and Derivative Reporting are the most complicated aspect of Mortgage Banking
Purpose of Hedging
Preserving the Secondary Margin
Key Pointsbull Volatility - Interest rates fluctuate on a moment by moment basis
bull Value Sensitivity - The locked pipeline and warehouse are exposed to interest rate risk from the time a lock commitment is issued to a customer until the loan is sold
bull Hedge - The purpose of a hedge transaction is to create an offsetting financial event that has the direct inverse reaction to the value change of the underlying hedged asset
bull Loans go up Hedge goes down ndash Rates downbull Loans go down Hedge goes up ndash Rates up
2) Loan is Closed IRLC is FulfilledLender owns LHFS
3) Closed Loan Sold to BankBank Pays for Loans
Hedging Works when the
Past Predicts the Future
Multi-Variant Correlation
r2
r2 = Correlation Coefficient
BE
US Markets
World Markets
Borrower ldquoPUTrdquo
Pipeline
r2
TBA (hedge) MandatoryAOT
Price
Price Price Volume
Hedging Off-Setbull The hedge transaction
bull Establish a financial transaction that possess the same sensitivity to changes in the interest rate environment
bull But behaves with the opposite impact from rate changes
bull The LONG position or originating a loan behaves with an inverse relationship to the changes in interest rates
bull The SHORT position or selling an MBS has a positive correlation to changes in interest rates If rates go up the value of the short position goes up
bull Being Long and Short in the same transaction offsets or cancels the impact of changes in value from changes in the interest rate environment
bull This results in preserving the value of the underlying asset
Value of the loan and hedge react inversely to changes in rates
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
Objective is Recognition of Future Cash-Flows
PV of Discounted NET Future Cash-flows
Amortization Method or Fair Value MethodASC 860-50-35-9
IRLC under ASC 815An IRLC (Interest Rate Lock Commitment)
bull is an off balance sheet financial commitment bull subject to market risk and a bull derivative under SFAS 149 ASC 815 andbull subject MTM under SFAS 159 ASC 825
bull All IRLC are Derivatives (except for cost to complete)bull An IRLC hedged with Best Efforts is a derivativebull An IRLC hedged with a short MBS is a derivativebull The hedge strategy does not change the derivative
bull Derivatives under GAAPbull Recorded at Fair Value
bull Best Efforts Commitmentsbull Do not have a penalty for legitimate cancelationbull If loan is not closed the BE is canceled without costbull Avoidance of pair-off risk is not a derivative (most agree)bull Optional derivative under ASC 825-10-25
bull If IRLC is MTM and BE locks are not MTM bull Potential misrepresentation of gain positionbull Recommend all commitments are DerivativesMTM
ASC 815 ndash Hedge Accounting
The Interest Rate Lock Commitments ndash IRLC ndashbull IRLCs are initially issued to generate a profitbull The imbedded profit is valued at each reporting period bull The resulting gain is recorded as a Derivative Asset
bull It is very unlikely an IRLC will be a Derivative Liability
Hedge Positionbull TBA-MBS can generate a gain or loss
bull depending upon price movement since the date of salebull gain is reported as a Derivative Assetbull loss is reported as a Derivative Liability
+25 IRLCDerivative Asset Margin
Preservation
-50 TBADerivative Liability
+130 TBADerivative Asset
+70 IRLCDerivative Asset
Always consider loan gain with hedge gain or loss
Hedging Journal Entries
Warehouse bull The warehouse is comprised of two segments
ndash Committed or Allocated to Mandatory Commitmentndash Uncommitted or Hedged with Short TBA-MBS
bull The month-end MTM of the LHFS adjusts the basis of the LHFS creating a gain or loss in the PampL
Pipeline Hedgebull The month-end open TBA position MTM gain or loss is
posted to a Derivative Asset or Derivative Liability and a MTM gain or loss in PampL
Allocated and Unallocated LHFS
Secondary Marketing Data
You must get this informationhellipbull Do you Believe the numbers
(Mandatory Commitment MTM off-setting LHFS excluded in example)
WH Committed not in TBA Hedge- Valued based on purchase priceWH Uncommitted is in TBA Hedge- Valued by hedge advisor
MTM JE
bull Reverse the prior month MTM
bull Post Pair-Off AP or ARbull Post current month MTM
bull Significant changes in volume can impact the PampL
bull If hedge was gain Derivative Asset
bull Confirm everything with your Auditorbull All external reports must be GAAP
Derivative Asset increases CapitalWe Create a Derivative Asset bybull DR Derivative Asset CR Income
bull What happens to IRLC Income ndash Becomes Capital
IMBs want more Capitalbull More IRLC means more Incomebull More Income means more Capitalbull More Capital means more Warehouse borrowingbull More Capital means qualifying for FHA amp Agencybull More IRLC means more Capital
Derivative Asset
Is Confusing to Business Ownersand leads to bad decisions
Capital Accounts with Derivative AssetThe Derivative Asset is not carried at Fair Value because the Derivative Asset cannot be sold for the carrying value
During 2018 several companies failed Capital = $2 million Derivative Asset = $2 million
The Owner did not understand why they were insolvent
Disclose the Impact of the Derivative Asset in Capital Accountsbull Common Stockbull Paid In Capitalbull Distributionsbull Retained Earnings (Move IRLC MTM impact from NI to Unrealized Gain)bull Unrealized Gain(Loss)
Thanks to Oystein Konsmo CFO at Nova Financial for implementing this practice
Derivative Asset Characteristics
What is the Locked Pipeline
bull IRLC is a lock commitments issued to borrowers bull They are ldquoApplications in Processrdquo bull IRLC are commitments ndash not Loans bull There is no active market for IRLCbull There is no Asset to basis adjust for MTM
bull Is a TBA-MBS tradeable in its current form YES
bull Is a IRLC tradeable in its current form NO
bull The IRLC must be Transformed into a loan then securitized to be valued as tradeable instrument
bull Transformational Costs are unavoidable and undeniable
bull IRLC is not pure derivative but is derivative under GAAP
bull Absorption Costing is a way to understand the basis for Transformational Costs = Work in Process but is it not perfect
bull I think MSR valuation of cash flow is a more accurate measure
Is an IRLC a Tradable Asset
How have CPAs Presented theDerivative Asset
INCONSISTANTLY
Derivative Asset vs Pipeline
Small Independent Large Public
Source ndash A Greer CPA
bull Warehouse Lenders Rely on CPA for GAAP Capitalbull Lenderrsquos Observe CPA Auditorshellip
ndash Overstate Capital with DAndash Under-apply Cost to Completendash Inconsistently apply Costs to Complete
bull Warehouse Lenders reduce Derivative Asset ndash Some arbitrarily reduce by 50ndash Some reduce based on Net Future Cash Flows
Warehouse Lenderrsquos Adjustment
What about GAAP
bull What does GAAP say about Transformation Costs
bull Direct Cost Deduction Method - direct costs only
bull Full Cost Absorption Method - direct and indirect costs
bull IRLC is a pure derivative - IRLC same as TBA-MBS
bull Net Future Cash Flow Valuation Method (discussed soon)
Transformation Costs or Cost to Completebull What is the value of the IRLC
bull Pull-thru adjusted MTM less Costs to Complete
bull What is the right amount of Transformation Costsbull Direct Cost Deduction Method - direct costs onlybull Full Cost Absorption Method - both direct and indirect costsbull IRLC is a pure derivative ndash no adjustment (IRLC = TBA-MBS)
bull Uncertainty Principalndash Exponential diminishing impact to closingndash You have it when you have it otherwise uncertainndash Day of Lock 99 uncertainty Day before closing 1 uncertainty
IMB Transformational Costs ndash Best PracticesDirect Expenses
bull LO commissions production commissionsbull Other Direct Production Costs
bull appraisals outsourcing courier credit reports other cosbull Other Direct Expenses
bull LO wages processors LOA bull underwriting funding disclosure and post closing
Indirect Expensesbull Allocated Production Rent Branch Rent Branch Overhead
Consequence of Ignoring Indirect Costs
Hawaii vs TexasHigh Balance vs Low Balance
Loan Size Matters
Loan Size Dynamics ndash One Loanbull ONE LOAN
bull High Balance low gainbull Low Balance high gain
bull Derivative Asset
bull Processing costs as of loan are different
bull Profit is same
Higher Gain
$50000000 Locked Pipeline
bull Texas lender is more than double Hawaii
bull Identical Cash Realization
bull Indirect Costs Matter
Direct Costs Only - Distort Results
Derivative Asset Value
View From Finance
Present Value of Net Future Cash Flow
Same as MSR
Derivative Asset OoopsMany CPAs firms have issued opinions on financial statements with derivative asset values I would challenge as not reasonable
Changing Presentation method now creates exposure to Opinion Risk
There is presently no consensus among CPA Auditors about how to apply GAAP
What is the Value of the IRLC - DA
Day of Lock Day Before Closing
High ProbabilityRevenue less Commission
Value is approaching Revenue
UnIncurred Costs Decrease as Percentage of Completion Increases
Low ProbabilityRevenue less all Costs
Value is approaching Zero
What is the value of an Intangible Asset
The Derivative Asset is an Intangible Asset
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
IRLC under ASC 815
ASC 815 ndash Commitments
ASC 815 ndash Hedge Accounting
Slide Number 41
Slide Number 42
Slide Number 43
Slide Number 44
Slide Number 45
Slide Number 46
Slide Number 47
Derivative Asset increases Capital
Slide Number 49
Slide Number 50
Slide Number 51
What is the Locked Pipeline
Slide Number 53
Slide Number 54
Slide Number 55
Slide Number 56
What about GAAP
Transformation Costs or Cost to Complete
IMB Transformational Costs ndash Best Practices
Slide Number 60
Slide Number 61
Slide Number 62
Slide Number 63
Derivative Asset Ooops
What is the Value of the IRLC - DA
Slide Number 66
AICPA Valuation Services
AICPA - Discounted Future Benefit
Hedging Data for DA Valuation
Percentage of Completion by Status
Net Cash Flow Valuation Data
IRLC-DA Grows in Value as Costs Incurred
Lock to LHFS DA Value Accretion
Revenue Potential vs Derivative Asset
GAAP Methods Only Right Once
Slide Number 76
IRLC Value is What You Negotiate
Slide Number 78
Slide Number 79
FASB Board Meeting ndash 32818
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
Slide Number 83
IRLC is Taxable when Recorded - BUT
Slide Number 85
Slide Number 86
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
PampL - with and without IRLC
IRLC Revenue is Confusing
Slide Number 91
Slide Number 92
Slide Number 93
Slide Number 94
Slide Number 95
Slide Number 96
Balance Sheet or Commitment
Gain or (Loss)
Warehouse - committed
$1000000000
$10000000
(1)
Pair-Off trades - closed not settled
($800000)
(2)
Locked Pipeline (net of pull-thru)
$3000000000
$30000000
(3)
Warehouse ndash not committed
$45000000
$450000
(4)
Hedge
$2700000000
($27000000)
(5)
Balance Sheet amp Income Statement Accounts
Assets
Cash
$1000000
Loans Held for Sale
$10000000
Loans Held for Sale
$450000
Loans Held for Sale
$100000
(1)
Loans Held for Sale
$4500
(4)
AR Loan Sales (not GAAP)
AR Pair Off
Derivative Asset (MTM gains)
$300000
(3)
Liabilities
Warehouse loan
$10000000
AP Commission
AP Pair-Off
$8000
(2)
Borrower Escrow
$450000
Derivative Liability (MTM losses)
$270000
(5)
Capital
MTM valuation
Retained Earning
$1000000
Revenue
MTM Gain or Loss (gain)
$100000
(1)
MTM Gain or Loss (gain)
$300000
(3)
MTM Gain or Loss (gain)
$4500
(4)
Expense
Pair-Off Gain or Loss (loss)
$8000
(2)
MTM Gain or Loss (loss)
$270000
(5)
$12132500
$12132500
Journal Entries
Warehouse Loans with Purchase Commitment (value based on purchase commitment)
If gain
Debit Loans Held For Sale
$10000000
Credit MTM Gain or Loss
$10000000
If loss
Debit MTM Gain of Loss
$10000000
Credit Loans Held For Sale
$10000000
Pair-Offs (value based on closed trade)
If gain
Debit Pair-Off Receivable
$800000
Credit Pair-Off Gain or Loss
$800000
If loss
Debit Pair-Off Gain or Loss
$800000
Credit Pair-Off Payable
$800000
Warehouse Loans without Purchase Commitment MTM (value at month-end)
If gain
Debit Loans Held for Sale
$450000
Credit MTM Gain or Loss^
$450000
If loss
Debit MTM Gain or Loss^
$450000
Credit Loans Held for Sale
$450000
Locked Pipeline MTM (pull-thru adjusted)
If gain
Debit Derivative Asset
$30000000
Credit MTM Gain or Loss^
$30000000
If loss
Debit MTM Gain or Loss^
$30000000
Credit Derivative Liability
$30000000
Hedge MTM
If gain
Debit Derivative Asset
$27000000
Credit MTM Gain or Loss^
$27000000
If loss
Debit MTM Gain or Loss^
$27000000
Credit Derivative Liability
$27000000
or Gain on Sale for mgmt reporting (not GAAP)
^ or MTM valuation in Capital for mgmt reporting (not GAAP)
Presentation OutlineAdvanced Mortgage Accounting amp Hedging1 Hedging Overview amp Hedge Position Adjustment2 Market Value Change amp The Perfect Hedge3 Hedge Accounting amp Hedge Journal Entries4 More About the Derivative Asset 5 Transformational Costs Best Practices6 AICPA Market Value of Intangible Asset
Accountants must understand Hedgingbull to confirm that the activity is reasonable and bull to explain the results to management
Hedging Activity and Derivative Reporting are the most complicated aspect of Mortgage Banking
Purpose of Hedging
Preserving the Secondary Margin
Key Pointsbull Volatility - Interest rates fluctuate on a moment by moment basis
bull Value Sensitivity - The locked pipeline and warehouse are exposed to interest rate risk from the time a lock commitment is issued to a customer until the loan is sold
bull Hedge - The purpose of a hedge transaction is to create an offsetting financial event that has the direct inverse reaction to the value change of the underlying hedged asset
bull Loans go up Hedge goes down ndash Rates downbull Loans go down Hedge goes up ndash Rates up
2) Loan is Closed IRLC is FulfilledLender owns LHFS
3) Closed Loan Sold to BankBank Pays for Loans
Hedging Works when the
Past Predicts the Future
Multi-Variant Correlation
r2
r2 = Correlation Coefficient
BE
US Markets
World Markets
Borrower ldquoPUTrdquo
Pipeline
r2
TBA (hedge) MandatoryAOT
Price
Price Price Volume
Hedging Off-Setbull The hedge transaction
bull Establish a financial transaction that possess the same sensitivity to changes in the interest rate environment
bull But behaves with the opposite impact from rate changes
bull The LONG position or originating a loan behaves with an inverse relationship to the changes in interest rates
bull The SHORT position or selling an MBS has a positive correlation to changes in interest rates If rates go up the value of the short position goes up
bull Being Long and Short in the same transaction offsets or cancels the impact of changes in value from changes in the interest rate environment
bull This results in preserving the value of the underlying asset
Value of the loan and hedge react inversely to changes in rates
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
Objective is Recognition of Future Cash-Flows
PV of Discounted NET Future Cash-flows
Amortization Method or Fair Value MethodASC 860-50-35-9
IRLC under ASC 815An IRLC (Interest Rate Lock Commitment)
bull is an off balance sheet financial commitment bull subject to market risk and a bull derivative under SFAS 149 ASC 815 andbull subject MTM under SFAS 159 ASC 825
bull All IRLC are Derivatives (except for cost to complete)bull An IRLC hedged with Best Efforts is a derivativebull An IRLC hedged with a short MBS is a derivativebull The hedge strategy does not change the derivative
bull Derivatives under GAAPbull Recorded at Fair Value
bull Best Efforts Commitmentsbull Do not have a penalty for legitimate cancelationbull If loan is not closed the BE is canceled without costbull Avoidance of pair-off risk is not a derivative (most agree)bull Optional derivative under ASC 825-10-25
bull If IRLC is MTM and BE locks are not MTM bull Potential misrepresentation of gain positionbull Recommend all commitments are DerivativesMTM
ASC 815 ndash Hedge Accounting
The Interest Rate Lock Commitments ndash IRLC ndashbull IRLCs are initially issued to generate a profitbull The imbedded profit is valued at each reporting period bull The resulting gain is recorded as a Derivative Asset
bull It is very unlikely an IRLC will be a Derivative Liability
Hedge Positionbull TBA-MBS can generate a gain or loss
bull depending upon price movement since the date of salebull gain is reported as a Derivative Assetbull loss is reported as a Derivative Liability
+25 IRLCDerivative Asset Margin
Preservation
-50 TBADerivative Liability
+130 TBADerivative Asset
+70 IRLCDerivative Asset
Always consider loan gain with hedge gain or loss
Hedging Journal Entries
Warehouse bull The warehouse is comprised of two segments
ndash Committed or Allocated to Mandatory Commitmentndash Uncommitted or Hedged with Short TBA-MBS
bull The month-end MTM of the LHFS adjusts the basis of the LHFS creating a gain or loss in the PampL
Pipeline Hedgebull The month-end open TBA position MTM gain or loss is
posted to a Derivative Asset or Derivative Liability and a MTM gain or loss in PampL
Allocated and Unallocated LHFS
Secondary Marketing Data
You must get this informationhellipbull Do you Believe the numbers
(Mandatory Commitment MTM off-setting LHFS excluded in example)
WH Committed not in TBA Hedge- Valued based on purchase priceWH Uncommitted is in TBA Hedge- Valued by hedge advisor
MTM JE
bull Reverse the prior month MTM
bull Post Pair-Off AP or ARbull Post current month MTM
bull Significant changes in volume can impact the PampL
bull If hedge was gain Derivative Asset
bull Confirm everything with your Auditorbull All external reports must be GAAP
Derivative Asset increases CapitalWe Create a Derivative Asset bybull DR Derivative Asset CR Income
bull What happens to IRLC Income ndash Becomes Capital
IMBs want more Capitalbull More IRLC means more Incomebull More Income means more Capitalbull More Capital means more Warehouse borrowingbull More Capital means qualifying for FHA amp Agencybull More IRLC means more Capital
Derivative Asset
Is Confusing to Business Ownersand leads to bad decisions
Capital Accounts with Derivative AssetThe Derivative Asset is not carried at Fair Value because the Derivative Asset cannot be sold for the carrying value
During 2018 several companies failed Capital = $2 million Derivative Asset = $2 million
The Owner did not understand why they were insolvent
Disclose the Impact of the Derivative Asset in Capital Accountsbull Common Stockbull Paid In Capitalbull Distributionsbull Retained Earnings (Move IRLC MTM impact from NI to Unrealized Gain)bull Unrealized Gain(Loss)
Thanks to Oystein Konsmo CFO at Nova Financial for implementing this practice
Derivative Asset Characteristics
What is the Locked Pipeline
bull IRLC is a lock commitments issued to borrowers bull They are ldquoApplications in Processrdquo bull IRLC are commitments ndash not Loans bull There is no active market for IRLCbull There is no Asset to basis adjust for MTM
bull Is a TBA-MBS tradeable in its current form YES
bull Is a IRLC tradeable in its current form NO
bull The IRLC must be Transformed into a loan then securitized to be valued as tradeable instrument
bull Transformational Costs are unavoidable and undeniable
bull IRLC is not pure derivative but is derivative under GAAP
bull Absorption Costing is a way to understand the basis for Transformational Costs = Work in Process but is it not perfect
bull I think MSR valuation of cash flow is a more accurate measure
Is an IRLC a Tradable Asset
How have CPAs Presented theDerivative Asset
INCONSISTANTLY
Derivative Asset vs Pipeline
Small Independent Large Public
Source ndash A Greer CPA
bull Warehouse Lenders Rely on CPA for GAAP Capitalbull Lenderrsquos Observe CPA Auditorshellip
ndash Overstate Capital with DAndash Under-apply Cost to Completendash Inconsistently apply Costs to Complete
bull Warehouse Lenders reduce Derivative Asset ndash Some arbitrarily reduce by 50ndash Some reduce based on Net Future Cash Flows
Warehouse Lenderrsquos Adjustment
What about GAAP
bull What does GAAP say about Transformation Costs
bull Direct Cost Deduction Method - direct costs only
bull Full Cost Absorption Method - direct and indirect costs
bull IRLC is a pure derivative - IRLC same as TBA-MBS
bull Net Future Cash Flow Valuation Method (discussed soon)
Transformation Costs or Cost to Completebull What is the value of the IRLC
bull Pull-thru adjusted MTM less Costs to Complete
bull What is the right amount of Transformation Costsbull Direct Cost Deduction Method - direct costs onlybull Full Cost Absorption Method - both direct and indirect costsbull IRLC is a pure derivative ndash no adjustment (IRLC = TBA-MBS)
bull Uncertainty Principalndash Exponential diminishing impact to closingndash You have it when you have it otherwise uncertainndash Day of Lock 99 uncertainty Day before closing 1 uncertainty
IMB Transformational Costs ndash Best PracticesDirect Expenses
bull LO commissions production commissionsbull Other Direct Production Costs
bull appraisals outsourcing courier credit reports other cosbull Other Direct Expenses
bull LO wages processors LOA bull underwriting funding disclosure and post closing
Indirect Expensesbull Allocated Production Rent Branch Rent Branch Overhead
Consequence of Ignoring Indirect Costs
Hawaii vs TexasHigh Balance vs Low Balance
Loan Size Matters
Loan Size Dynamics ndash One Loanbull ONE LOAN
bull High Balance low gainbull Low Balance high gain
bull Derivative Asset
bull Processing costs as of loan are different
bull Profit is same
Higher Gain
$50000000 Locked Pipeline
bull Texas lender is more than double Hawaii
bull Identical Cash Realization
bull Indirect Costs Matter
Direct Costs Only - Distort Results
Derivative Asset Value
View From Finance
Present Value of Net Future Cash Flow
Same as MSR
Derivative Asset OoopsMany CPAs firms have issued opinions on financial statements with derivative asset values I would challenge as not reasonable
Changing Presentation method now creates exposure to Opinion Risk
There is presently no consensus among CPA Auditors about how to apply GAAP
What is the Value of the IRLC - DA
Day of Lock Day Before Closing
High ProbabilityRevenue less Commission
Value is approaching Revenue
UnIncurred Costs Decrease as Percentage of Completion Increases
Low ProbabilityRevenue less all Costs
Value is approaching Zero
What is the value of an Intangible Asset
The Derivative Asset is an Intangible Asset
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
Accountants must understand Hedgingbull to confirm that the activity is reasonable and bull to explain the results to management
Hedging Activity and Derivative Reporting are the most complicated aspect of Mortgage Banking
Purpose of Hedging
Preserving the Secondary Margin
Key Pointsbull Volatility - Interest rates fluctuate on a moment by moment basis
bull Value Sensitivity - The locked pipeline and warehouse are exposed to interest rate risk from the time a lock commitment is issued to a customer until the loan is sold
bull Hedge - The purpose of a hedge transaction is to create an offsetting financial event that has the direct inverse reaction to the value change of the underlying hedged asset
bull Loans go up Hedge goes down ndash Rates downbull Loans go down Hedge goes up ndash Rates up
2) Loan is Closed IRLC is FulfilledLender owns LHFS
3) Closed Loan Sold to BankBank Pays for Loans
Hedging Works when the
Past Predicts the Future
Multi-Variant Correlation
r2
r2 = Correlation Coefficient
BE
US Markets
World Markets
Borrower ldquoPUTrdquo
Pipeline
r2
TBA (hedge) MandatoryAOT
Price
Price Price Volume
Hedging Off-Setbull The hedge transaction
bull Establish a financial transaction that possess the same sensitivity to changes in the interest rate environment
bull But behaves with the opposite impact from rate changes
bull The LONG position or originating a loan behaves with an inverse relationship to the changes in interest rates
bull The SHORT position or selling an MBS has a positive correlation to changes in interest rates If rates go up the value of the short position goes up
bull Being Long and Short in the same transaction offsets or cancels the impact of changes in value from changes in the interest rate environment
bull This results in preserving the value of the underlying asset
Value of the loan and hedge react inversely to changes in rates
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
Objective is Recognition of Future Cash-Flows
PV of Discounted NET Future Cash-flows
Amortization Method or Fair Value MethodASC 860-50-35-9
IRLC under ASC 815An IRLC (Interest Rate Lock Commitment)
bull is an off balance sheet financial commitment bull subject to market risk and a bull derivative under SFAS 149 ASC 815 andbull subject MTM under SFAS 159 ASC 825
bull All IRLC are Derivatives (except for cost to complete)bull An IRLC hedged with Best Efforts is a derivativebull An IRLC hedged with a short MBS is a derivativebull The hedge strategy does not change the derivative
bull Derivatives under GAAPbull Recorded at Fair Value
bull Best Efforts Commitmentsbull Do not have a penalty for legitimate cancelationbull If loan is not closed the BE is canceled without costbull Avoidance of pair-off risk is not a derivative (most agree)bull Optional derivative under ASC 825-10-25
bull If IRLC is MTM and BE locks are not MTM bull Potential misrepresentation of gain positionbull Recommend all commitments are DerivativesMTM
ASC 815 ndash Hedge Accounting
The Interest Rate Lock Commitments ndash IRLC ndashbull IRLCs are initially issued to generate a profitbull The imbedded profit is valued at each reporting period bull The resulting gain is recorded as a Derivative Asset
bull It is very unlikely an IRLC will be a Derivative Liability
Hedge Positionbull TBA-MBS can generate a gain or loss
bull depending upon price movement since the date of salebull gain is reported as a Derivative Assetbull loss is reported as a Derivative Liability
+25 IRLCDerivative Asset Margin
Preservation
-50 TBADerivative Liability
+130 TBADerivative Asset
+70 IRLCDerivative Asset
Always consider loan gain with hedge gain or loss
Hedging Journal Entries
Warehouse bull The warehouse is comprised of two segments
ndash Committed or Allocated to Mandatory Commitmentndash Uncommitted or Hedged with Short TBA-MBS
bull The month-end MTM of the LHFS adjusts the basis of the LHFS creating a gain or loss in the PampL
Pipeline Hedgebull The month-end open TBA position MTM gain or loss is
posted to a Derivative Asset or Derivative Liability and a MTM gain or loss in PampL
Allocated and Unallocated LHFS
Secondary Marketing Data
You must get this informationhellipbull Do you Believe the numbers
(Mandatory Commitment MTM off-setting LHFS excluded in example)
WH Committed not in TBA Hedge- Valued based on purchase priceWH Uncommitted is in TBA Hedge- Valued by hedge advisor
MTM JE
bull Reverse the prior month MTM
bull Post Pair-Off AP or ARbull Post current month MTM
bull Significant changes in volume can impact the PampL
bull If hedge was gain Derivative Asset
bull Confirm everything with your Auditorbull All external reports must be GAAP
Derivative Asset increases CapitalWe Create a Derivative Asset bybull DR Derivative Asset CR Income
bull What happens to IRLC Income ndash Becomes Capital
IMBs want more Capitalbull More IRLC means more Incomebull More Income means more Capitalbull More Capital means more Warehouse borrowingbull More Capital means qualifying for FHA amp Agencybull More IRLC means more Capital
Derivative Asset
Is Confusing to Business Ownersand leads to bad decisions
Capital Accounts with Derivative AssetThe Derivative Asset is not carried at Fair Value because the Derivative Asset cannot be sold for the carrying value
During 2018 several companies failed Capital = $2 million Derivative Asset = $2 million
The Owner did not understand why they were insolvent
Disclose the Impact of the Derivative Asset in Capital Accountsbull Common Stockbull Paid In Capitalbull Distributionsbull Retained Earnings (Move IRLC MTM impact from NI to Unrealized Gain)bull Unrealized Gain(Loss)
Thanks to Oystein Konsmo CFO at Nova Financial for implementing this practice
Derivative Asset Characteristics
What is the Locked Pipeline
bull IRLC is a lock commitments issued to borrowers bull They are ldquoApplications in Processrdquo bull IRLC are commitments ndash not Loans bull There is no active market for IRLCbull There is no Asset to basis adjust for MTM
bull Is a TBA-MBS tradeable in its current form YES
bull Is a IRLC tradeable in its current form NO
bull The IRLC must be Transformed into a loan then securitized to be valued as tradeable instrument
bull Transformational Costs are unavoidable and undeniable
bull IRLC is not pure derivative but is derivative under GAAP
bull Absorption Costing is a way to understand the basis for Transformational Costs = Work in Process but is it not perfect
bull I think MSR valuation of cash flow is a more accurate measure
Is an IRLC a Tradable Asset
How have CPAs Presented theDerivative Asset
INCONSISTANTLY
Derivative Asset vs Pipeline
Small Independent Large Public
Source ndash A Greer CPA
bull Warehouse Lenders Rely on CPA for GAAP Capitalbull Lenderrsquos Observe CPA Auditorshellip
ndash Overstate Capital with DAndash Under-apply Cost to Completendash Inconsistently apply Costs to Complete
bull Warehouse Lenders reduce Derivative Asset ndash Some arbitrarily reduce by 50ndash Some reduce based on Net Future Cash Flows
Warehouse Lenderrsquos Adjustment
What about GAAP
bull What does GAAP say about Transformation Costs
bull Direct Cost Deduction Method - direct costs only
bull Full Cost Absorption Method - direct and indirect costs
bull IRLC is a pure derivative - IRLC same as TBA-MBS
bull Net Future Cash Flow Valuation Method (discussed soon)
Transformation Costs or Cost to Completebull What is the value of the IRLC
bull Pull-thru adjusted MTM less Costs to Complete
bull What is the right amount of Transformation Costsbull Direct Cost Deduction Method - direct costs onlybull Full Cost Absorption Method - both direct and indirect costsbull IRLC is a pure derivative ndash no adjustment (IRLC = TBA-MBS)
bull Uncertainty Principalndash Exponential diminishing impact to closingndash You have it when you have it otherwise uncertainndash Day of Lock 99 uncertainty Day before closing 1 uncertainty
IMB Transformational Costs ndash Best PracticesDirect Expenses
bull LO commissions production commissionsbull Other Direct Production Costs
bull appraisals outsourcing courier credit reports other cosbull Other Direct Expenses
bull LO wages processors LOA bull underwriting funding disclosure and post closing
Indirect Expensesbull Allocated Production Rent Branch Rent Branch Overhead
Consequence of Ignoring Indirect Costs
Hawaii vs TexasHigh Balance vs Low Balance
Loan Size Matters
Loan Size Dynamics ndash One Loanbull ONE LOAN
bull High Balance low gainbull Low Balance high gain
bull Derivative Asset
bull Processing costs as of loan are different
bull Profit is same
Higher Gain
$50000000 Locked Pipeline
bull Texas lender is more than double Hawaii
bull Identical Cash Realization
bull Indirect Costs Matter
Direct Costs Only - Distort Results
Derivative Asset Value
View From Finance
Present Value of Net Future Cash Flow
Same as MSR
Derivative Asset OoopsMany CPAs firms have issued opinions on financial statements with derivative asset values I would challenge as not reasonable
Changing Presentation method now creates exposure to Opinion Risk
There is presently no consensus among CPA Auditors about how to apply GAAP
What is the Value of the IRLC - DA
Day of Lock Day Before Closing
High ProbabilityRevenue less Commission
Value is approaching Revenue
UnIncurred Costs Decrease as Percentage of Completion Increases
Low ProbabilityRevenue less all Costs
Value is approaching Zero
What is the value of an Intangible Asset
The Derivative Asset is an Intangible Asset
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
Accountants must understand Hedgingbull to confirm that the activity is reasonable and bull to explain the results to management
Hedging Activity and Derivative Reporting are the most complicated aspect of Mortgage Banking
Purpose of Hedging
Preserving the Secondary Margin
Key Pointsbull Volatility - Interest rates fluctuate on a moment by moment basis
bull Value Sensitivity - The locked pipeline and warehouse are exposed to interest rate risk from the time a lock commitment is issued to a customer until the loan is sold
bull Hedge - The purpose of a hedge transaction is to create an offsetting financial event that has the direct inverse reaction to the value change of the underlying hedged asset
bull Loans go up Hedge goes down ndash Rates downbull Loans go down Hedge goes up ndash Rates up
2) Loan is Closed IRLC is FulfilledLender owns LHFS
3) Closed Loan Sold to BankBank Pays for Loans
Hedging Works when the
Past Predicts the Future
Multi-Variant Correlation
r2
r2 = Correlation Coefficient
BE
US Markets
World Markets
Borrower ldquoPUTrdquo
Pipeline
r2
TBA (hedge) MandatoryAOT
Price
Price Price Volume
Hedging Off-Setbull The hedge transaction
bull Establish a financial transaction that possess the same sensitivity to changes in the interest rate environment
bull But behaves with the opposite impact from rate changes
bull The LONG position or originating a loan behaves with an inverse relationship to the changes in interest rates
bull The SHORT position or selling an MBS has a positive correlation to changes in interest rates If rates go up the value of the short position goes up
bull Being Long and Short in the same transaction offsets or cancels the impact of changes in value from changes in the interest rate environment
bull This results in preserving the value of the underlying asset
Value of the loan and hedge react inversely to changes in rates
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
Objective is Recognition of Future Cash-Flows
PV of Discounted NET Future Cash-flows
Amortization Method or Fair Value MethodASC 860-50-35-9
IRLC under ASC 815An IRLC (Interest Rate Lock Commitment)
bull is an off balance sheet financial commitment bull subject to market risk and a bull derivative under SFAS 149 ASC 815 andbull subject MTM under SFAS 159 ASC 825
bull All IRLC are Derivatives (except for cost to complete)bull An IRLC hedged with Best Efforts is a derivativebull An IRLC hedged with a short MBS is a derivativebull The hedge strategy does not change the derivative
bull Derivatives under GAAPbull Recorded at Fair Value
bull Best Efforts Commitmentsbull Do not have a penalty for legitimate cancelationbull If loan is not closed the BE is canceled without costbull Avoidance of pair-off risk is not a derivative (most agree)bull Optional derivative under ASC 825-10-25
bull If IRLC is MTM and BE locks are not MTM bull Potential misrepresentation of gain positionbull Recommend all commitments are DerivativesMTM
ASC 815 ndash Hedge Accounting
The Interest Rate Lock Commitments ndash IRLC ndashbull IRLCs are initially issued to generate a profitbull The imbedded profit is valued at each reporting period bull The resulting gain is recorded as a Derivative Asset
bull It is very unlikely an IRLC will be a Derivative Liability
Hedge Positionbull TBA-MBS can generate a gain or loss
bull depending upon price movement since the date of salebull gain is reported as a Derivative Assetbull loss is reported as a Derivative Liability
+25 IRLCDerivative Asset Margin
Preservation
-50 TBADerivative Liability
+130 TBADerivative Asset
+70 IRLCDerivative Asset
Always consider loan gain with hedge gain or loss
Hedging Journal Entries
Warehouse bull The warehouse is comprised of two segments
ndash Committed or Allocated to Mandatory Commitmentndash Uncommitted or Hedged with Short TBA-MBS
bull The month-end MTM of the LHFS adjusts the basis of the LHFS creating a gain or loss in the PampL
Pipeline Hedgebull The month-end open TBA position MTM gain or loss is
posted to a Derivative Asset or Derivative Liability and a MTM gain or loss in PampL
Allocated and Unallocated LHFS
Secondary Marketing Data
You must get this informationhellipbull Do you Believe the numbers
(Mandatory Commitment MTM off-setting LHFS excluded in example)
WH Committed not in TBA Hedge- Valued based on purchase priceWH Uncommitted is in TBA Hedge- Valued by hedge advisor
MTM JE
bull Reverse the prior month MTM
bull Post Pair-Off AP or ARbull Post current month MTM
bull Significant changes in volume can impact the PampL
bull If hedge was gain Derivative Asset
bull Confirm everything with your Auditorbull All external reports must be GAAP
Derivative Asset increases CapitalWe Create a Derivative Asset bybull DR Derivative Asset CR Income
bull What happens to IRLC Income ndash Becomes Capital
IMBs want more Capitalbull More IRLC means more Incomebull More Income means more Capitalbull More Capital means more Warehouse borrowingbull More Capital means qualifying for FHA amp Agencybull More IRLC means more Capital
Derivative Asset
Is Confusing to Business Ownersand leads to bad decisions
Capital Accounts with Derivative AssetThe Derivative Asset is not carried at Fair Value because the Derivative Asset cannot be sold for the carrying value
During 2018 several companies failed Capital = $2 million Derivative Asset = $2 million
The Owner did not understand why they were insolvent
Disclose the Impact of the Derivative Asset in Capital Accountsbull Common Stockbull Paid In Capitalbull Distributionsbull Retained Earnings (Move IRLC MTM impact from NI to Unrealized Gain)bull Unrealized Gain(Loss)
Thanks to Oystein Konsmo CFO at Nova Financial for implementing this practice
Derivative Asset Characteristics
What is the Locked Pipeline
bull IRLC is a lock commitments issued to borrowers bull They are ldquoApplications in Processrdquo bull IRLC are commitments ndash not Loans bull There is no active market for IRLCbull There is no Asset to basis adjust for MTM
bull Is a TBA-MBS tradeable in its current form YES
bull Is a IRLC tradeable in its current form NO
bull The IRLC must be Transformed into a loan then securitized to be valued as tradeable instrument
bull Transformational Costs are unavoidable and undeniable
bull IRLC is not pure derivative but is derivative under GAAP
bull Absorption Costing is a way to understand the basis for Transformational Costs = Work in Process but is it not perfect
bull I think MSR valuation of cash flow is a more accurate measure
Is an IRLC a Tradable Asset
How have CPAs Presented theDerivative Asset
INCONSISTANTLY
Derivative Asset vs Pipeline
Small Independent Large Public
Source ndash A Greer CPA
bull Warehouse Lenders Rely on CPA for GAAP Capitalbull Lenderrsquos Observe CPA Auditorshellip
ndash Overstate Capital with DAndash Under-apply Cost to Completendash Inconsistently apply Costs to Complete
bull Warehouse Lenders reduce Derivative Asset ndash Some arbitrarily reduce by 50ndash Some reduce based on Net Future Cash Flows
Warehouse Lenderrsquos Adjustment
What about GAAP
bull What does GAAP say about Transformation Costs
bull Direct Cost Deduction Method - direct costs only
bull Full Cost Absorption Method - direct and indirect costs
bull IRLC is a pure derivative - IRLC same as TBA-MBS
bull Net Future Cash Flow Valuation Method (discussed soon)
Transformation Costs or Cost to Completebull What is the value of the IRLC
bull Pull-thru adjusted MTM less Costs to Complete
bull What is the right amount of Transformation Costsbull Direct Cost Deduction Method - direct costs onlybull Full Cost Absorption Method - both direct and indirect costsbull IRLC is a pure derivative ndash no adjustment (IRLC = TBA-MBS)
bull Uncertainty Principalndash Exponential diminishing impact to closingndash You have it when you have it otherwise uncertainndash Day of Lock 99 uncertainty Day before closing 1 uncertainty
IMB Transformational Costs ndash Best PracticesDirect Expenses
bull LO commissions production commissionsbull Other Direct Production Costs
bull appraisals outsourcing courier credit reports other cosbull Other Direct Expenses
bull LO wages processors LOA bull underwriting funding disclosure and post closing
Indirect Expensesbull Allocated Production Rent Branch Rent Branch Overhead
Consequence of Ignoring Indirect Costs
Hawaii vs TexasHigh Balance vs Low Balance
Loan Size Matters
Loan Size Dynamics ndash One Loanbull ONE LOAN
bull High Balance low gainbull Low Balance high gain
bull Derivative Asset
bull Processing costs as of loan are different
bull Profit is same
Higher Gain
$50000000 Locked Pipeline
bull Texas lender is more than double Hawaii
bull Identical Cash Realization
bull Indirect Costs Matter
Direct Costs Only - Distort Results
Derivative Asset Value
View From Finance
Present Value of Net Future Cash Flow
Same as MSR
Derivative Asset OoopsMany CPAs firms have issued opinions on financial statements with derivative asset values I would challenge as not reasonable
Changing Presentation method now creates exposure to Opinion Risk
There is presently no consensus among CPA Auditors about how to apply GAAP
What is the Value of the IRLC - DA
Day of Lock Day Before Closing
High ProbabilityRevenue less Commission
Value is approaching Revenue
UnIncurred Costs Decrease as Percentage of Completion Increases
Low ProbabilityRevenue less all Costs
Value is approaching Zero
What is the value of an Intangible Asset
The Derivative Asset is an Intangible Asset
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
Accountants must understand Hedgingbull to confirm that the activity is reasonable and bull to explain the results to management
Hedging Activity and Derivative Reporting are the most complicated aspect of Mortgage Banking
Purpose of Hedging
Preserving the Secondary Margin
Key Pointsbull Volatility - Interest rates fluctuate on a moment by moment basis
bull Value Sensitivity - The locked pipeline and warehouse are exposed to interest rate risk from the time a lock commitment is issued to a customer until the loan is sold
bull Hedge - The purpose of a hedge transaction is to create an offsetting financial event that has the direct inverse reaction to the value change of the underlying hedged asset
bull Loans go up Hedge goes down ndash Rates downbull Loans go down Hedge goes up ndash Rates up
2) Loan is Closed IRLC is FulfilledLender owns LHFS
3) Closed Loan Sold to BankBank Pays for Loans
Hedging Works when the
Past Predicts the Future
Multi-Variant Correlation
r2
r2 = Correlation Coefficient
BE
US Markets
World Markets
Borrower ldquoPUTrdquo
Pipeline
r2
TBA (hedge) MandatoryAOT
Price
Price Price Volume
Hedging Off-Setbull The hedge transaction
bull Establish a financial transaction that possess the same sensitivity to changes in the interest rate environment
bull But behaves with the opposite impact from rate changes
bull The LONG position or originating a loan behaves with an inverse relationship to the changes in interest rates
bull The SHORT position or selling an MBS has a positive correlation to changes in interest rates If rates go up the value of the short position goes up
bull Being Long and Short in the same transaction offsets or cancels the impact of changes in value from changes in the interest rate environment
bull This results in preserving the value of the underlying asset
Value of the loan and hedge react inversely to changes in rates
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
Objective is Recognition of Future Cash-Flows
PV of Discounted NET Future Cash-flows
Amortization Method or Fair Value MethodASC 860-50-35-9
IRLC under ASC 815An IRLC (Interest Rate Lock Commitment)
bull is an off balance sheet financial commitment bull subject to market risk and a bull derivative under SFAS 149 ASC 815 andbull subject MTM under SFAS 159 ASC 825
bull All IRLC are Derivatives (except for cost to complete)bull An IRLC hedged with Best Efforts is a derivativebull An IRLC hedged with a short MBS is a derivativebull The hedge strategy does not change the derivative
bull Derivatives under GAAPbull Recorded at Fair Value
bull Best Efforts Commitmentsbull Do not have a penalty for legitimate cancelationbull If loan is not closed the BE is canceled without costbull Avoidance of pair-off risk is not a derivative (most agree)bull Optional derivative under ASC 825-10-25
bull If IRLC is MTM and BE locks are not MTM bull Potential misrepresentation of gain positionbull Recommend all commitments are DerivativesMTM
ASC 815 ndash Hedge Accounting
The Interest Rate Lock Commitments ndash IRLC ndashbull IRLCs are initially issued to generate a profitbull The imbedded profit is valued at each reporting period bull The resulting gain is recorded as a Derivative Asset
bull It is very unlikely an IRLC will be a Derivative Liability
Hedge Positionbull TBA-MBS can generate a gain or loss
bull depending upon price movement since the date of salebull gain is reported as a Derivative Assetbull loss is reported as a Derivative Liability
+25 IRLCDerivative Asset Margin
Preservation
-50 TBADerivative Liability
+130 TBADerivative Asset
+70 IRLCDerivative Asset
Always consider loan gain with hedge gain or loss
Hedging Journal Entries
Warehouse bull The warehouse is comprised of two segments
ndash Committed or Allocated to Mandatory Commitmentndash Uncommitted or Hedged with Short TBA-MBS
bull The month-end MTM of the LHFS adjusts the basis of the LHFS creating a gain or loss in the PampL
Pipeline Hedgebull The month-end open TBA position MTM gain or loss is
posted to a Derivative Asset or Derivative Liability and a MTM gain or loss in PampL
Allocated and Unallocated LHFS
Secondary Marketing Data
You must get this informationhellipbull Do you Believe the numbers
(Mandatory Commitment MTM off-setting LHFS excluded in example)
WH Committed not in TBA Hedge- Valued based on purchase priceWH Uncommitted is in TBA Hedge- Valued by hedge advisor
MTM JE
bull Reverse the prior month MTM
bull Post Pair-Off AP or ARbull Post current month MTM
bull Significant changes in volume can impact the PampL
bull If hedge was gain Derivative Asset
bull Confirm everything with your Auditorbull All external reports must be GAAP
Derivative Asset increases CapitalWe Create a Derivative Asset bybull DR Derivative Asset CR Income
bull What happens to IRLC Income ndash Becomes Capital
IMBs want more Capitalbull More IRLC means more Incomebull More Income means more Capitalbull More Capital means more Warehouse borrowingbull More Capital means qualifying for FHA amp Agencybull More IRLC means more Capital
Derivative Asset
Is Confusing to Business Ownersand leads to bad decisions
Capital Accounts with Derivative AssetThe Derivative Asset is not carried at Fair Value because the Derivative Asset cannot be sold for the carrying value
During 2018 several companies failed Capital = $2 million Derivative Asset = $2 million
The Owner did not understand why they were insolvent
Disclose the Impact of the Derivative Asset in Capital Accountsbull Common Stockbull Paid In Capitalbull Distributionsbull Retained Earnings (Move IRLC MTM impact from NI to Unrealized Gain)bull Unrealized Gain(Loss)
Thanks to Oystein Konsmo CFO at Nova Financial for implementing this practice
Derivative Asset Characteristics
What is the Locked Pipeline
bull IRLC is a lock commitments issued to borrowers bull They are ldquoApplications in Processrdquo bull IRLC are commitments ndash not Loans bull There is no active market for IRLCbull There is no Asset to basis adjust for MTM
bull Is a TBA-MBS tradeable in its current form YES
bull Is a IRLC tradeable in its current form NO
bull The IRLC must be Transformed into a loan then securitized to be valued as tradeable instrument
bull Transformational Costs are unavoidable and undeniable
bull IRLC is not pure derivative but is derivative under GAAP
bull Absorption Costing is a way to understand the basis for Transformational Costs = Work in Process but is it not perfect
bull I think MSR valuation of cash flow is a more accurate measure
Is an IRLC a Tradable Asset
How have CPAs Presented theDerivative Asset
INCONSISTANTLY
Derivative Asset vs Pipeline
Small Independent Large Public
Source ndash A Greer CPA
bull Warehouse Lenders Rely on CPA for GAAP Capitalbull Lenderrsquos Observe CPA Auditorshellip
ndash Overstate Capital with DAndash Under-apply Cost to Completendash Inconsistently apply Costs to Complete
bull Warehouse Lenders reduce Derivative Asset ndash Some arbitrarily reduce by 50ndash Some reduce based on Net Future Cash Flows
Warehouse Lenderrsquos Adjustment
What about GAAP
bull What does GAAP say about Transformation Costs
bull Direct Cost Deduction Method - direct costs only
bull Full Cost Absorption Method - direct and indirect costs
bull IRLC is a pure derivative - IRLC same as TBA-MBS
bull Net Future Cash Flow Valuation Method (discussed soon)
Transformation Costs or Cost to Completebull What is the value of the IRLC
bull Pull-thru adjusted MTM less Costs to Complete
bull What is the right amount of Transformation Costsbull Direct Cost Deduction Method - direct costs onlybull Full Cost Absorption Method - both direct and indirect costsbull IRLC is a pure derivative ndash no adjustment (IRLC = TBA-MBS)
bull Uncertainty Principalndash Exponential diminishing impact to closingndash You have it when you have it otherwise uncertainndash Day of Lock 99 uncertainty Day before closing 1 uncertainty
IMB Transformational Costs ndash Best PracticesDirect Expenses
bull LO commissions production commissionsbull Other Direct Production Costs
bull appraisals outsourcing courier credit reports other cosbull Other Direct Expenses
bull LO wages processors LOA bull underwriting funding disclosure and post closing
Indirect Expensesbull Allocated Production Rent Branch Rent Branch Overhead
Consequence of Ignoring Indirect Costs
Hawaii vs TexasHigh Balance vs Low Balance
Loan Size Matters
Loan Size Dynamics ndash One Loanbull ONE LOAN
bull High Balance low gainbull Low Balance high gain
bull Derivative Asset
bull Processing costs as of loan are different
bull Profit is same
Higher Gain
$50000000 Locked Pipeline
bull Texas lender is more than double Hawaii
bull Identical Cash Realization
bull Indirect Costs Matter
Direct Costs Only - Distort Results
Derivative Asset Value
View From Finance
Present Value of Net Future Cash Flow
Same as MSR
Derivative Asset OoopsMany CPAs firms have issued opinions on financial statements with derivative asset values I would challenge as not reasonable
Changing Presentation method now creates exposure to Opinion Risk
There is presently no consensus among CPA Auditors about how to apply GAAP
What is the Value of the IRLC - DA
Day of Lock Day Before Closing
High ProbabilityRevenue less Commission
Value is approaching Revenue
UnIncurred Costs Decrease as Percentage of Completion Increases
Low ProbabilityRevenue less all Costs
Value is approaching Zero
What is the value of an Intangible Asset
The Derivative Asset is an Intangible Asset
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
Accountants must understand Hedgingbull to confirm that the activity is reasonable and bull to explain the results to management
Hedging Activity and Derivative Reporting are the most complicated aspect of Mortgage Banking
Purpose of Hedging
Preserving the Secondary Margin
Key Pointsbull Volatility - Interest rates fluctuate on a moment by moment basis
bull Value Sensitivity - The locked pipeline and warehouse are exposed to interest rate risk from the time a lock commitment is issued to a customer until the loan is sold
bull Hedge - The purpose of a hedge transaction is to create an offsetting financial event that has the direct inverse reaction to the value change of the underlying hedged asset
bull Loans go up Hedge goes down ndash Rates downbull Loans go down Hedge goes up ndash Rates up
2) Loan is Closed IRLC is FulfilledLender owns LHFS
3) Closed Loan Sold to BankBank Pays for Loans
Hedging Works when the
Past Predicts the Future
Multi-Variant Correlation
r2
r2 = Correlation Coefficient
BE
US Markets
World Markets
Borrower ldquoPUTrdquo
Pipeline
r2
TBA (hedge) MandatoryAOT
Price
Price Price Volume
Hedging Off-Setbull The hedge transaction
bull Establish a financial transaction that possess the same sensitivity to changes in the interest rate environment
bull But behaves with the opposite impact from rate changes
bull The LONG position or originating a loan behaves with an inverse relationship to the changes in interest rates
bull The SHORT position or selling an MBS has a positive correlation to changes in interest rates If rates go up the value of the short position goes up
bull Being Long and Short in the same transaction offsets or cancels the impact of changes in value from changes in the interest rate environment
bull This results in preserving the value of the underlying asset
Value of the loan and hedge react inversely to changes in rates
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
Objective is Recognition of Future Cash-Flows
PV of Discounted NET Future Cash-flows
Amortization Method or Fair Value MethodASC 860-50-35-9
IRLC under ASC 815An IRLC (Interest Rate Lock Commitment)
bull is an off balance sheet financial commitment bull subject to market risk and a bull derivative under SFAS 149 ASC 815 andbull subject MTM under SFAS 159 ASC 825
bull All IRLC are Derivatives (except for cost to complete)bull An IRLC hedged with Best Efforts is a derivativebull An IRLC hedged with a short MBS is a derivativebull The hedge strategy does not change the derivative
bull Derivatives under GAAPbull Recorded at Fair Value
bull Best Efforts Commitmentsbull Do not have a penalty for legitimate cancelationbull If loan is not closed the BE is canceled without costbull Avoidance of pair-off risk is not a derivative (most agree)bull Optional derivative under ASC 825-10-25
bull If IRLC is MTM and BE locks are not MTM bull Potential misrepresentation of gain positionbull Recommend all commitments are DerivativesMTM
ASC 815 ndash Hedge Accounting
The Interest Rate Lock Commitments ndash IRLC ndashbull IRLCs are initially issued to generate a profitbull The imbedded profit is valued at each reporting period bull The resulting gain is recorded as a Derivative Asset
bull It is very unlikely an IRLC will be a Derivative Liability
Hedge Positionbull TBA-MBS can generate a gain or loss
bull depending upon price movement since the date of salebull gain is reported as a Derivative Assetbull loss is reported as a Derivative Liability
+25 IRLCDerivative Asset Margin
Preservation
-50 TBADerivative Liability
+130 TBADerivative Asset
+70 IRLCDerivative Asset
Always consider loan gain with hedge gain or loss
Hedging Journal Entries
Warehouse bull The warehouse is comprised of two segments
ndash Committed or Allocated to Mandatory Commitmentndash Uncommitted or Hedged with Short TBA-MBS
bull The month-end MTM of the LHFS adjusts the basis of the LHFS creating a gain or loss in the PampL
Pipeline Hedgebull The month-end open TBA position MTM gain or loss is
posted to a Derivative Asset or Derivative Liability and a MTM gain or loss in PampL
Allocated and Unallocated LHFS
Secondary Marketing Data
You must get this informationhellipbull Do you Believe the numbers
(Mandatory Commitment MTM off-setting LHFS excluded in example)
WH Committed not in TBA Hedge- Valued based on purchase priceWH Uncommitted is in TBA Hedge- Valued by hedge advisor
MTM JE
bull Reverse the prior month MTM
bull Post Pair-Off AP or ARbull Post current month MTM
bull Significant changes in volume can impact the PampL
bull If hedge was gain Derivative Asset
bull Confirm everything with your Auditorbull All external reports must be GAAP
Derivative Asset increases CapitalWe Create a Derivative Asset bybull DR Derivative Asset CR Income
bull What happens to IRLC Income ndash Becomes Capital
IMBs want more Capitalbull More IRLC means more Incomebull More Income means more Capitalbull More Capital means more Warehouse borrowingbull More Capital means qualifying for FHA amp Agencybull More IRLC means more Capital
Derivative Asset
Is Confusing to Business Ownersand leads to bad decisions
Capital Accounts with Derivative AssetThe Derivative Asset is not carried at Fair Value because the Derivative Asset cannot be sold for the carrying value
During 2018 several companies failed Capital = $2 million Derivative Asset = $2 million
The Owner did not understand why they were insolvent
Disclose the Impact of the Derivative Asset in Capital Accountsbull Common Stockbull Paid In Capitalbull Distributionsbull Retained Earnings (Move IRLC MTM impact from NI to Unrealized Gain)bull Unrealized Gain(Loss)
Thanks to Oystein Konsmo CFO at Nova Financial for implementing this practice
Derivative Asset Characteristics
What is the Locked Pipeline
bull IRLC is a lock commitments issued to borrowers bull They are ldquoApplications in Processrdquo bull IRLC are commitments ndash not Loans bull There is no active market for IRLCbull There is no Asset to basis adjust for MTM
bull Is a TBA-MBS tradeable in its current form YES
bull Is a IRLC tradeable in its current form NO
bull The IRLC must be Transformed into a loan then securitized to be valued as tradeable instrument
bull Transformational Costs are unavoidable and undeniable
bull IRLC is not pure derivative but is derivative under GAAP
bull Absorption Costing is a way to understand the basis for Transformational Costs = Work in Process but is it not perfect
bull I think MSR valuation of cash flow is a more accurate measure
Is an IRLC a Tradable Asset
How have CPAs Presented theDerivative Asset
INCONSISTANTLY
Derivative Asset vs Pipeline
Small Independent Large Public
Source ndash A Greer CPA
bull Warehouse Lenders Rely on CPA for GAAP Capitalbull Lenderrsquos Observe CPA Auditorshellip
ndash Overstate Capital with DAndash Under-apply Cost to Completendash Inconsistently apply Costs to Complete
bull Warehouse Lenders reduce Derivative Asset ndash Some arbitrarily reduce by 50ndash Some reduce based on Net Future Cash Flows
Warehouse Lenderrsquos Adjustment
What about GAAP
bull What does GAAP say about Transformation Costs
bull Direct Cost Deduction Method - direct costs only
bull Full Cost Absorption Method - direct and indirect costs
bull IRLC is a pure derivative - IRLC same as TBA-MBS
bull Net Future Cash Flow Valuation Method (discussed soon)
Transformation Costs or Cost to Completebull What is the value of the IRLC
bull Pull-thru adjusted MTM less Costs to Complete
bull What is the right amount of Transformation Costsbull Direct Cost Deduction Method - direct costs onlybull Full Cost Absorption Method - both direct and indirect costsbull IRLC is a pure derivative ndash no adjustment (IRLC = TBA-MBS)
bull Uncertainty Principalndash Exponential diminishing impact to closingndash You have it when you have it otherwise uncertainndash Day of Lock 99 uncertainty Day before closing 1 uncertainty
IMB Transformational Costs ndash Best PracticesDirect Expenses
bull LO commissions production commissionsbull Other Direct Production Costs
bull appraisals outsourcing courier credit reports other cosbull Other Direct Expenses
bull LO wages processors LOA bull underwriting funding disclosure and post closing
Indirect Expensesbull Allocated Production Rent Branch Rent Branch Overhead
Consequence of Ignoring Indirect Costs
Hawaii vs TexasHigh Balance vs Low Balance
Loan Size Matters
Loan Size Dynamics ndash One Loanbull ONE LOAN
bull High Balance low gainbull Low Balance high gain
bull Derivative Asset
bull Processing costs as of loan are different
bull Profit is same
Higher Gain
$50000000 Locked Pipeline
bull Texas lender is more than double Hawaii
bull Identical Cash Realization
bull Indirect Costs Matter
Direct Costs Only - Distort Results
Derivative Asset Value
View From Finance
Present Value of Net Future Cash Flow
Same as MSR
Derivative Asset OoopsMany CPAs firms have issued opinions on financial statements with derivative asset values I would challenge as not reasonable
Changing Presentation method now creates exposure to Opinion Risk
There is presently no consensus among CPA Auditors about how to apply GAAP
What is the Value of the IRLC - DA
Day of Lock Day Before Closing
High ProbabilityRevenue less Commission
Value is approaching Revenue
UnIncurred Costs Decrease as Percentage of Completion Increases
Low ProbabilityRevenue less all Costs
Value is approaching Zero
What is the value of an Intangible Asset
The Derivative Asset is an Intangible Asset
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
IRLC under ASC 815
ASC 815 ndash Commitments
ASC 815 ndash Hedge Accounting
Slide Number 41
Slide Number 42
Slide Number 43
Slide Number 44
Slide Number 45
Slide Number 46
Slide Number 47
Derivative Asset increases Capital
Slide Number 49
Slide Number 50
Slide Number 51
What is the Locked Pipeline
Slide Number 53
Slide Number 54
Slide Number 55
Slide Number 56
What about GAAP
Transformation Costs or Cost to Complete
IMB Transformational Costs ndash Best Practices
Slide Number 60
Slide Number 61
Slide Number 62
Slide Number 63
Derivative Asset Ooops
What is the Value of the IRLC - DA
Slide Number 66
AICPA Valuation Services
AICPA - Discounted Future Benefit
Hedging Data for DA Valuation
Percentage of Completion by Status
Net Cash Flow Valuation Data
IRLC-DA Grows in Value as Costs Incurred
Lock to LHFS DA Value Accretion
Revenue Potential vs Derivative Asset
GAAP Methods Only Right Once
Slide Number 76
IRLC Value is What You Negotiate
Slide Number 78
Slide Number 79
FASB Board Meeting ndash 32818
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
Slide Number 83
IRLC is Taxable when Recorded - BUT
Slide Number 85
Slide Number 86
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
PampL - with and without IRLC
IRLC Revenue is Confusing
Slide Number 91
Slide Number 92
Slide Number 93
Slide Number 94
Slide Number 95
Slide Number 96
Balance Sheet or Commitment
Gain or (Loss)
Warehouse - committed
$1000000000
$10000000
(1)
Pair-Off trades - closed not settled
($800000)
(2)
Locked Pipeline (net of pull-thru)
$3000000000
$30000000
(3)
Warehouse ndash not committed
$45000000
$450000
(4)
Hedge
$2700000000
($27000000)
(5)
Balance Sheet amp Income Statement Accounts
Assets
Cash
$1000000
Loans Held for Sale
$10000000
Loans Held for Sale
$450000
Loans Held for Sale
$100000
(1)
Loans Held for Sale
$4500
(4)
AR Loan Sales (not GAAP)
AR Pair Off
Derivative Asset (MTM gains)
$300000
(3)
Liabilities
Warehouse loan
$10000000
AP Commission
AP Pair-Off
$8000
(2)
Borrower Escrow
$450000
Derivative Liability (MTM losses)
$270000
(5)
Capital
MTM valuation
Retained Earning
$1000000
Revenue
MTM Gain or Loss (gain)
$100000
(1)
MTM Gain or Loss (gain)
$300000
(3)
MTM Gain or Loss (gain)
$4500
(4)
Expense
Pair-Off Gain or Loss (loss)
$8000
(2)
MTM Gain or Loss (loss)
$270000
(5)
$12132500
$12132500
Journal Entries
Warehouse Loans with Purchase Commitment (value based on purchase commitment)
If gain
Debit Loans Held For Sale
$10000000
Credit MTM Gain or Loss
$10000000
If loss
Debit MTM Gain of Loss
$10000000
Credit Loans Held For Sale
$10000000
Pair-Offs (value based on closed trade)
If gain
Debit Pair-Off Receivable
$800000
Credit Pair-Off Gain or Loss
$800000
If loss
Debit Pair-Off Gain or Loss
$800000
Credit Pair-Off Payable
$800000
Warehouse Loans without Purchase Commitment MTM (value at month-end)
If gain
Debit Loans Held for Sale
$450000
Credit MTM Gain or Loss^
$450000
If loss
Debit MTM Gain or Loss^
$450000
Credit Loans Held for Sale
$450000
Locked Pipeline MTM (pull-thru adjusted)
If gain
Debit Derivative Asset
$30000000
Credit MTM Gain or Loss^
$30000000
If loss
Debit MTM Gain or Loss^
$30000000
Credit Derivative Liability
$30000000
Hedge MTM
If gain
Debit Derivative Asset
$27000000
Credit MTM Gain or Loss^
$27000000
If loss
Debit MTM Gain or Loss^
$27000000
Credit Derivative Liability
$27000000
or Gain on Sale for mgmt reporting (not GAAP)
^ or MTM valuation in Capital for mgmt reporting (not GAAP)
Purpose of Hedging
Preserving the Secondary Margin
Key Pointsbull Volatility - Interest rates fluctuate on a moment by moment basis
bull Value Sensitivity - The locked pipeline and warehouse are exposed to interest rate risk from the time a lock commitment is issued to a customer until the loan is sold
bull Hedge - The purpose of a hedge transaction is to create an offsetting financial event that has the direct inverse reaction to the value change of the underlying hedged asset
bull Loans go up Hedge goes down ndash Rates downbull Loans go down Hedge goes up ndash Rates up
2) Loan is Closed IRLC is FulfilledLender owns LHFS
3) Closed Loan Sold to BankBank Pays for Loans
Hedging Works when the
Past Predicts the Future
Multi-Variant Correlation
r2
r2 = Correlation Coefficient
BE
US Markets
World Markets
Borrower ldquoPUTrdquo
Pipeline
r2
TBA (hedge) MandatoryAOT
Price
Price Price Volume
Hedging Off-Setbull The hedge transaction
bull Establish a financial transaction that possess the same sensitivity to changes in the interest rate environment
bull But behaves with the opposite impact from rate changes
bull The LONG position or originating a loan behaves with an inverse relationship to the changes in interest rates
bull The SHORT position or selling an MBS has a positive correlation to changes in interest rates If rates go up the value of the short position goes up
bull Being Long and Short in the same transaction offsets or cancels the impact of changes in value from changes in the interest rate environment
bull This results in preserving the value of the underlying asset
Value of the loan and hedge react inversely to changes in rates
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
Objective is Recognition of Future Cash-Flows
PV of Discounted NET Future Cash-flows
Amortization Method or Fair Value MethodASC 860-50-35-9
IRLC under ASC 815An IRLC (Interest Rate Lock Commitment)
bull is an off balance sheet financial commitment bull subject to market risk and a bull derivative under SFAS 149 ASC 815 andbull subject MTM under SFAS 159 ASC 825
bull All IRLC are Derivatives (except for cost to complete)bull An IRLC hedged with Best Efforts is a derivativebull An IRLC hedged with a short MBS is a derivativebull The hedge strategy does not change the derivative
bull Derivatives under GAAPbull Recorded at Fair Value
bull Best Efforts Commitmentsbull Do not have a penalty for legitimate cancelationbull If loan is not closed the BE is canceled without costbull Avoidance of pair-off risk is not a derivative (most agree)bull Optional derivative under ASC 825-10-25
bull If IRLC is MTM and BE locks are not MTM bull Potential misrepresentation of gain positionbull Recommend all commitments are DerivativesMTM
ASC 815 ndash Hedge Accounting
The Interest Rate Lock Commitments ndash IRLC ndashbull IRLCs are initially issued to generate a profitbull The imbedded profit is valued at each reporting period bull The resulting gain is recorded as a Derivative Asset
bull It is very unlikely an IRLC will be a Derivative Liability
Hedge Positionbull TBA-MBS can generate a gain or loss
bull depending upon price movement since the date of salebull gain is reported as a Derivative Assetbull loss is reported as a Derivative Liability
+25 IRLCDerivative Asset Margin
Preservation
-50 TBADerivative Liability
+130 TBADerivative Asset
+70 IRLCDerivative Asset
Always consider loan gain with hedge gain or loss
Hedging Journal Entries
Warehouse bull The warehouse is comprised of two segments
ndash Committed or Allocated to Mandatory Commitmentndash Uncommitted or Hedged with Short TBA-MBS
bull The month-end MTM of the LHFS adjusts the basis of the LHFS creating a gain or loss in the PampL
Pipeline Hedgebull The month-end open TBA position MTM gain or loss is
posted to a Derivative Asset or Derivative Liability and a MTM gain or loss in PampL
Allocated and Unallocated LHFS
Secondary Marketing Data
You must get this informationhellipbull Do you Believe the numbers
(Mandatory Commitment MTM off-setting LHFS excluded in example)
WH Committed not in TBA Hedge- Valued based on purchase priceWH Uncommitted is in TBA Hedge- Valued by hedge advisor
MTM JE
bull Reverse the prior month MTM
bull Post Pair-Off AP or ARbull Post current month MTM
bull Significant changes in volume can impact the PampL
bull If hedge was gain Derivative Asset
bull Confirm everything with your Auditorbull All external reports must be GAAP
Derivative Asset increases CapitalWe Create a Derivative Asset bybull DR Derivative Asset CR Income
bull What happens to IRLC Income ndash Becomes Capital
IMBs want more Capitalbull More IRLC means more Incomebull More Income means more Capitalbull More Capital means more Warehouse borrowingbull More Capital means qualifying for FHA amp Agencybull More IRLC means more Capital
Derivative Asset
Is Confusing to Business Ownersand leads to bad decisions
Capital Accounts with Derivative AssetThe Derivative Asset is not carried at Fair Value because the Derivative Asset cannot be sold for the carrying value
During 2018 several companies failed Capital = $2 million Derivative Asset = $2 million
The Owner did not understand why they were insolvent
Disclose the Impact of the Derivative Asset in Capital Accountsbull Common Stockbull Paid In Capitalbull Distributionsbull Retained Earnings (Move IRLC MTM impact from NI to Unrealized Gain)bull Unrealized Gain(Loss)
Thanks to Oystein Konsmo CFO at Nova Financial for implementing this practice
Derivative Asset Characteristics
What is the Locked Pipeline
bull IRLC is a lock commitments issued to borrowers bull They are ldquoApplications in Processrdquo bull IRLC are commitments ndash not Loans bull There is no active market for IRLCbull There is no Asset to basis adjust for MTM
bull Is a TBA-MBS tradeable in its current form YES
bull Is a IRLC tradeable in its current form NO
bull The IRLC must be Transformed into a loan then securitized to be valued as tradeable instrument
bull Transformational Costs are unavoidable and undeniable
bull IRLC is not pure derivative but is derivative under GAAP
bull Absorption Costing is a way to understand the basis for Transformational Costs = Work in Process but is it not perfect
bull I think MSR valuation of cash flow is a more accurate measure
Is an IRLC a Tradable Asset
How have CPAs Presented theDerivative Asset
INCONSISTANTLY
Derivative Asset vs Pipeline
Small Independent Large Public
Source ndash A Greer CPA
bull Warehouse Lenders Rely on CPA for GAAP Capitalbull Lenderrsquos Observe CPA Auditorshellip
ndash Overstate Capital with DAndash Under-apply Cost to Completendash Inconsistently apply Costs to Complete
bull Warehouse Lenders reduce Derivative Asset ndash Some arbitrarily reduce by 50ndash Some reduce based on Net Future Cash Flows
Warehouse Lenderrsquos Adjustment
What about GAAP
bull What does GAAP say about Transformation Costs
bull Direct Cost Deduction Method - direct costs only
bull Full Cost Absorption Method - direct and indirect costs
bull IRLC is a pure derivative - IRLC same as TBA-MBS
bull Net Future Cash Flow Valuation Method (discussed soon)
Transformation Costs or Cost to Completebull What is the value of the IRLC
bull Pull-thru adjusted MTM less Costs to Complete
bull What is the right amount of Transformation Costsbull Direct Cost Deduction Method - direct costs onlybull Full Cost Absorption Method - both direct and indirect costsbull IRLC is a pure derivative ndash no adjustment (IRLC = TBA-MBS)
bull Uncertainty Principalndash Exponential diminishing impact to closingndash You have it when you have it otherwise uncertainndash Day of Lock 99 uncertainty Day before closing 1 uncertainty
IMB Transformational Costs ndash Best PracticesDirect Expenses
bull LO commissions production commissionsbull Other Direct Production Costs
bull appraisals outsourcing courier credit reports other cosbull Other Direct Expenses
bull LO wages processors LOA bull underwriting funding disclosure and post closing
Indirect Expensesbull Allocated Production Rent Branch Rent Branch Overhead
Consequence of Ignoring Indirect Costs
Hawaii vs TexasHigh Balance vs Low Balance
Loan Size Matters
Loan Size Dynamics ndash One Loanbull ONE LOAN
bull High Balance low gainbull Low Balance high gain
bull Derivative Asset
bull Processing costs as of loan are different
bull Profit is same
Higher Gain
$50000000 Locked Pipeline
bull Texas lender is more than double Hawaii
bull Identical Cash Realization
bull Indirect Costs Matter
Direct Costs Only - Distort Results
Derivative Asset Value
View From Finance
Present Value of Net Future Cash Flow
Same as MSR
Derivative Asset OoopsMany CPAs firms have issued opinions on financial statements with derivative asset values I would challenge as not reasonable
Changing Presentation method now creates exposure to Opinion Risk
There is presently no consensus among CPA Auditors about how to apply GAAP
What is the Value of the IRLC - DA
Day of Lock Day Before Closing
High ProbabilityRevenue less Commission
Value is approaching Revenue
UnIncurred Costs Decrease as Percentage of Completion Increases
Low ProbabilityRevenue less all Costs
Value is approaching Zero
What is the value of an Intangible Asset
The Derivative Asset is an Intangible Asset
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
2) Loan is Closed IRLC is FulfilledLender owns LHFS
3) Closed Loan Sold to BankBank Pays for Loans
Hedging Works when the
Past Predicts the Future
Multi-Variant Correlation
r2
r2 = Correlation Coefficient
BE
US Markets
World Markets
Borrower ldquoPUTrdquo
Pipeline
r2
TBA (hedge) MandatoryAOT
Price
Price Price Volume
Hedging Off-Setbull The hedge transaction
bull Establish a financial transaction that possess the same sensitivity to changes in the interest rate environment
bull But behaves with the opposite impact from rate changes
bull The LONG position or originating a loan behaves with an inverse relationship to the changes in interest rates
bull The SHORT position or selling an MBS has a positive correlation to changes in interest rates If rates go up the value of the short position goes up
bull Being Long and Short in the same transaction offsets or cancels the impact of changes in value from changes in the interest rate environment
bull This results in preserving the value of the underlying asset
Value of the loan and hedge react inversely to changes in rates
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
Objective is Recognition of Future Cash-Flows
PV of Discounted NET Future Cash-flows
Amortization Method or Fair Value MethodASC 860-50-35-9
IRLC under ASC 815An IRLC (Interest Rate Lock Commitment)
bull is an off balance sheet financial commitment bull subject to market risk and a bull derivative under SFAS 149 ASC 815 andbull subject MTM under SFAS 159 ASC 825
bull All IRLC are Derivatives (except for cost to complete)bull An IRLC hedged with Best Efforts is a derivativebull An IRLC hedged with a short MBS is a derivativebull The hedge strategy does not change the derivative
bull Derivatives under GAAPbull Recorded at Fair Value
bull Best Efforts Commitmentsbull Do not have a penalty for legitimate cancelationbull If loan is not closed the BE is canceled without costbull Avoidance of pair-off risk is not a derivative (most agree)bull Optional derivative under ASC 825-10-25
bull If IRLC is MTM and BE locks are not MTM bull Potential misrepresentation of gain positionbull Recommend all commitments are DerivativesMTM
ASC 815 ndash Hedge Accounting
The Interest Rate Lock Commitments ndash IRLC ndashbull IRLCs are initially issued to generate a profitbull The imbedded profit is valued at each reporting period bull The resulting gain is recorded as a Derivative Asset
bull It is very unlikely an IRLC will be a Derivative Liability
Hedge Positionbull TBA-MBS can generate a gain or loss
bull depending upon price movement since the date of salebull gain is reported as a Derivative Assetbull loss is reported as a Derivative Liability
+25 IRLCDerivative Asset Margin
Preservation
-50 TBADerivative Liability
+130 TBADerivative Asset
+70 IRLCDerivative Asset
Always consider loan gain with hedge gain or loss
Hedging Journal Entries
Warehouse bull The warehouse is comprised of two segments
ndash Committed or Allocated to Mandatory Commitmentndash Uncommitted or Hedged with Short TBA-MBS
bull The month-end MTM of the LHFS adjusts the basis of the LHFS creating a gain or loss in the PampL
Pipeline Hedgebull The month-end open TBA position MTM gain or loss is
posted to a Derivative Asset or Derivative Liability and a MTM gain or loss in PampL
Allocated and Unallocated LHFS
Secondary Marketing Data
You must get this informationhellipbull Do you Believe the numbers
(Mandatory Commitment MTM off-setting LHFS excluded in example)
WH Committed not in TBA Hedge- Valued based on purchase priceWH Uncommitted is in TBA Hedge- Valued by hedge advisor
MTM JE
bull Reverse the prior month MTM
bull Post Pair-Off AP or ARbull Post current month MTM
bull Significant changes in volume can impact the PampL
bull If hedge was gain Derivative Asset
bull Confirm everything with your Auditorbull All external reports must be GAAP
Derivative Asset increases CapitalWe Create a Derivative Asset bybull DR Derivative Asset CR Income
bull What happens to IRLC Income ndash Becomes Capital
IMBs want more Capitalbull More IRLC means more Incomebull More Income means more Capitalbull More Capital means more Warehouse borrowingbull More Capital means qualifying for FHA amp Agencybull More IRLC means more Capital
Derivative Asset
Is Confusing to Business Ownersand leads to bad decisions
Capital Accounts with Derivative AssetThe Derivative Asset is not carried at Fair Value because the Derivative Asset cannot be sold for the carrying value
During 2018 several companies failed Capital = $2 million Derivative Asset = $2 million
The Owner did not understand why they were insolvent
Disclose the Impact of the Derivative Asset in Capital Accountsbull Common Stockbull Paid In Capitalbull Distributionsbull Retained Earnings (Move IRLC MTM impact from NI to Unrealized Gain)bull Unrealized Gain(Loss)
Thanks to Oystein Konsmo CFO at Nova Financial for implementing this practice
Derivative Asset Characteristics
What is the Locked Pipeline
bull IRLC is a lock commitments issued to borrowers bull They are ldquoApplications in Processrdquo bull IRLC are commitments ndash not Loans bull There is no active market for IRLCbull There is no Asset to basis adjust for MTM
bull Is a TBA-MBS tradeable in its current form YES
bull Is a IRLC tradeable in its current form NO
bull The IRLC must be Transformed into a loan then securitized to be valued as tradeable instrument
bull Transformational Costs are unavoidable and undeniable
bull IRLC is not pure derivative but is derivative under GAAP
bull Absorption Costing is a way to understand the basis for Transformational Costs = Work in Process but is it not perfect
bull I think MSR valuation of cash flow is a more accurate measure
Is an IRLC a Tradable Asset
How have CPAs Presented theDerivative Asset
INCONSISTANTLY
Derivative Asset vs Pipeline
Small Independent Large Public
Source ndash A Greer CPA
bull Warehouse Lenders Rely on CPA for GAAP Capitalbull Lenderrsquos Observe CPA Auditorshellip
ndash Overstate Capital with DAndash Under-apply Cost to Completendash Inconsistently apply Costs to Complete
bull Warehouse Lenders reduce Derivative Asset ndash Some arbitrarily reduce by 50ndash Some reduce based on Net Future Cash Flows
Warehouse Lenderrsquos Adjustment
What about GAAP
bull What does GAAP say about Transformation Costs
bull Direct Cost Deduction Method - direct costs only
bull Full Cost Absorption Method - direct and indirect costs
bull IRLC is a pure derivative - IRLC same as TBA-MBS
bull Net Future Cash Flow Valuation Method (discussed soon)
Transformation Costs or Cost to Completebull What is the value of the IRLC
bull Pull-thru adjusted MTM less Costs to Complete
bull What is the right amount of Transformation Costsbull Direct Cost Deduction Method - direct costs onlybull Full Cost Absorption Method - both direct and indirect costsbull IRLC is a pure derivative ndash no adjustment (IRLC = TBA-MBS)
bull Uncertainty Principalndash Exponential diminishing impact to closingndash You have it when you have it otherwise uncertainndash Day of Lock 99 uncertainty Day before closing 1 uncertainty
IMB Transformational Costs ndash Best PracticesDirect Expenses
bull LO commissions production commissionsbull Other Direct Production Costs
bull appraisals outsourcing courier credit reports other cosbull Other Direct Expenses
bull LO wages processors LOA bull underwriting funding disclosure and post closing
Indirect Expensesbull Allocated Production Rent Branch Rent Branch Overhead
Consequence of Ignoring Indirect Costs
Hawaii vs TexasHigh Balance vs Low Balance
Loan Size Matters
Loan Size Dynamics ndash One Loanbull ONE LOAN
bull High Balance low gainbull Low Balance high gain
bull Derivative Asset
bull Processing costs as of loan are different
bull Profit is same
Higher Gain
$50000000 Locked Pipeline
bull Texas lender is more than double Hawaii
bull Identical Cash Realization
bull Indirect Costs Matter
Direct Costs Only - Distort Results
Derivative Asset Value
View From Finance
Present Value of Net Future Cash Flow
Same as MSR
Derivative Asset OoopsMany CPAs firms have issued opinions on financial statements with derivative asset values I would challenge as not reasonable
Changing Presentation method now creates exposure to Opinion Risk
There is presently no consensus among CPA Auditors about how to apply GAAP
What is the Value of the IRLC - DA
Day of Lock Day Before Closing
High ProbabilityRevenue less Commission
Value is approaching Revenue
UnIncurred Costs Decrease as Percentage of Completion Increases
Low ProbabilityRevenue less all Costs
Value is approaching Zero
What is the value of an Intangible Asset
The Derivative Asset is an Intangible Asset
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
IRLC under ASC 815
ASC 815 ndash Commitments
ASC 815 ndash Hedge Accounting
Slide Number 41
Slide Number 42
Slide Number 43
Slide Number 44
Slide Number 45
Slide Number 46
Slide Number 47
Derivative Asset increases Capital
Slide Number 49
Slide Number 50
Slide Number 51
What is the Locked Pipeline
Slide Number 53
Slide Number 54
Slide Number 55
Slide Number 56
What about GAAP
Transformation Costs or Cost to Complete
IMB Transformational Costs ndash Best Practices
Slide Number 60
Slide Number 61
Slide Number 62
Slide Number 63
Derivative Asset Ooops
What is the Value of the IRLC - DA
Slide Number 66
AICPA Valuation Services
AICPA - Discounted Future Benefit
Hedging Data for DA Valuation
Percentage of Completion by Status
Net Cash Flow Valuation Data
IRLC-DA Grows in Value as Costs Incurred
Lock to LHFS DA Value Accretion
Revenue Potential vs Derivative Asset
GAAP Methods Only Right Once
Slide Number 76
IRLC Value is What You Negotiate
Slide Number 78
Slide Number 79
FASB Board Meeting ndash 32818
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
Slide Number 83
IRLC is Taxable when Recorded - BUT
Slide Number 85
Slide Number 86
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
PampL - with and without IRLC
IRLC Revenue is Confusing
Slide Number 91
Slide Number 92
Slide Number 93
Slide Number 94
Slide Number 95
Slide Number 96
Balance Sheet or Commitment
Gain or (Loss)
Warehouse - committed
$1000000000
$10000000
(1)
Pair-Off trades - closed not settled
($800000)
(2)
Locked Pipeline (net of pull-thru)
$3000000000
$30000000
(3)
Warehouse ndash not committed
$45000000
$450000
(4)
Hedge
$2700000000
($27000000)
(5)
Balance Sheet amp Income Statement Accounts
Assets
Cash
$1000000
Loans Held for Sale
$10000000
Loans Held for Sale
$450000
Loans Held for Sale
$100000
(1)
Loans Held for Sale
$4500
(4)
AR Loan Sales (not GAAP)
AR Pair Off
Derivative Asset (MTM gains)
$300000
(3)
Liabilities
Warehouse loan
$10000000
AP Commission
AP Pair-Off
$8000
(2)
Borrower Escrow
$450000
Derivative Liability (MTM losses)
$270000
(5)
Capital
MTM valuation
Retained Earning
$1000000
Revenue
MTM Gain or Loss (gain)
$100000
(1)
MTM Gain or Loss (gain)
$300000
(3)
MTM Gain or Loss (gain)
$4500
(4)
Expense
Pair-Off Gain or Loss (loss)
$8000
(2)
MTM Gain or Loss (loss)
$270000
(5)
$12132500
$12132500
Journal Entries
Warehouse Loans with Purchase Commitment (value based on purchase commitment)
If gain
Debit Loans Held For Sale
$10000000
Credit MTM Gain or Loss
$10000000
If loss
Debit MTM Gain of Loss
$10000000
Credit Loans Held For Sale
$10000000
Pair-Offs (value based on closed trade)
If gain
Debit Pair-Off Receivable
$800000
Credit Pair-Off Gain or Loss
$800000
If loss
Debit Pair-Off Gain or Loss
$800000
Credit Pair-Off Payable
$800000
Warehouse Loans without Purchase Commitment MTM (value at month-end)
If gain
Debit Loans Held for Sale
$450000
Credit MTM Gain or Loss^
$450000
If loss
Debit MTM Gain or Loss^
$450000
Credit Loans Held for Sale
$450000
Locked Pipeline MTM (pull-thru adjusted)
If gain
Debit Derivative Asset
$30000000
Credit MTM Gain or Loss^
$30000000
If loss
Debit MTM Gain or Loss^
$30000000
Credit Derivative Liability
$30000000
Hedge MTM
If gain
Debit Derivative Asset
$27000000
Credit MTM Gain or Loss^
$27000000
If loss
Debit MTM Gain or Loss^
$27000000
Credit Derivative Liability
$27000000
or Gain on Sale for mgmt reporting (not GAAP)
^ or MTM valuation in Capital for mgmt reporting (not GAAP)
Hedging Works when the
Past Predicts the Future
Multi-Variant Correlation
r2
r2 = Correlation Coefficient
BE
US Markets
World Markets
Borrower ldquoPUTrdquo
Pipeline
r2
TBA (hedge) MandatoryAOT
Price
Price Price Volume
Hedging Off-Setbull The hedge transaction
bull Establish a financial transaction that possess the same sensitivity to changes in the interest rate environment
bull But behaves with the opposite impact from rate changes
bull The LONG position or originating a loan behaves with an inverse relationship to the changes in interest rates
bull The SHORT position or selling an MBS has a positive correlation to changes in interest rates If rates go up the value of the short position goes up
bull Being Long and Short in the same transaction offsets or cancels the impact of changes in value from changes in the interest rate environment
bull This results in preserving the value of the underlying asset
Value of the loan and hedge react inversely to changes in rates
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
Objective is Recognition of Future Cash-Flows
PV of Discounted NET Future Cash-flows
Amortization Method or Fair Value MethodASC 860-50-35-9
IRLC under ASC 815An IRLC (Interest Rate Lock Commitment)
bull is an off balance sheet financial commitment bull subject to market risk and a bull derivative under SFAS 149 ASC 815 andbull subject MTM under SFAS 159 ASC 825
bull All IRLC are Derivatives (except for cost to complete)bull An IRLC hedged with Best Efforts is a derivativebull An IRLC hedged with a short MBS is a derivativebull The hedge strategy does not change the derivative
bull Derivatives under GAAPbull Recorded at Fair Value
bull Best Efforts Commitmentsbull Do not have a penalty for legitimate cancelationbull If loan is not closed the BE is canceled without costbull Avoidance of pair-off risk is not a derivative (most agree)bull Optional derivative under ASC 825-10-25
bull If IRLC is MTM and BE locks are not MTM bull Potential misrepresentation of gain positionbull Recommend all commitments are DerivativesMTM
ASC 815 ndash Hedge Accounting
The Interest Rate Lock Commitments ndash IRLC ndashbull IRLCs are initially issued to generate a profitbull The imbedded profit is valued at each reporting period bull The resulting gain is recorded as a Derivative Asset
bull It is very unlikely an IRLC will be a Derivative Liability
Hedge Positionbull TBA-MBS can generate a gain or loss
bull depending upon price movement since the date of salebull gain is reported as a Derivative Assetbull loss is reported as a Derivative Liability
+25 IRLCDerivative Asset Margin
Preservation
-50 TBADerivative Liability
+130 TBADerivative Asset
+70 IRLCDerivative Asset
Always consider loan gain with hedge gain or loss
Hedging Journal Entries
Warehouse bull The warehouse is comprised of two segments
ndash Committed or Allocated to Mandatory Commitmentndash Uncommitted or Hedged with Short TBA-MBS
bull The month-end MTM of the LHFS adjusts the basis of the LHFS creating a gain or loss in the PampL
Pipeline Hedgebull The month-end open TBA position MTM gain or loss is
posted to a Derivative Asset or Derivative Liability and a MTM gain or loss in PampL
Allocated and Unallocated LHFS
Secondary Marketing Data
You must get this informationhellipbull Do you Believe the numbers
(Mandatory Commitment MTM off-setting LHFS excluded in example)
WH Committed not in TBA Hedge- Valued based on purchase priceWH Uncommitted is in TBA Hedge- Valued by hedge advisor
MTM JE
bull Reverse the prior month MTM
bull Post Pair-Off AP or ARbull Post current month MTM
bull Significant changes in volume can impact the PampL
bull If hedge was gain Derivative Asset
bull Confirm everything with your Auditorbull All external reports must be GAAP
Derivative Asset increases CapitalWe Create a Derivative Asset bybull DR Derivative Asset CR Income
bull What happens to IRLC Income ndash Becomes Capital
IMBs want more Capitalbull More IRLC means more Incomebull More Income means more Capitalbull More Capital means more Warehouse borrowingbull More Capital means qualifying for FHA amp Agencybull More IRLC means more Capital
Derivative Asset
Is Confusing to Business Ownersand leads to bad decisions
Capital Accounts with Derivative AssetThe Derivative Asset is not carried at Fair Value because the Derivative Asset cannot be sold for the carrying value
During 2018 several companies failed Capital = $2 million Derivative Asset = $2 million
The Owner did not understand why they were insolvent
Disclose the Impact of the Derivative Asset in Capital Accountsbull Common Stockbull Paid In Capitalbull Distributionsbull Retained Earnings (Move IRLC MTM impact from NI to Unrealized Gain)bull Unrealized Gain(Loss)
Thanks to Oystein Konsmo CFO at Nova Financial for implementing this practice
Derivative Asset Characteristics
What is the Locked Pipeline
bull IRLC is a lock commitments issued to borrowers bull They are ldquoApplications in Processrdquo bull IRLC are commitments ndash not Loans bull There is no active market for IRLCbull There is no Asset to basis adjust for MTM
bull Is a TBA-MBS tradeable in its current form YES
bull Is a IRLC tradeable in its current form NO
bull The IRLC must be Transformed into a loan then securitized to be valued as tradeable instrument
bull Transformational Costs are unavoidable and undeniable
bull IRLC is not pure derivative but is derivative under GAAP
bull Absorption Costing is a way to understand the basis for Transformational Costs = Work in Process but is it not perfect
bull I think MSR valuation of cash flow is a more accurate measure
Is an IRLC a Tradable Asset
How have CPAs Presented theDerivative Asset
INCONSISTANTLY
Derivative Asset vs Pipeline
Small Independent Large Public
Source ndash A Greer CPA
bull Warehouse Lenders Rely on CPA for GAAP Capitalbull Lenderrsquos Observe CPA Auditorshellip
ndash Overstate Capital with DAndash Under-apply Cost to Completendash Inconsistently apply Costs to Complete
bull Warehouse Lenders reduce Derivative Asset ndash Some arbitrarily reduce by 50ndash Some reduce based on Net Future Cash Flows
Warehouse Lenderrsquos Adjustment
What about GAAP
bull What does GAAP say about Transformation Costs
bull Direct Cost Deduction Method - direct costs only
bull Full Cost Absorption Method - direct and indirect costs
bull IRLC is a pure derivative - IRLC same as TBA-MBS
bull Net Future Cash Flow Valuation Method (discussed soon)
Transformation Costs or Cost to Completebull What is the value of the IRLC
bull Pull-thru adjusted MTM less Costs to Complete
bull What is the right amount of Transformation Costsbull Direct Cost Deduction Method - direct costs onlybull Full Cost Absorption Method - both direct and indirect costsbull IRLC is a pure derivative ndash no adjustment (IRLC = TBA-MBS)
bull Uncertainty Principalndash Exponential diminishing impact to closingndash You have it when you have it otherwise uncertainndash Day of Lock 99 uncertainty Day before closing 1 uncertainty
IMB Transformational Costs ndash Best PracticesDirect Expenses
bull LO commissions production commissionsbull Other Direct Production Costs
bull appraisals outsourcing courier credit reports other cosbull Other Direct Expenses
bull LO wages processors LOA bull underwriting funding disclosure and post closing
Indirect Expensesbull Allocated Production Rent Branch Rent Branch Overhead
Consequence of Ignoring Indirect Costs
Hawaii vs TexasHigh Balance vs Low Balance
Loan Size Matters
Loan Size Dynamics ndash One Loanbull ONE LOAN
bull High Balance low gainbull Low Balance high gain
bull Derivative Asset
bull Processing costs as of loan are different
bull Profit is same
Higher Gain
$50000000 Locked Pipeline
bull Texas lender is more than double Hawaii
bull Identical Cash Realization
bull Indirect Costs Matter
Direct Costs Only - Distort Results
Derivative Asset Value
View From Finance
Present Value of Net Future Cash Flow
Same as MSR
Derivative Asset OoopsMany CPAs firms have issued opinions on financial statements with derivative asset values I would challenge as not reasonable
Changing Presentation method now creates exposure to Opinion Risk
There is presently no consensus among CPA Auditors about how to apply GAAP
What is the Value of the IRLC - DA
Day of Lock Day Before Closing
High ProbabilityRevenue less Commission
Value is approaching Revenue
UnIncurred Costs Decrease as Percentage of Completion Increases
Low ProbabilityRevenue less all Costs
Value is approaching Zero
What is the value of an Intangible Asset
The Derivative Asset is an Intangible Asset
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
IRLC under ASC 815
ASC 815 ndash Commitments
ASC 815 ndash Hedge Accounting
Slide Number 41
Slide Number 42
Slide Number 43
Slide Number 44
Slide Number 45
Slide Number 46
Slide Number 47
Derivative Asset increases Capital
Slide Number 49
Slide Number 50
Slide Number 51
What is the Locked Pipeline
Slide Number 53
Slide Number 54
Slide Number 55
Slide Number 56
What about GAAP
Transformation Costs or Cost to Complete
IMB Transformational Costs ndash Best Practices
Slide Number 60
Slide Number 61
Slide Number 62
Slide Number 63
Derivative Asset Ooops
What is the Value of the IRLC - DA
Slide Number 66
AICPA Valuation Services
AICPA - Discounted Future Benefit
Hedging Data for DA Valuation
Percentage of Completion by Status
Net Cash Flow Valuation Data
IRLC-DA Grows in Value as Costs Incurred
Lock to LHFS DA Value Accretion
Revenue Potential vs Derivative Asset
GAAP Methods Only Right Once
Slide Number 76
IRLC Value is What You Negotiate
Slide Number 78
Slide Number 79
FASB Board Meeting ndash 32818
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
Slide Number 83
IRLC is Taxable when Recorded - BUT
Slide Number 85
Slide Number 86
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
PampL - with and without IRLC
IRLC Revenue is Confusing
Slide Number 91
Slide Number 92
Slide Number 93
Slide Number 94
Slide Number 95
Slide Number 96
Balance Sheet or Commitment
Gain or (Loss)
Warehouse - committed
$1000000000
$10000000
(1)
Pair-Off trades - closed not settled
($800000)
(2)
Locked Pipeline (net of pull-thru)
$3000000000
$30000000
(3)
Warehouse ndash not committed
$45000000
$450000
(4)
Hedge
$2700000000
($27000000)
(5)
Balance Sheet amp Income Statement Accounts
Assets
Cash
$1000000
Loans Held for Sale
$10000000
Loans Held for Sale
$450000
Loans Held for Sale
$100000
(1)
Loans Held for Sale
$4500
(4)
AR Loan Sales (not GAAP)
AR Pair Off
Derivative Asset (MTM gains)
$300000
(3)
Liabilities
Warehouse loan
$10000000
AP Commission
AP Pair-Off
$8000
(2)
Borrower Escrow
$450000
Derivative Liability (MTM losses)
$270000
(5)
Capital
MTM valuation
Retained Earning
$1000000
Revenue
MTM Gain or Loss (gain)
$100000
(1)
MTM Gain or Loss (gain)
$300000
(3)
MTM Gain or Loss (gain)
$4500
(4)
Expense
Pair-Off Gain or Loss (loss)
$8000
(2)
MTM Gain or Loss (loss)
$270000
(5)
$12132500
$12132500
Journal Entries
Warehouse Loans with Purchase Commitment (value based on purchase commitment)
If gain
Debit Loans Held For Sale
$10000000
Credit MTM Gain or Loss
$10000000
If loss
Debit MTM Gain of Loss
$10000000
Credit Loans Held For Sale
$10000000
Pair-Offs (value based on closed trade)
If gain
Debit Pair-Off Receivable
$800000
Credit Pair-Off Gain or Loss
$800000
If loss
Debit Pair-Off Gain or Loss
$800000
Credit Pair-Off Payable
$800000
Warehouse Loans without Purchase Commitment MTM (value at month-end)
If gain
Debit Loans Held for Sale
$450000
Credit MTM Gain or Loss^
$450000
If loss
Debit MTM Gain or Loss^
$450000
Credit Loans Held for Sale
$450000
Locked Pipeline MTM (pull-thru adjusted)
If gain
Debit Derivative Asset
$30000000
Credit MTM Gain or Loss^
$30000000
If loss
Debit MTM Gain or Loss^
$30000000
Credit Derivative Liability
$30000000
Hedge MTM
If gain
Debit Derivative Asset
$27000000
Credit MTM Gain or Loss^
$27000000
If loss
Debit MTM Gain or Loss^
$27000000
Credit Derivative Liability
$27000000
or Gain on Sale for mgmt reporting (not GAAP)
^ or MTM valuation in Capital for mgmt reporting (not GAAP)
Multi-Variant Correlation
r2
r2 = Correlation Coefficient
BE
US Markets
World Markets
Borrower ldquoPUTrdquo
Pipeline
r2
TBA (hedge) MandatoryAOT
Price
Price Price Volume
Hedging Off-Setbull The hedge transaction
bull Establish a financial transaction that possess the same sensitivity to changes in the interest rate environment
bull But behaves with the opposite impact from rate changes
bull The LONG position or originating a loan behaves with an inverse relationship to the changes in interest rates
bull The SHORT position or selling an MBS has a positive correlation to changes in interest rates If rates go up the value of the short position goes up
bull Being Long and Short in the same transaction offsets or cancels the impact of changes in value from changes in the interest rate environment
bull This results in preserving the value of the underlying asset
Value of the loan and hedge react inversely to changes in rates
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
Objective is Recognition of Future Cash-Flows
PV of Discounted NET Future Cash-flows
Amortization Method or Fair Value MethodASC 860-50-35-9
IRLC under ASC 815An IRLC (Interest Rate Lock Commitment)
bull is an off balance sheet financial commitment bull subject to market risk and a bull derivative under SFAS 149 ASC 815 andbull subject MTM under SFAS 159 ASC 825
bull All IRLC are Derivatives (except for cost to complete)bull An IRLC hedged with Best Efforts is a derivativebull An IRLC hedged with a short MBS is a derivativebull The hedge strategy does not change the derivative
bull Derivatives under GAAPbull Recorded at Fair Value
bull Best Efforts Commitmentsbull Do not have a penalty for legitimate cancelationbull If loan is not closed the BE is canceled without costbull Avoidance of pair-off risk is not a derivative (most agree)bull Optional derivative under ASC 825-10-25
bull If IRLC is MTM and BE locks are not MTM bull Potential misrepresentation of gain positionbull Recommend all commitments are DerivativesMTM
ASC 815 ndash Hedge Accounting
The Interest Rate Lock Commitments ndash IRLC ndashbull IRLCs are initially issued to generate a profitbull The imbedded profit is valued at each reporting period bull The resulting gain is recorded as a Derivative Asset
bull It is very unlikely an IRLC will be a Derivative Liability
Hedge Positionbull TBA-MBS can generate a gain or loss
bull depending upon price movement since the date of salebull gain is reported as a Derivative Assetbull loss is reported as a Derivative Liability
+25 IRLCDerivative Asset Margin
Preservation
-50 TBADerivative Liability
+130 TBADerivative Asset
+70 IRLCDerivative Asset
Always consider loan gain with hedge gain or loss
Hedging Journal Entries
Warehouse bull The warehouse is comprised of two segments
ndash Committed or Allocated to Mandatory Commitmentndash Uncommitted or Hedged with Short TBA-MBS
bull The month-end MTM of the LHFS adjusts the basis of the LHFS creating a gain or loss in the PampL
Pipeline Hedgebull The month-end open TBA position MTM gain or loss is
posted to a Derivative Asset or Derivative Liability and a MTM gain or loss in PampL
Allocated and Unallocated LHFS
Secondary Marketing Data
You must get this informationhellipbull Do you Believe the numbers
(Mandatory Commitment MTM off-setting LHFS excluded in example)
WH Committed not in TBA Hedge- Valued based on purchase priceWH Uncommitted is in TBA Hedge- Valued by hedge advisor
MTM JE
bull Reverse the prior month MTM
bull Post Pair-Off AP or ARbull Post current month MTM
bull Significant changes in volume can impact the PampL
bull If hedge was gain Derivative Asset
bull Confirm everything with your Auditorbull All external reports must be GAAP
Derivative Asset increases CapitalWe Create a Derivative Asset bybull DR Derivative Asset CR Income
bull What happens to IRLC Income ndash Becomes Capital
IMBs want more Capitalbull More IRLC means more Incomebull More Income means more Capitalbull More Capital means more Warehouse borrowingbull More Capital means qualifying for FHA amp Agencybull More IRLC means more Capital
Derivative Asset
Is Confusing to Business Ownersand leads to bad decisions
Capital Accounts with Derivative AssetThe Derivative Asset is not carried at Fair Value because the Derivative Asset cannot be sold for the carrying value
During 2018 several companies failed Capital = $2 million Derivative Asset = $2 million
The Owner did not understand why they were insolvent
Disclose the Impact of the Derivative Asset in Capital Accountsbull Common Stockbull Paid In Capitalbull Distributionsbull Retained Earnings (Move IRLC MTM impact from NI to Unrealized Gain)bull Unrealized Gain(Loss)
Thanks to Oystein Konsmo CFO at Nova Financial for implementing this practice
Derivative Asset Characteristics
What is the Locked Pipeline
bull IRLC is a lock commitments issued to borrowers bull They are ldquoApplications in Processrdquo bull IRLC are commitments ndash not Loans bull There is no active market for IRLCbull There is no Asset to basis adjust for MTM
bull Is a TBA-MBS tradeable in its current form YES
bull Is a IRLC tradeable in its current form NO
bull The IRLC must be Transformed into a loan then securitized to be valued as tradeable instrument
bull Transformational Costs are unavoidable and undeniable
bull IRLC is not pure derivative but is derivative under GAAP
bull Absorption Costing is a way to understand the basis for Transformational Costs = Work in Process but is it not perfect
bull I think MSR valuation of cash flow is a more accurate measure
Is an IRLC a Tradable Asset
How have CPAs Presented theDerivative Asset
INCONSISTANTLY
Derivative Asset vs Pipeline
Small Independent Large Public
Source ndash A Greer CPA
bull Warehouse Lenders Rely on CPA for GAAP Capitalbull Lenderrsquos Observe CPA Auditorshellip
ndash Overstate Capital with DAndash Under-apply Cost to Completendash Inconsistently apply Costs to Complete
bull Warehouse Lenders reduce Derivative Asset ndash Some arbitrarily reduce by 50ndash Some reduce based on Net Future Cash Flows
Warehouse Lenderrsquos Adjustment
What about GAAP
bull What does GAAP say about Transformation Costs
bull Direct Cost Deduction Method - direct costs only
bull Full Cost Absorption Method - direct and indirect costs
bull IRLC is a pure derivative - IRLC same as TBA-MBS
bull Net Future Cash Flow Valuation Method (discussed soon)
Transformation Costs or Cost to Completebull What is the value of the IRLC
bull Pull-thru adjusted MTM less Costs to Complete
bull What is the right amount of Transformation Costsbull Direct Cost Deduction Method - direct costs onlybull Full Cost Absorption Method - both direct and indirect costsbull IRLC is a pure derivative ndash no adjustment (IRLC = TBA-MBS)
bull Uncertainty Principalndash Exponential diminishing impact to closingndash You have it when you have it otherwise uncertainndash Day of Lock 99 uncertainty Day before closing 1 uncertainty
IMB Transformational Costs ndash Best PracticesDirect Expenses
bull LO commissions production commissionsbull Other Direct Production Costs
bull appraisals outsourcing courier credit reports other cosbull Other Direct Expenses
bull LO wages processors LOA bull underwriting funding disclosure and post closing
Indirect Expensesbull Allocated Production Rent Branch Rent Branch Overhead
Consequence of Ignoring Indirect Costs
Hawaii vs TexasHigh Balance vs Low Balance
Loan Size Matters
Loan Size Dynamics ndash One Loanbull ONE LOAN
bull High Balance low gainbull Low Balance high gain
bull Derivative Asset
bull Processing costs as of loan are different
bull Profit is same
Higher Gain
$50000000 Locked Pipeline
bull Texas lender is more than double Hawaii
bull Identical Cash Realization
bull Indirect Costs Matter
Direct Costs Only - Distort Results
Derivative Asset Value
View From Finance
Present Value of Net Future Cash Flow
Same as MSR
Derivative Asset OoopsMany CPAs firms have issued opinions on financial statements with derivative asset values I would challenge as not reasonable
Changing Presentation method now creates exposure to Opinion Risk
There is presently no consensus among CPA Auditors about how to apply GAAP
What is the Value of the IRLC - DA
Day of Lock Day Before Closing
High ProbabilityRevenue less Commission
Value is approaching Revenue
UnIncurred Costs Decrease as Percentage of Completion Increases
Low ProbabilityRevenue less all Costs
Value is approaching Zero
What is the value of an Intangible Asset
The Derivative Asset is an Intangible Asset
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
IRLC under ASC 815
ASC 815 ndash Commitments
ASC 815 ndash Hedge Accounting
Slide Number 41
Slide Number 42
Slide Number 43
Slide Number 44
Slide Number 45
Slide Number 46
Slide Number 47
Derivative Asset increases Capital
Slide Number 49
Slide Number 50
Slide Number 51
What is the Locked Pipeline
Slide Number 53
Slide Number 54
Slide Number 55
Slide Number 56
What about GAAP
Transformation Costs or Cost to Complete
IMB Transformational Costs ndash Best Practices
Slide Number 60
Slide Number 61
Slide Number 62
Slide Number 63
Derivative Asset Ooops
What is the Value of the IRLC - DA
Slide Number 66
AICPA Valuation Services
AICPA - Discounted Future Benefit
Hedging Data for DA Valuation
Percentage of Completion by Status
Net Cash Flow Valuation Data
IRLC-DA Grows in Value as Costs Incurred
Lock to LHFS DA Value Accretion
Revenue Potential vs Derivative Asset
GAAP Methods Only Right Once
Slide Number 76
IRLC Value is What You Negotiate
Slide Number 78
Slide Number 79
FASB Board Meeting ndash 32818
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
Slide Number 83
IRLC is Taxable when Recorded - BUT
Slide Number 85
Slide Number 86
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
PampL - with and without IRLC
IRLC Revenue is Confusing
Slide Number 91
Slide Number 92
Slide Number 93
Slide Number 94
Slide Number 95
Slide Number 96
Balance Sheet or Commitment
Gain or (Loss)
Warehouse - committed
$1000000000
$10000000
(1)
Pair-Off trades - closed not settled
($800000)
(2)
Locked Pipeline (net of pull-thru)
$3000000000
$30000000
(3)
Warehouse ndash not committed
$45000000
$450000
(4)
Hedge
$2700000000
($27000000)
(5)
Balance Sheet amp Income Statement Accounts
Assets
Cash
$1000000
Loans Held for Sale
$10000000
Loans Held for Sale
$450000
Loans Held for Sale
$100000
(1)
Loans Held for Sale
$4500
(4)
AR Loan Sales (not GAAP)
AR Pair Off
Derivative Asset (MTM gains)
$300000
(3)
Liabilities
Warehouse loan
$10000000
AP Commission
AP Pair-Off
$8000
(2)
Borrower Escrow
$450000
Derivative Liability (MTM losses)
$270000
(5)
Capital
MTM valuation
Retained Earning
$1000000
Revenue
MTM Gain or Loss (gain)
$100000
(1)
MTM Gain or Loss (gain)
$300000
(3)
MTM Gain or Loss (gain)
$4500
(4)
Expense
Pair-Off Gain or Loss (loss)
$8000
(2)
MTM Gain or Loss (loss)
$270000
(5)
$12132500
$12132500
Journal Entries
Warehouse Loans with Purchase Commitment (value based on purchase commitment)
If gain
Debit Loans Held For Sale
$10000000
Credit MTM Gain or Loss
$10000000
If loss
Debit MTM Gain of Loss
$10000000
Credit Loans Held For Sale
$10000000
Pair-Offs (value based on closed trade)
If gain
Debit Pair-Off Receivable
$800000
Credit Pair-Off Gain or Loss
$800000
If loss
Debit Pair-Off Gain or Loss
$800000
Credit Pair-Off Payable
$800000
Warehouse Loans without Purchase Commitment MTM (value at month-end)
If gain
Debit Loans Held for Sale
$450000
Credit MTM Gain or Loss^
$450000
If loss
Debit MTM Gain or Loss^
$450000
Credit Loans Held for Sale
$450000
Locked Pipeline MTM (pull-thru adjusted)
If gain
Debit Derivative Asset
$30000000
Credit MTM Gain or Loss^
$30000000
If loss
Debit MTM Gain or Loss^
$30000000
Credit Derivative Liability
$30000000
Hedge MTM
If gain
Debit Derivative Asset
$27000000
Credit MTM Gain or Loss^
$27000000
If loss
Debit MTM Gain or Loss^
$27000000
Credit Derivative Liability
$27000000
or Gain on Sale for mgmt reporting (not GAAP)
^ or MTM valuation in Capital for mgmt reporting (not GAAP)
Hedging Off-Setbull The hedge transaction
bull Establish a financial transaction that possess the same sensitivity to changes in the interest rate environment
bull But behaves with the opposite impact from rate changes
bull The LONG position or originating a loan behaves with an inverse relationship to the changes in interest rates
bull The SHORT position or selling an MBS has a positive correlation to changes in interest rates If rates go up the value of the short position goes up
bull Being Long and Short in the same transaction offsets or cancels the impact of changes in value from changes in the interest rate environment
bull This results in preserving the value of the underlying asset
Value of the loan and hedge react inversely to changes in rates
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
Objective is Recognition of Future Cash-Flows
PV of Discounted NET Future Cash-flows
Amortization Method or Fair Value MethodASC 860-50-35-9
IRLC under ASC 815An IRLC (Interest Rate Lock Commitment)
bull is an off balance sheet financial commitment bull subject to market risk and a bull derivative under SFAS 149 ASC 815 andbull subject MTM under SFAS 159 ASC 825
bull All IRLC are Derivatives (except for cost to complete)bull An IRLC hedged with Best Efforts is a derivativebull An IRLC hedged with a short MBS is a derivativebull The hedge strategy does not change the derivative
bull Derivatives under GAAPbull Recorded at Fair Value
bull Best Efforts Commitmentsbull Do not have a penalty for legitimate cancelationbull If loan is not closed the BE is canceled without costbull Avoidance of pair-off risk is not a derivative (most agree)bull Optional derivative under ASC 825-10-25
bull If IRLC is MTM and BE locks are not MTM bull Potential misrepresentation of gain positionbull Recommend all commitments are DerivativesMTM
ASC 815 ndash Hedge Accounting
The Interest Rate Lock Commitments ndash IRLC ndashbull IRLCs are initially issued to generate a profitbull The imbedded profit is valued at each reporting period bull The resulting gain is recorded as a Derivative Asset
bull It is very unlikely an IRLC will be a Derivative Liability
Hedge Positionbull TBA-MBS can generate a gain or loss
bull depending upon price movement since the date of salebull gain is reported as a Derivative Assetbull loss is reported as a Derivative Liability
+25 IRLCDerivative Asset Margin
Preservation
-50 TBADerivative Liability
+130 TBADerivative Asset
+70 IRLCDerivative Asset
Always consider loan gain with hedge gain or loss
Hedging Journal Entries
Warehouse bull The warehouse is comprised of two segments
ndash Committed or Allocated to Mandatory Commitmentndash Uncommitted or Hedged with Short TBA-MBS
bull The month-end MTM of the LHFS adjusts the basis of the LHFS creating a gain or loss in the PampL
Pipeline Hedgebull The month-end open TBA position MTM gain or loss is
posted to a Derivative Asset or Derivative Liability and a MTM gain or loss in PampL
Allocated and Unallocated LHFS
Secondary Marketing Data
You must get this informationhellipbull Do you Believe the numbers
(Mandatory Commitment MTM off-setting LHFS excluded in example)
WH Committed not in TBA Hedge- Valued based on purchase priceWH Uncommitted is in TBA Hedge- Valued by hedge advisor
MTM JE
bull Reverse the prior month MTM
bull Post Pair-Off AP or ARbull Post current month MTM
bull Significant changes in volume can impact the PampL
bull If hedge was gain Derivative Asset
bull Confirm everything with your Auditorbull All external reports must be GAAP
Derivative Asset increases CapitalWe Create a Derivative Asset bybull DR Derivative Asset CR Income
bull What happens to IRLC Income ndash Becomes Capital
IMBs want more Capitalbull More IRLC means more Incomebull More Income means more Capitalbull More Capital means more Warehouse borrowingbull More Capital means qualifying for FHA amp Agencybull More IRLC means more Capital
Derivative Asset
Is Confusing to Business Ownersand leads to bad decisions
Capital Accounts with Derivative AssetThe Derivative Asset is not carried at Fair Value because the Derivative Asset cannot be sold for the carrying value
During 2018 several companies failed Capital = $2 million Derivative Asset = $2 million
The Owner did not understand why they were insolvent
Disclose the Impact of the Derivative Asset in Capital Accountsbull Common Stockbull Paid In Capitalbull Distributionsbull Retained Earnings (Move IRLC MTM impact from NI to Unrealized Gain)bull Unrealized Gain(Loss)
Thanks to Oystein Konsmo CFO at Nova Financial for implementing this practice
Derivative Asset Characteristics
What is the Locked Pipeline
bull IRLC is a lock commitments issued to borrowers bull They are ldquoApplications in Processrdquo bull IRLC are commitments ndash not Loans bull There is no active market for IRLCbull There is no Asset to basis adjust for MTM
bull Is a TBA-MBS tradeable in its current form YES
bull Is a IRLC tradeable in its current form NO
bull The IRLC must be Transformed into a loan then securitized to be valued as tradeable instrument
bull Transformational Costs are unavoidable and undeniable
bull IRLC is not pure derivative but is derivative under GAAP
bull Absorption Costing is a way to understand the basis for Transformational Costs = Work in Process but is it not perfect
bull I think MSR valuation of cash flow is a more accurate measure
Is an IRLC a Tradable Asset
How have CPAs Presented theDerivative Asset
INCONSISTANTLY
Derivative Asset vs Pipeline
Small Independent Large Public
Source ndash A Greer CPA
bull Warehouse Lenders Rely on CPA for GAAP Capitalbull Lenderrsquos Observe CPA Auditorshellip
ndash Overstate Capital with DAndash Under-apply Cost to Completendash Inconsistently apply Costs to Complete
bull Warehouse Lenders reduce Derivative Asset ndash Some arbitrarily reduce by 50ndash Some reduce based on Net Future Cash Flows
Warehouse Lenderrsquos Adjustment
What about GAAP
bull What does GAAP say about Transformation Costs
bull Direct Cost Deduction Method - direct costs only
bull Full Cost Absorption Method - direct and indirect costs
bull IRLC is a pure derivative - IRLC same as TBA-MBS
bull Net Future Cash Flow Valuation Method (discussed soon)
Transformation Costs or Cost to Completebull What is the value of the IRLC
bull Pull-thru adjusted MTM less Costs to Complete
bull What is the right amount of Transformation Costsbull Direct Cost Deduction Method - direct costs onlybull Full Cost Absorption Method - both direct and indirect costsbull IRLC is a pure derivative ndash no adjustment (IRLC = TBA-MBS)
bull Uncertainty Principalndash Exponential diminishing impact to closingndash You have it when you have it otherwise uncertainndash Day of Lock 99 uncertainty Day before closing 1 uncertainty
IMB Transformational Costs ndash Best PracticesDirect Expenses
bull LO commissions production commissionsbull Other Direct Production Costs
bull appraisals outsourcing courier credit reports other cosbull Other Direct Expenses
bull LO wages processors LOA bull underwriting funding disclosure and post closing
Indirect Expensesbull Allocated Production Rent Branch Rent Branch Overhead
Consequence of Ignoring Indirect Costs
Hawaii vs TexasHigh Balance vs Low Balance
Loan Size Matters
Loan Size Dynamics ndash One Loanbull ONE LOAN
bull High Balance low gainbull Low Balance high gain
bull Derivative Asset
bull Processing costs as of loan are different
bull Profit is same
Higher Gain
$50000000 Locked Pipeline
bull Texas lender is more than double Hawaii
bull Identical Cash Realization
bull Indirect Costs Matter
Direct Costs Only - Distort Results
Derivative Asset Value
View From Finance
Present Value of Net Future Cash Flow
Same as MSR
Derivative Asset OoopsMany CPAs firms have issued opinions on financial statements with derivative asset values I would challenge as not reasonable
Changing Presentation method now creates exposure to Opinion Risk
There is presently no consensus among CPA Auditors about how to apply GAAP
What is the Value of the IRLC - DA
Day of Lock Day Before Closing
High ProbabilityRevenue less Commission
Value is approaching Revenue
UnIncurred Costs Decrease as Percentage of Completion Increases
Low ProbabilityRevenue less all Costs
Value is approaching Zero
What is the value of an Intangible Asset
The Derivative Asset is an Intangible Asset
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
Objective is Recognition of Future Cash-Flows
PV of Discounted NET Future Cash-flows
Amortization Method or Fair Value MethodASC 860-50-35-9
IRLC under ASC 815An IRLC (Interest Rate Lock Commitment)
bull is an off balance sheet financial commitment bull subject to market risk and a bull derivative under SFAS 149 ASC 815 andbull subject MTM under SFAS 159 ASC 825
bull All IRLC are Derivatives (except for cost to complete)bull An IRLC hedged with Best Efforts is a derivativebull An IRLC hedged with a short MBS is a derivativebull The hedge strategy does not change the derivative
bull Derivatives under GAAPbull Recorded at Fair Value
bull Best Efforts Commitmentsbull Do not have a penalty for legitimate cancelationbull If loan is not closed the BE is canceled without costbull Avoidance of pair-off risk is not a derivative (most agree)bull Optional derivative under ASC 825-10-25
bull If IRLC is MTM and BE locks are not MTM bull Potential misrepresentation of gain positionbull Recommend all commitments are DerivativesMTM
ASC 815 ndash Hedge Accounting
The Interest Rate Lock Commitments ndash IRLC ndashbull IRLCs are initially issued to generate a profitbull The imbedded profit is valued at each reporting period bull The resulting gain is recorded as a Derivative Asset
bull It is very unlikely an IRLC will be a Derivative Liability
Hedge Positionbull TBA-MBS can generate a gain or loss
bull depending upon price movement since the date of salebull gain is reported as a Derivative Assetbull loss is reported as a Derivative Liability
+25 IRLCDerivative Asset Margin
Preservation
-50 TBADerivative Liability
+130 TBADerivative Asset
+70 IRLCDerivative Asset
Always consider loan gain with hedge gain or loss
Hedging Journal Entries
Warehouse bull The warehouse is comprised of two segments
ndash Committed or Allocated to Mandatory Commitmentndash Uncommitted or Hedged with Short TBA-MBS
bull The month-end MTM of the LHFS adjusts the basis of the LHFS creating a gain or loss in the PampL
Pipeline Hedgebull The month-end open TBA position MTM gain or loss is
posted to a Derivative Asset or Derivative Liability and a MTM gain or loss in PampL
Allocated and Unallocated LHFS
Secondary Marketing Data
You must get this informationhellipbull Do you Believe the numbers
(Mandatory Commitment MTM off-setting LHFS excluded in example)
WH Committed not in TBA Hedge- Valued based on purchase priceWH Uncommitted is in TBA Hedge- Valued by hedge advisor
MTM JE
bull Reverse the prior month MTM
bull Post Pair-Off AP or ARbull Post current month MTM
bull Significant changes in volume can impact the PampL
bull If hedge was gain Derivative Asset
bull Confirm everything with your Auditorbull All external reports must be GAAP
Derivative Asset increases CapitalWe Create a Derivative Asset bybull DR Derivative Asset CR Income
bull What happens to IRLC Income ndash Becomes Capital
IMBs want more Capitalbull More IRLC means more Incomebull More Income means more Capitalbull More Capital means more Warehouse borrowingbull More Capital means qualifying for FHA amp Agencybull More IRLC means more Capital
Derivative Asset
Is Confusing to Business Ownersand leads to bad decisions
Capital Accounts with Derivative AssetThe Derivative Asset is not carried at Fair Value because the Derivative Asset cannot be sold for the carrying value
During 2018 several companies failed Capital = $2 million Derivative Asset = $2 million
The Owner did not understand why they were insolvent
Disclose the Impact of the Derivative Asset in Capital Accountsbull Common Stockbull Paid In Capitalbull Distributionsbull Retained Earnings (Move IRLC MTM impact from NI to Unrealized Gain)bull Unrealized Gain(Loss)
Thanks to Oystein Konsmo CFO at Nova Financial for implementing this practice
Derivative Asset Characteristics
What is the Locked Pipeline
bull IRLC is a lock commitments issued to borrowers bull They are ldquoApplications in Processrdquo bull IRLC are commitments ndash not Loans bull There is no active market for IRLCbull There is no Asset to basis adjust for MTM
bull Is a TBA-MBS tradeable in its current form YES
bull Is a IRLC tradeable in its current form NO
bull The IRLC must be Transformed into a loan then securitized to be valued as tradeable instrument
bull Transformational Costs are unavoidable and undeniable
bull IRLC is not pure derivative but is derivative under GAAP
bull Absorption Costing is a way to understand the basis for Transformational Costs = Work in Process but is it not perfect
bull I think MSR valuation of cash flow is a more accurate measure
Is an IRLC a Tradable Asset
How have CPAs Presented theDerivative Asset
INCONSISTANTLY
Derivative Asset vs Pipeline
Small Independent Large Public
Source ndash A Greer CPA
bull Warehouse Lenders Rely on CPA for GAAP Capitalbull Lenderrsquos Observe CPA Auditorshellip
ndash Overstate Capital with DAndash Under-apply Cost to Completendash Inconsistently apply Costs to Complete
bull Warehouse Lenders reduce Derivative Asset ndash Some arbitrarily reduce by 50ndash Some reduce based on Net Future Cash Flows
Warehouse Lenderrsquos Adjustment
What about GAAP
bull What does GAAP say about Transformation Costs
bull Direct Cost Deduction Method - direct costs only
bull Full Cost Absorption Method - direct and indirect costs
bull IRLC is a pure derivative - IRLC same as TBA-MBS
bull Net Future Cash Flow Valuation Method (discussed soon)
Transformation Costs or Cost to Completebull What is the value of the IRLC
bull Pull-thru adjusted MTM less Costs to Complete
bull What is the right amount of Transformation Costsbull Direct Cost Deduction Method - direct costs onlybull Full Cost Absorption Method - both direct and indirect costsbull IRLC is a pure derivative ndash no adjustment (IRLC = TBA-MBS)
bull Uncertainty Principalndash Exponential diminishing impact to closingndash You have it when you have it otherwise uncertainndash Day of Lock 99 uncertainty Day before closing 1 uncertainty
IMB Transformational Costs ndash Best PracticesDirect Expenses
bull LO commissions production commissionsbull Other Direct Production Costs
bull appraisals outsourcing courier credit reports other cosbull Other Direct Expenses
bull LO wages processors LOA bull underwriting funding disclosure and post closing
Indirect Expensesbull Allocated Production Rent Branch Rent Branch Overhead
Consequence of Ignoring Indirect Costs
Hawaii vs TexasHigh Balance vs Low Balance
Loan Size Matters
Loan Size Dynamics ndash One Loanbull ONE LOAN
bull High Balance low gainbull Low Balance high gain
bull Derivative Asset
bull Processing costs as of loan are different
bull Profit is same
Higher Gain
$50000000 Locked Pipeline
bull Texas lender is more than double Hawaii
bull Identical Cash Realization
bull Indirect Costs Matter
Direct Costs Only - Distort Results
Derivative Asset Value
View From Finance
Present Value of Net Future Cash Flow
Same as MSR
Derivative Asset OoopsMany CPAs firms have issued opinions on financial statements with derivative asset values I would challenge as not reasonable
Changing Presentation method now creates exposure to Opinion Risk
There is presently no consensus among CPA Auditors about how to apply GAAP
What is the Value of the IRLC - DA
Day of Lock Day Before Closing
High ProbabilityRevenue less Commission
Value is approaching Revenue
UnIncurred Costs Decrease as Percentage of Completion Increases
Low ProbabilityRevenue less all Costs
Value is approaching Zero
What is the value of an Intangible Asset
The Derivative Asset is an Intangible Asset
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
Objective is Recognition of Future Cash-Flows
PV of Discounted NET Future Cash-flows
Amortization Method or Fair Value MethodASC 860-50-35-9
IRLC under ASC 815An IRLC (Interest Rate Lock Commitment)
bull is an off balance sheet financial commitment bull subject to market risk and a bull derivative under SFAS 149 ASC 815 andbull subject MTM under SFAS 159 ASC 825
bull All IRLC are Derivatives (except for cost to complete)bull An IRLC hedged with Best Efforts is a derivativebull An IRLC hedged with a short MBS is a derivativebull The hedge strategy does not change the derivative
bull Derivatives under GAAPbull Recorded at Fair Value
bull Best Efforts Commitmentsbull Do not have a penalty for legitimate cancelationbull If loan is not closed the BE is canceled without costbull Avoidance of pair-off risk is not a derivative (most agree)bull Optional derivative under ASC 825-10-25
bull If IRLC is MTM and BE locks are not MTM bull Potential misrepresentation of gain positionbull Recommend all commitments are DerivativesMTM
ASC 815 ndash Hedge Accounting
The Interest Rate Lock Commitments ndash IRLC ndashbull IRLCs are initially issued to generate a profitbull The imbedded profit is valued at each reporting period bull The resulting gain is recorded as a Derivative Asset
bull It is very unlikely an IRLC will be a Derivative Liability
Hedge Positionbull TBA-MBS can generate a gain or loss
bull depending upon price movement since the date of salebull gain is reported as a Derivative Assetbull loss is reported as a Derivative Liability
+25 IRLCDerivative Asset Margin
Preservation
-50 TBADerivative Liability
+130 TBADerivative Asset
+70 IRLCDerivative Asset
Always consider loan gain with hedge gain or loss
Hedging Journal Entries
Warehouse bull The warehouse is comprised of two segments
ndash Committed or Allocated to Mandatory Commitmentndash Uncommitted or Hedged with Short TBA-MBS
bull The month-end MTM of the LHFS adjusts the basis of the LHFS creating a gain or loss in the PampL
Pipeline Hedgebull The month-end open TBA position MTM gain or loss is
posted to a Derivative Asset or Derivative Liability and a MTM gain or loss in PampL
Allocated and Unallocated LHFS
Secondary Marketing Data
You must get this informationhellipbull Do you Believe the numbers
(Mandatory Commitment MTM off-setting LHFS excluded in example)
WH Committed not in TBA Hedge- Valued based on purchase priceWH Uncommitted is in TBA Hedge- Valued by hedge advisor
MTM JE
bull Reverse the prior month MTM
bull Post Pair-Off AP or ARbull Post current month MTM
bull Significant changes in volume can impact the PampL
bull If hedge was gain Derivative Asset
bull Confirm everything with your Auditorbull All external reports must be GAAP
Derivative Asset increases CapitalWe Create a Derivative Asset bybull DR Derivative Asset CR Income
bull What happens to IRLC Income ndash Becomes Capital
IMBs want more Capitalbull More IRLC means more Incomebull More Income means more Capitalbull More Capital means more Warehouse borrowingbull More Capital means qualifying for FHA amp Agencybull More IRLC means more Capital
Derivative Asset
Is Confusing to Business Ownersand leads to bad decisions
Capital Accounts with Derivative AssetThe Derivative Asset is not carried at Fair Value because the Derivative Asset cannot be sold for the carrying value
During 2018 several companies failed Capital = $2 million Derivative Asset = $2 million
The Owner did not understand why they were insolvent
Disclose the Impact of the Derivative Asset in Capital Accountsbull Common Stockbull Paid In Capitalbull Distributionsbull Retained Earnings (Move IRLC MTM impact from NI to Unrealized Gain)bull Unrealized Gain(Loss)
Thanks to Oystein Konsmo CFO at Nova Financial for implementing this practice
Derivative Asset Characteristics
What is the Locked Pipeline
bull IRLC is a lock commitments issued to borrowers bull They are ldquoApplications in Processrdquo bull IRLC are commitments ndash not Loans bull There is no active market for IRLCbull There is no Asset to basis adjust for MTM
bull Is a TBA-MBS tradeable in its current form YES
bull Is a IRLC tradeable in its current form NO
bull The IRLC must be Transformed into a loan then securitized to be valued as tradeable instrument
bull Transformational Costs are unavoidable and undeniable
bull IRLC is not pure derivative but is derivative under GAAP
bull Absorption Costing is a way to understand the basis for Transformational Costs = Work in Process but is it not perfect
bull I think MSR valuation of cash flow is a more accurate measure
Is an IRLC a Tradable Asset
How have CPAs Presented theDerivative Asset
INCONSISTANTLY
Derivative Asset vs Pipeline
Small Independent Large Public
Source ndash A Greer CPA
bull Warehouse Lenders Rely on CPA for GAAP Capitalbull Lenderrsquos Observe CPA Auditorshellip
ndash Overstate Capital with DAndash Under-apply Cost to Completendash Inconsistently apply Costs to Complete
bull Warehouse Lenders reduce Derivative Asset ndash Some arbitrarily reduce by 50ndash Some reduce based on Net Future Cash Flows
Warehouse Lenderrsquos Adjustment
What about GAAP
bull What does GAAP say about Transformation Costs
bull Direct Cost Deduction Method - direct costs only
bull Full Cost Absorption Method - direct and indirect costs
bull IRLC is a pure derivative - IRLC same as TBA-MBS
bull Net Future Cash Flow Valuation Method (discussed soon)
Transformation Costs or Cost to Completebull What is the value of the IRLC
bull Pull-thru adjusted MTM less Costs to Complete
bull What is the right amount of Transformation Costsbull Direct Cost Deduction Method - direct costs onlybull Full Cost Absorption Method - both direct and indirect costsbull IRLC is a pure derivative ndash no adjustment (IRLC = TBA-MBS)
bull Uncertainty Principalndash Exponential diminishing impact to closingndash You have it when you have it otherwise uncertainndash Day of Lock 99 uncertainty Day before closing 1 uncertainty
IMB Transformational Costs ndash Best PracticesDirect Expenses
bull LO commissions production commissionsbull Other Direct Production Costs
bull appraisals outsourcing courier credit reports other cosbull Other Direct Expenses
bull LO wages processors LOA bull underwriting funding disclosure and post closing
Indirect Expensesbull Allocated Production Rent Branch Rent Branch Overhead
Consequence of Ignoring Indirect Costs
Hawaii vs TexasHigh Balance vs Low Balance
Loan Size Matters
Loan Size Dynamics ndash One Loanbull ONE LOAN
bull High Balance low gainbull Low Balance high gain
bull Derivative Asset
bull Processing costs as of loan are different
bull Profit is same
Higher Gain
$50000000 Locked Pipeline
bull Texas lender is more than double Hawaii
bull Identical Cash Realization
bull Indirect Costs Matter
Direct Costs Only - Distort Results
Derivative Asset Value
View From Finance
Present Value of Net Future Cash Flow
Same as MSR
Derivative Asset OoopsMany CPAs firms have issued opinions on financial statements with derivative asset values I would challenge as not reasonable
Changing Presentation method now creates exposure to Opinion Risk
There is presently no consensus among CPA Auditors about how to apply GAAP
What is the Value of the IRLC - DA
Day of Lock Day Before Closing
High ProbabilityRevenue less Commission
Value is approaching Revenue
UnIncurred Costs Decrease as Percentage of Completion Increases
Low ProbabilityRevenue less all Costs
Value is approaching Zero
What is the value of an Intangible Asset
The Derivative Asset is an Intangible Asset
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
Objective is Recognition of Future Cash-Flows
PV of Discounted NET Future Cash-flows
Amortization Method or Fair Value MethodASC 860-50-35-9
IRLC under ASC 815An IRLC (Interest Rate Lock Commitment)
bull is an off balance sheet financial commitment bull subject to market risk and a bull derivative under SFAS 149 ASC 815 andbull subject MTM under SFAS 159 ASC 825
bull All IRLC are Derivatives (except for cost to complete)bull An IRLC hedged with Best Efforts is a derivativebull An IRLC hedged with a short MBS is a derivativebull The hedge strategy does not change the derivative
bull Derivatives under GAAPbull Recorded at Fair Value
bull Best Efforts Commitmentsbull Do not have a penalty for legitimate cancelationbull If loan is not closed the BE is canceled without costbull Avoidance of pair-off risk is not a derivative (most agree)bull Optional derivative under ASC 825-10-25
bull If IRLC is MTM and BE locks are not MTM bull Potential misrepresentation of gain positionbull Recommend all commitments are DerivativesMTM
ASC 815 ndash Hedge Accounting
The Interest Rate Lock Commitments ndash IRLC ndashbull IRLCs are initially issued to generate a profitbull The imbedded profit is valued at each reporting period bull The resulting gain is recorded as a Derivative Asset
bull It is very unlikely an IRLC will be a Derivative Liability
Hedge Positionbull TBA-MBS can generate a gain or loss
bull depending upon price movement since the date of salebull gain is reported as a Derivative Assetbull loss is reported as a Derivative Liability
+25 IRLCDerivative Asset Margin
Preservation
-50 TBADerivative Liability
+130 TBADerivative Asset
+70 IRLCDerivative Asset
Always consider loan gain with hedge gain or loss
Hedging Journal Entries
Warehouse bull The warehouse is comprised of two segments
ndash Committed or Allocated to Mandatory Commitmentndash Uncommitted or Hedged with Short TBA-MBS
bull The month-end MTM of the LHFS adjusts the basis of the LHFS creating a gain or loss in the PampL
Pipeline Hedgebull The month-end open TBA position MTM gain or loss is
posted to a Derivative Asset or Derivative Liability and a MTM gain or loss in PampL
Allocated and Unallocated LHFS
Secondary Marketing Data
You must get this informationhellipbull Do you Believe the numbers
(Mandatory Commitment MTM off-setting LHFS excluded in example)
WH Committed not in TBA Hedge- Valued based on purchase priceWH Uncommitted is in TBA Hedge- Valued by hedge advisor
MTM JE
bull Reverse the prior month MTM
bull Post Pair-Off AP or ARbull Post current month MTM
bull Significant changes in volume can impact the PampL
bull If hedge was gain Derivative Asset
bull Confirm everything with your Auditorbull All external reports must be GAAP
Derivative Asset increases CapitalWe Create a Derivative Asset bybull DR Derivative Asset CR Income
bull What happens to IRLC Income ndash Becomes Capital
IMBs want more Capitalbull More IRLC means more Incomebull More Income means more Capitalbull More Capital means more Warehouse borrowingbull More Capital means qualifying for FHA amp Agencybull More IRLC means more Capital
Derivative Asset
Is Confusing to Business Ownersand leads to bad decisions
Capital Accounts with Derivative AssetThe Derivative Asset is not carried at Fair Value because the Derivative Asset cannot be sold for the carrying value
During 2018 several companies failed Capital = $2 million Derivative Asset = $2 million
The Owner did not understand why they were insolvent
Disclose the Impact of the Derivative Asset in Capital Accountsbull Common Stockbull Paid In Capitalbull Distributionsbull Retained Earnings (Move IRLC MTM impact from NI to Unrealized Gain)bull Unrealized Gain(Loss)
Thanks to Oystein Konsmo CFO at Nova Financial for implementing this practice
Derivative Asset Characteristics
What is the Locked Pipeline
bull IRLC is a lock commitments issued to borrowers bull They are ldquoApplications in Processrdquo bull IRLC are commitments ndash not Loans bull There is no active market for IRLCbull There is no Asset to basis adjust for MTM
bull Is a TBA-MBS tradeable in its current form YES
bull Is a IRLC tradeable in its current form NO
bull The IRLC must be Transformed into a loan then securitized to be valued as tradeable instrument
bull Transformational Costs are unavoidable and undeniable
bull IRLC is not pure derivative but is derivative under GAAP
bull Absorption Costing is a way to understand the basis for Transformational Costs = Work in Process but is it not perfect
bull I think MSR valuation of cash flow is a more accurate measure
Is an IRLC a Tradable Asset
How have CPAs Presented theDerivative Asset
INCONSISTANTLY
Derivative Asset vs Pipeline
Small Independent Large Public
Source ndash A Greer CPA
bull Warehouse Lenders Rely on CPA for GAAP Capitalbull Lenderrsquos Observe CPA Auditorshellip
ndash Overstate Capital with DAndash Under-apply Cost to Completendash Inconsistently apply Costs to Complete
bull Warehouse Lenders reduce Derivative Asset ndash Some arbitrarily reduce by 50ndash Some reduce based on Net Future Cash Flows
Warehouse Lenderrsquos Adjustment
What about GAAP
bull What does GAAP say about Transformation Costs
bull Direct Cost Deduction Method - direct costs only
bull Full Cost Absorption Method - direct and indirect costs
bull IRLC is a pure derivative - IRLC same as TBA-MBS
bull Net Future Cash Flow Valuation Method (discussed soon)
Transformation Costs or Cost to Completebull What is the value of the IRLC
bull Pull-thru adjusted MTM less Costs to Complete
bull What is the right amount of Transformation Costsbull Direct Cost Deduction Method - direct costs onlybull Full Cost Absorption Method - both direct and indirect costsbull IRLC is a pure derivative ndash no adjustment (IRLC = TBA-MBS)
bull Uncertainty Principalndash Exponential diminishing impact to closingndash You have it when you have it otherwise uncertainndash Day of Lock 99 uncertainty Day before closing 1 uncertainty
IMB Transformational Costs ndash Best PracticesDirect Expenses
bull LO commissions production commissionsbull Other Direct Production Costs
bull appraisals outsourcing courier credit reports other cosbull Other Direct Expenses
bull LO wages processors LOA bull underwriting funding disclosure and post closing
Indirect Expensesbull Allocated Production Rent Branch Rent Branch Overhead
Consequence of Ignoring Indirect Costs
Hawaii vs TexasHigh Balance vs Low Balance
Loan Size Matters
Loan Size Dynamics ndash One Loanbull ONE LOAN
bull High Balance low gainbull Low Balance high gain
bull Derivative Asset
bull Processing costs as of loan are different
bull Profit is same
Higher Gain
$50000000 Locked Pipeline
bull Texas lender is more than double Hawaii
bull Identical Cash Realization
bull Indirect Costs Matter
Direct Costs Only - Distort Results
Derivative Asset Value
View From Finance
Present Value of Net Future Cash Flow
Same as MSR
Derivative Asset OoopsMany CPAs firms have issued opinions on financial statements with derivative asset values I would challenge as not reasonable
Changing Presentation method now creates exposure to Opinion Risk
There is presently no consensus among CPA Auditors about how to apply GAAP
What is the Value of the IRLC - DA
Day of Lock Day Before Closing
High ProbabilityRevenue less Commission
Value is approaching Revenue
UnIncurred Costs Decrease as Percentage of Completion Increases
Low ProbabilityRevenue less all Costs
Value is approaching Zero
What is the value of an Intangible Asset
The Derivative Asset is an Intangible Asset
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
Objective is Recognition of Future Cash-Flows
PV of Discounted NET Future Cash-flows
Amortization Method or Fair Value MethodASC 860-50-35-9
IRLC under ASC 815An IRLC (Interest Rate Lock Commitment)
bull is an off balance sheet financial commitment bull subject to market risk and a bull derivative under SFAS 149 ASC 815 andbull subject MTM under SFAS 159 ASC 825
bull All IRLC are Derivatives (except for cost to complete)bull An IRLC hedged with Best Efforts is a derivativebull An IRLC hedged with a short MBS is a derivativebull The hedge strategy does not change the derivative
bull Derivatives under GAAPbull Recorded at Fair Value
bull Best Efforts Commitmentsbull Do not have a penalty for legitimate cancelationbull If loan is not closed the BE is canceled without costbull Avoidance of pair-off risk is not a derivative (most agree)bull Optional derivative under ASC 825-10-25
bull If IRLC is MTM and BE locks are not MTM bull Potential misrepresentation of gain positionbull Recommend all commitments are DerivativesMTM
ASC 815 ndash Hedge Accounting
The Interest Rate Lock Commitments ndash IRLC ndashbull IRLCs are initially issued to generate a profitbull The imbedded profit is valued at each reporting period bull The resulting gain is recorded as a Derivative Asset
bull It is very unlikely an IRLC will be a Derivative Liability
Hedge Positionbull TBA-MBS can generate a gain or loss
bull depending upon price movement since the date of salebull gain is reported as a Derivative Assetbull loss is reported as a Derivative Liability
+25 IRLCDerivative Asset Margin
Preservation
-50 TBADerivative Liability
+130 TBADerivative Asset
+70 IRLCDerivative Asset
Always consider loan gain with hedge gain or loss
Hedging Journal Entries
Warehouse bull The warehouse is comprised of two segments
ndash Committed or Allocated to Mandatory Commitmentndash Uncommitted or Hedged with Short TBA-MBS
bull The month-end MTM of the LHFS adjusts the basis of the LHFS creating a gain or loss in the PampL
Pipeline Hedgebull The month-end open TBA position MTM gain or loss is
posted to a Derivative Asset or Derivative Liability and a MTM gain or loss in PampL
Allocated and Unallocated LHFS
Secondary Marketing Data
You must get this informationhellipbull Do you Believe the numbers
(Mandatory Commitment MTM off-setting LHFS excluded in example)
WH Committed not in TBA Hedge- Valued based on purchase priceWH Uncommitted is in TBA Hedge- Valued by hedge advisor
MTM JE
bull Reverse the prior month MTM
bull Post Pair-Off AP or ARbull Post current month MTM
bull Significant changes in volume can impact the PampL
bull If hedge was gain Derivative Asset
bull Confirm everything with your Auditorbull All external reports must be GAAP
Derivative Asset increases CapitalWe Create a Derivative Asset bybull DR Derivative Asset CR Income
bull What happens to IRLC Income ndash Becomes Capital
IMBs want more Capitalbull More IRLC means more Incomebull More Income means more Capitalbull More Capital means more Warehouse borrowingbull More Capital means qualifying for FHA amp Agencybull More IRLC means more Capital
Derivative Asset
Is Confusing to Business Ownersand leads to bad decisions
Capital Accounts with Derivative AssetThe Derivative Asset is not carried at Fair Value because the Derivative Asset cannot be sold for the carrying value
During 2018 several companies failed Capital = $2 million Derivative Asset = $2 million
The Owner did not understand why they were insolvent
Disclose the Impact of the Derivative Asset in Capital Accountsbull Common Stockbull Paid In Capitalbull Distributionsbull Retained Earnings (Move IRLC MTM impact from NI to Unrealized Gain)bull Unrealized Gain(Loss)
Thanks to Oystein Konsmo CFO at Nova Financial for implementing this practice
Derivative Asset Characteristics
What is the Locked Pipeline
bull IRLC is a lock commitments issued to borrowers bull They are ldquoApplications in Processrdquo bull IRLC are commitments ndash not Loans bull There is no active market for IRLCbull There is no Asset to basis adjust for MTM
bull Is a TBA-MBS tradeable in its current form YES
bull Is a IRLC tradeable in its current form NO
bull The IRLC must be Transformed into a loan then securitized to be valued as tradeable instrument
bull Transformational Costs are unavoidable and undeniable
bull IRLC is not pure derivative but is derivative under GAAP
bull Absorption Costing is a way to understand the basis for Transformational Costs = Work in Process but is it not perfect
bull I think MSR valuation of cash flow is a more accurate measure
Is an IRLC a Tradable Asset
How have CPAs Presented theDerivative Asset
INCONSISTANTLY
Derivative Asset vs Pipeline
Small Independent Large Public
Source ndash A Greer CPA
bull Warehouse Lenders Rely on CPA for GAAP Capitalbull Lenderrsquos Observe CPA Auditorshellip
ndash Overstate Capital with DAndash Under-apply Cost to Completendash Inconsistently apply Costs to Complete
bull Warehouse Lenders reduce Derivative Asset ndash Some arbitrarily reduce by 50ndash Some reduce based on Net Future Cash Flows
Warehouse Lenderrsquos Adjustment
What about GAAP
bull What does GAAP say about Transformation Costs
bull Direct Cost Deduction Method - direct costs only
bull Full Cost Absorption Method - direct and indirect costs
bull IRLC is a pure derivative - IRLC same as TBA-MBS
bull Net Future Cash Flow Valuation Method (discussed soon)
Transformation Costs or Cost to Completebull What is the value of the IRLC
bull Pull-thru adjusted MTM less Costs to Complete
bull What is the right amount of Transformation Costsbull Direct Cost Deduction Method - direct costs onlybull Full Cost Absorption Method - both direct and indirect costsbull IRLC is a pure derivative ndash no adjustment (IRLC = TBA-MBS)
bull Uncertainty Principalndash Exponential diminishing impact to closingndash You have it when you have it otherwise uncertainndash Day of Lock 99 uncertainty Day before closing 1 uncertainty
IMB Transformational Costs ndash Best PracticesDirect Expenses
bull LO commissions production commissionsbull Other Direct Production Costs
bull appraisals outsourcing courier credit reports other cosbull Other Direct Expenses
bull LO wages processors LOA bull underwriting funding disclosure and post closing
Indirect Expensesbull Allocated Production Rent Branch Rent Branch Overhead
Consequence of Ignoring Indirect Costs
Hawaii vs TexasHigh Balance vs Low Balance
Loan Size Matters
Loan Size Dynamics ndash One Loanbull ONE LOAN
bull High Balance low gainbull Low Balance high gain
bull Derivative Asset
bull Processing costs as of loan are different
bull Profit is same
Higher Gain
$50000000 Locked Pipeline
bull Texas lender is more than double Hawaii
bull Identical Cash Realization
bull Indirect Costs Matter
Direct Costs Only - Distort Results
Derivative Asset Value
View From Finance
Present Value of Net Future Cash Flow
Same as MSR
Derivative Asset OoopsMany CPAs firms have issued opinions on financial statements with derivative asset values I would challenge as not reasonable
Changing Presentation method now creates exposure to Opinion Risk
There is presently no consensus among CPA Auditors about how to apply GAAP
What is the Value of the IRLC - DA
Day of Lock Day Before Closing
High ProbabilityRevenue less Commission
Value is approaching Revenue
UnIncurred Costs Decrease as Percentage of Completion Increases
Low ProbabilityRevenue less all Costs
Value is approaching Zero
What is the value of an Intangible Asset
The Derivative Asset is an Intangible Asset
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
Objective is Recognition of Future Cash-Flows
PV of Discounted NET Future Cash-flows
Amortization Method or Fair Value MethodASC 860-50-35-9
IRLC under ASC 815An IRLC (Interest Rate Lock Commitment)
bull is an off balance sheet financial commitment bull subject to market risk and a bull derivative under SFAS 149 ASC 815 andbull subject MTM under SFAS 159 ASC 825
bull All IRLC are Derivatives (except for cost to complete)bull An IRLC hedged with Best Efforts is a derivativebull An IRLC hedged with a short MBS is a derivativebull The hedge strategy does not change the derivative
bull Derivatives under GAAPbull Recorded at Fair Value
bull Best Efforts Commitmentsbull Do not have a penalty for legitimate cancelationbull If loan is not closed the BE is canceled without costbull Avoidance of pair-off risk is not a derivative (most agree)bull Optional derivative under ASC 825-10-25
bull If IRLC is MTM and BE locks are not MTM bull Potential misrepresentation of gain positionbull Recommend all commitments are DerivativesMTM
ASC 815 ndash Hedge Accounting
The Interest Rate Lock Commitments ndash IRLC ndashbull IRLCs are initially issued to generate a profitbull The imbedded profit is valued at each reporting period bull The resulting gain is recorded as a Derivative Asset
bull It is very unlikely an IRLC will be a Derivative Liability
Hedge Positionbull TBA-MBS can generate a gain or loss
bull depending upon price movement since the date of salebull gain is reported as a Derivative Assetbull loss is reported as a Derivative Liability
+25 IRLCDerivative Asset Margin
Preservation
-50 TBADerivative Liability
+130 TBADerivative Asset
+70 IRLCDerivative Asset
Always consider loan gain with hedge gain or loss
Hedging Journal Entries
Warehouse bull The warehouse is comprised of two segments
ndash Committed or Allocated to Mandatory Commitmentndash Uncommitted or Hedged with Short TBA-MBS
bull The month-end MTM of the LHFS adjusts the basis of the LHFS creating a gain or loss in the PampL
Pipeline Hedgebull The month-end open TBA position MTM gain or loss is
posted to a Derivative Asset or Derivative Liability and a MTM gain or loss in PampL
Allocated and Unallocated LHFS
Secondary Marketing Data
You must get this informationhellipbull Do you Believe the numbers
(Mandatory Commitment MTM off-setting LHFS excluded in example)
WH Committed not in TBA Hedge- Valued based on purchase priceWH Uncommitted is in TBA Hedge- Valued by hedge advisor
MTM JE
bull Reverse the prior month MTM
bull Post Pair-Off AP or ARbull Post current month MTM
bull Significant changes in volume can impact the PampL
bull If hedge was gain Derivative Asset
bull Confirm everything with your Auditorbull All external reports must be GAAP
Derivative Asset increases CapitalWe Create a Derivative Asset bybull DR Derivative Asset CR Income
bull What happens to IRLC Income ndash Becomes Capital
IMBs want more Capitalbull More IRLC means more Incomebull More Income means more Capitalbull More Capital means more Warehouse borrowingbull More Capital means qualifying for FHA amp Agencybull More IRLC means more Capital
Derivative Asset
Is Confusing to Business Ownersand leads to bad decisions
Capital Accounts with Derivative AssetThe Derivative Asset is not carried at Fair Value because the Derivative Asset cannot be sold for the carrying value
During 2018 several companies failed Capital = $2 million Derivative Asset = $2 million
The Owner did not understand why they were insolvent
Disclose the Impact of the Derivative Asset in Capital Accountsbull Common Stockbull Paid In Capitalbull Distributionsbull Retained Earnings (Move IRLC MTM impact from NI to Unrealized Gain)bull Unrealized Gain(Loss)
Thanks to Oystein Konsmo CFO at Nova Financial for implementing this practice
Derivative Asset Characteristics
What is the Locked Pipeline
bull IRLC is a lock commitments issued to borrowers bull They are ldquoApplications in Processrdquo bull IRLC are commitments ndash not Loans bull There is no active market for IRLCbull There is no Asset to basis adjust for MTM
bull Is a TBA-MBS tradeable in its current form YES
bull Is a IRLC tradeable in its current form NO
bull The IRLC must be Transformed into a loan then securitized to be valued as tradeable instrument
bull Transformational Costs are unavoidable and undeniable
bull IRLC is not pure derivative but is derivative under GAAP
bull Absorption Costing is a way to understand the basis for Transformational Costs = Work in Process but is it not perfect
bull I think MSR valuation of cash flow is a more accurate measure
Is an IRLC a Tradable Asset
How have CPAs Presented theDerivative Asset
INCONSISTANTLY
Derivative Asset vs Pipeline
Small Independent Large Public
Source ndash A Greer CPA
bull Warehouse Lenders Rely on CPA for GAAP Capitalbull Lenderrsquos Observe CPA Auditorshellip
ndash Overstate Capital with DAndash Under-apply Cost to Completendash Inconsistently apply Costs to Complete
bull Warehouse Lenders reduce Derivative Asset ndash Some arbitrarily reduce by 50ndash Some reduce based on Net Future Cash Flows
Warehouse Lenderrsquos Adjustment
What about GAAP
bull What does GAAP say about Transformation Costs
bull Direct Cost Deduction Method - direct costs only
bull Full Cost Absorption Method - direct and indirect costs
bull IRLC is a pure derivative - IRLC same as TBA-MBS
bull Net Future Cash Flow Valuation Method (discussed soon)
Transformation Costs or Cost to Completebull What is the value of the IRLC
bull Pull-thru adjusted MTM less Costs to Complete
bull What is the right amount of Transformation Costsbull Direct Cost Deduction Method - direct costs onlybull Full Cost Absorption Method - both direct and indirect costsbull IRLC is a pure derivative ndash no adjustment (IRLC = TBA-MBS)
bull Uncertainty Principalndash Exponential diminishing impact to closingndash You have it when you have it otherwise uncertainndash Day of Lock 99 uncertainty Day before closing 1 uncertainty
IMB Transformational Costs ndash Best PracticesDirect Expenses
bull LO commissions production commissionsbull Other Direct Production Costs
bull appraisals outsourcing courier credit reports other cosbull Other Direct Expenses
bull LO wages processors LOA bull underwriting funding disclosure and post closing
Indirect Expensesbull Allocated Production Rent Branch Rent Branch Overhead
Consequence of Ignoring Indirect Costs
Hawaii vs TexasHigh Balance vs Low Balance
Loan Size Matters
Loan Size Dynamics ndash One Loanbull ONE LOAN
bull High Balance low gainbull Low Balance high gain
bull Derivative Asset
bull Processing costs as of loan are different
bull Profit is same
Higher Gain
$50000000 Locked Pipeline
bull Texas lender is more than double Hawaii
bull Identical Cash Realization
bull Indirect Costs Matter
Direct Costs Only - Distort Results
Derivative Asset Value
View From Finance
Present Value of Net Future Cash Flow
Same as MSR
Derivative Asset OoopsMany CPAs firms have issued opinions on financial statements with derivative asset values I would challenge as not reasonable
Changing Presentation method now creates exposure to Opinion Risk
There is presently no consensus among CPA Auditors about how to apply GAAP
What is the Value of the IRLC - DA
Day of Lock Day Before Closing
High ProbabilityRevenue less Commission
Value is approaching Revenue
UnIncurred Costs Decrease as Percentage of Completion Increases
Low ProbabilityRevenue less all Costs
Value is approaching Zero
What is the value of an Intangible Asset
The Derivative Asset is an Intangible Asset
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
Objective is Recognition of Future Cash-Flows
PV of Discounted NET Future Cash-flows
Amortization Method or Fair Value MethodASC 860-50-35-9
IRLC under ASC 815An IRLC (Interest Rate Lock Commitment)
bull is an off balance sheet financial commitment bull subject to market risk and a bull derivative under SFAS 149 ASC 815 andbull subject MTM under SFAS 159 ASC 825
bull All IRLC are Derivatives (except for cost to complete)bull An IRLC hedged with Best Efforts is a derivativebull An IRLC hedged with a short MBS is a derivativebull The hedge strategy does not change the derivative
bull Derivatives under GAAPbull Recorded at Fair Value
bull Best Efforts Commitmentsbull Do not have a penalty for legitimate cancelationbull If loan is not closed the BE is canceled without costbull Avoidance of pair-off risk is not a derivative (most agree)bull Optional derivative under ASC 825-10-25
bull If IRLC is MTM and BE locks are not MTM bull Potential misrepresentation of gain positionbull Recommend all commitments are DerivativesMTM
ASC 815 ndash Hedge Accounting
The Interest Rate Lock Commitments ndash IRLC ndashbull IRLCs are initially issued to generate a profitbull The imbedded profit is valued at each reporting period bull The resulting gain is recorded as a Derivative Asset
bull It is very unlikely an IRLC will be a Derivative Liability
Hedge Positionbull TBA-MBS can generate a gain or loss
bull depending upon price movement since the date of salebull gain is reported as a Derivative Assetbull loss is reported as a Derivative Liability
+25 IRLCDerivative Asset Margin
Preservation
-50 TBADerivative Liability
+130 TBADerivative Asset
+70 IRLCDerivative Asset
Always consider loan gain with hedge gain or loss
Hedging Journal Entries
Warehouse bull The warehouse is comprised of two segments
ndash Committed or Allocated to Mandatory Commitmentndash Uncommitted or Hedged with Short TBA-MBS
bull The month-end MTM of the LHFS adjusts the basis of the LHFS creating a gain or loss in the PampL
Pipeline Hedgebull The month-end open TBA position MTM gain or loss is
posted to a Derivative Asset or Derivative Liability and a MTM gain or loss in PampL
Allocated and Unallocated LHFS
Secondary Marketing Data
You must get this informationhellipbull Do you Believe the numbers
(Mandatory Commitment MTM off-setting LHFS excluded in example)
WH Committed not in TBA Hedge- Valued based on purchase priceWH Uncommitted is in TBA Hedge- Valued by hedge advisor
MTM JE
bull Reverse the prior month MTM
bull Post Pair-Off AP or ARbull Post current month MTM
bull Significant changes in volume can impact the PampL
bull If hedge was gain Derivative Asset
bull Confirm everything with your Auditorbull All external reports must be GAAP
Derivative Asset increases CapitalWe Create a Derivative Asset bybull DR Derivative Asset CR Income
bull What happens to IRLC Income ndash Becomes Capital
IMBs want more Capitalbull More IRLC means more Incomebull More Income means more Capitalbull More Capital means more Warehouse borrowingbull More Capital means qualifying for FHA amp Agencybull More IRLC means more Capital
Derivative Asset
Is Confusing to Business Ownersand leads to bad decisions
Capital Accounts with Derivative AssetThe Derivative Asset is not carried at Fair Value because the Derivative Asset cannot be sold for the carrying value
During 2018 several companies failed Capital = $2 million Derivative Asset = $2 million
The Owner did not understand why they were insolvent
Disclose the Impact of the Derivative Asset in Capital Accountsbull Common Stockbull Paid In Capitalbull Distributionsbull Retained Earnings (Move IRLC MTM impact from NI to Unrealized Gain)bull Unrealized Gain(Loss)
Thanks to Oystein Konsmo CFO at Nova Financial for implementing this practice
Derivative Asset Characteristics
What is the Locked Pipeline
bull IRLC is a lock commitments issued to borrowers bull They are ldquoApplications in Processrdquo bull IRLC are commitments ndash not Loans bull There is no active market for IRLCbull There is no Asset to basis adjust for MTM
bull Is a TBA-MBS tradeable in its current form YES
bull Is a IRLC tradeable in its current form NO
bull The IRLC must be Transformed into a loan then securitized to be valued as tradeable instrument
bull Transformational Costs are unavoidable and undeniable
bull IRLC is not pure derivative but is derivative under GAAP
bull Absorption Costing is a way to understand the basis for Transformational Costs = Work in Process but is it not perfect
bull I think MSR valuation of cash flow is a more accurate measure
Is an IRLC a Tradable Asset
How have CPAs Presented theDerivative Asset
INCONSISTANTLY
Derivative Asset vs Pipeline
Small Independent Large Public
Source ndash A Greer CPA
bull Warehouse Lenders Rely on CPA for GAAP Capitalbull Lenderrsquos Observe CPA Auditorshellip
ndash Overstate Capital with DAndash Under-apply Cost to Completendash Inconsistently apply Costs to Complete
bull Warehouse Lenders reduce Derivative Asset ndash Some arbitrarily reduce by 50ndash Some reduce based on Net Future Cash Flows
Warehouse Lenderrsquos Adjustment
What about GAAP
bull What does GAAP say about Transformation Costs
bull Direct Cost Deduction Method - direct costs only
bull Full Cost Absorption Method - direct and indirect costs
bull IRLC is a pure derivative - IRLC same as TBA-MBS
bull Net Future Cash Flow Valuation Method (discussed soon)
Transformation Costs or Cost to Completebull What is the value of the IRLC
bull Pull-thru adjusted MTM less Costs to Complete
bull What is the right amount of Transformation Costsbull Direct Cost Deduction Method - direct costs onlybull Full Cost Absorption Method - both direct and indirect costsbull IRLC is a pure derivative ndash no adjustment (IRLC = TBA-MBS)
bull Uncertainty Principalndash Exponential diminishing impact to closingndash You have it when you have it otherwise uncertainndash Day of Lock 99 uncertainty Day before closing 1 uncertainty
IMB Transformational Costs ndash Best PracticesDirect Expenses
bull LO commissions production commissionsbull Other Direct Production Costs
bull appraisals outsourcing courier credit reports other cosbull Other Direct Expenses
bull LO wages processors LOA bull underwriting funding disclosure and post closing
Indirect Expensesbull Allocated Production Rent Branch Rent Branch Overhead
Consequence of Ignoring Indirect Costs
Hawaii vs TexasHigh Balance vs Low Balance
Loan Size Matters
Loan Size Dynamics ndash One Loanbull ONE LOAN
bull High Balance low gainbull Low Balance high gain
bull Derivative Asset
bull Processing costs as of loan are different
bull Profit is same
Higher Gain
$50000000 Locked Pipeline
bull Texas lender is more than double Hawaii
bull Identical Cash Realization
bull Indirect Costs Matter
Direct Costs Only - Distort Results
Derivative Asset Value
View From Finance
Present Value of Net Future Cash Flow
Same as MSR
Derivative Asset OoopsMany CPAs firms have issued opinions on financial statements with derivative asset values I would challenge as not reasonable
Changing Presentation method now creates exposure to Opinion Risk
There is presently no consensus among CPA Auditors about how to apply GAAP
What is the Value of the IRLC - DA
Day of Lock Day Before Closing
High ProbabilityRevenue less Commission
Value is approaching Revenue
UnIncurred Costs Decrease as Percentage of Completion Increases
Low ProbabilityRevenue less all Costs
Value is approaching Zero
What is the value of an Intangible Asset
The Derivative Asset is an Intangible Asset
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
Objective is Recognition of Future Cash-Flows
PV of Discounted NET Future Cash-flows
Amortization Method or Fair Value MethodASC 860-50-35-9
IRLC under ASC 815An IRLC (Interest Rate Lock Commitment)
bull is an off balance sheet financial commitment bull subject to market risk and a bull derivative under SFAS 149 ASC 815 andbull subject MTM under SFAS 159 ASC 825
bull All IRLC are Derivatives (except for cost to complete)bull An IRLC hedged with Best Efforts is a derivativebull An IRLC hedged with a short MBS is a derivativebull The hedge strategy does not change the derivative
bull Derivatives under GAAPbull Recorded at Fair Value
bull Best Efforts Commitmentsbull Do not have a penalty for legitimate cancelationbull If loan is not closed the BE is canceled without costbull Avoidance of pair-off risk is not a derivative (most agree)bull Optional derivative under ASC 825-10-25
bull If IRLC is MTM and BE locks are not MTM bull Potential misrepresentation of gain positionbull Recommend all commitments are DerivativesMTM
ASC 815 ndash Hedge Accounting
The Interest Rate Lock Commitments ndash IRLC ndashbull IRLCs are initially issued to generate a profitbull The imbedded profit is valued at each reporting period bull The resulting gain is recorded as a Derivative Asset
bull It is very unlikely an IRLC will be a Derivative Liability
Hedge Positionbull TBA-MBS can generate a gain or loss
bull depending upon price movement since the date of salebull gain is reported as a Derivative Assetbull loss is reported as a Derivative Liability
+25 IRLCDerivative Asset Margin
Preservation
-50 TBADerivative Liability
+130 TBADerivative Asset
+70 IRLCDerivative Asset
Always consider loan gain with hedge gain or loss
Hedging Journal Entries
Warehouse bull The warehouse is comprised of two segments
ndash Committed or Allocated to Mandatory Commitmentndash Uncommitted or Hedged with Short TBA-MBS
bull The month-end MTM of the LHFS adjusts the basis of the LHFS creating a gain or loss in the PampL
Pipeline Hedgebull The month-end open TBA position MTM gain or loss is
posted to a Derivative Asset or Derivative Liability and a MTM gain or loss in PampL
Allocated and Unallocated LHFS
Secondary Marketing Data
You must get this informationhellipbull Do you Believe the numbers
(Mandatory Commitment MTM off-setting LHFS excluded in example)
WH Committed not in TBA Hedge- Valued based on purchase priceWH Uncommitted is in TBA Hedge- Valued by hedge advisor
MTM JE
bull Reverse the prior month MTM
bull Post Pair-Off AP or ARbull Post current month MTM
bull Significant changes in volume can impact the PampL
bull If hedge was gain Derivative Asset
bull Confirm everything with your Auditorbull All external reports must be GAAP
Derivative Asset increases CapitalWe Create a Derivative Asset bybull DR Derivative Asset CR Income
bull What happens to IRLC Income ndash Becomes Capital
IMBs want more Capitalbull More IRLC means more Incomebull More Income means more Capitalbull More Capital means more Warehouse borrowingbull More Capital means qualifying for FHA amp Agencybull More IRLC means more Capital
Derivative Asset
Is Confusing to Business Ownersand leads to bad decisions
Capital Accounts with Derivative AssetThe Derivative Asset is not carried at Fair Value because the Derivative Asset cannot be sold for the carrying value
During 2018 several companies failed Capital = $2 million Derivative Asset = $2 million
The Owner did not understand why they were insolvent
Disclose the Impact of the Derivative Asset in Capital Accountsbull Common Stockbull Paid In Capitalbull Distributionsbull Retained Earnings (Move IRLC MTM impact from NI to Unrealized Gain)bull Unrealized Gain(Loss)
Thanks to Oystein Konsmo CFO at Nova Financial for implementing this practice
Derivative Asset Characteristics
What is the Locked Pipeline
bull IRLC is a lock commitments issued to borrowers bull They are ldquoApplications in Processrdquo bull IRLC are commitments ndash not Loans bull There is no active market for IRLCbull There is no Asset to basis adjust for MTM
bull Is a TBA-MBS tradeable in its current form YES
bull Is a IRLC tradeable in its current form NO
bull The IRLC must be Transformed into a loan then securitized to be valued as tradeable instrument
bull Transformational Costs are unavoidable and undeniable
bull IRLC is not pure derivative but is derivative under GAAP
bull Absorption Costing is a way to understand the basis for Transformational Costs = Work in Process but is it not perfect
bull I think MSR valuation of cash flow is a more accurate measure
Is an IRLC a Tradable Asset
How have CPAs Presented theDerivative Asset
INCONSISTANTLY
Derivative Asset vs Pipeline
Small Independent Large Public
Source ndash A Greer CPA
bull Warehouse Lenders Rely on CPA for GAAP Capitalbull Lenderrsquos Observe CPA Auditorshellip
ndash Overstate Capital with DAndash Under-apply Cost to Completendash Inconsistently apply Costs to Complete
bull Warehouse Lenders reduce Derivative Asset ndash Some arbitrarily reduce by 50ndash Some reduce based on Net Future Cash Flows
Warehouse Lenderrsquos Adjustment
What about GAAP
bull What does GAAP say about Transformation Costs
bull Direct Cost Deduction Method - direct costs only
bull Full Cost Absorption Method - direct and indirect costs
bull IRLC is a pure derivative - IRLC same as TBA-MBS
bull Net Future Cash Flow Valuation Method (discussed soon)
Transformation Costs or Cost to Completebull What is the value of the IRLC
bull Pull-thru adjusted MTM less Costs to Complete
bull What is the right amount of Transformation Costsbull Direct Cost Deduction Method - direct costs onlybull Full Cost Absorption Method - both direct and indirect costsbull IRLC is a pure derivative ndash no adjustment (IRLC = TBA-MBS)
bull Uncertainty Principalndash Exponential diminishing impact to closingndash You have it when you have it otherwise uncertainndash Day of Lock 99 uncertainty Day before closing 1 uncertainty
IMB Transformational Costs ndash Best PracticesDirect Expenses
bull LO commissions production commissionsbull Other Direct Production Costs
bull appraisals outsourcing courier credit reports other cosbull Other Direct Expenses
bull LO wages processors LOA bull underwriting funding disclosure and post closing
Indirect Expensesbull Allocated Production Rent Branch Rent Branch Overhead
Consequence of Ignoring Indirect Costs
Hawaii vs TexasHigh Balance vs Low Balance
Loan Size Matters
Loan Size Dynamics ndash One Loanbull ONE LOAN
bull High Balance low gainbull Low Balance high gain
bull Derivative Asset
bull Processing costs as of loan are different
bull Profit is same
Higher Gain
$50000000 Locked Pipeline
bull Texas lender is more than double Hawaii
bull Identical Cash Realization
bull Indirect Costs Matter
Direct Costs Only - Distort Results
Derivative Asset Value
View From Finance
Present Value of Net Future Cash Flow
Same as MSR
Derivative Asset OoopsMany CPAs firms have issued opinions on financial statements with derivative asset values I would challenge as not reasonable
Changing Presentation method now creates exposure to Opinion Risk
There is presently no consensus among CPA Auditors about how to apply GAAP
What is the Value of the IRLC - DA
Day of Lock Day Before Closing
High ProbabilityRevenue less Commission
Value is approaching Revenue
UnIncurred Costs Decrease as Percentage of Completion Increases
Low ProbabilityRevenue less all Costs
Value is approaching Zero
What is the value of an Intangible Asset
The Derivative Asset is an Intangible Asset
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
Objective is Recognition of Future Cash-Flows
PV of Discounted NET Future Cash-flows
Amortization Method or Fair Value MethodASC 860-50-35-9
IRLC under ASC 815An IRLC (Interest Rate Lock Commitment)
bull is an off balance sheet financial commitment bull subject to market risk and a bull derivative under SFAS 149 ASC 815 andbull subject MTM under SFAS 159 ASC 825
bull All IRLC are Derivatives (except for cost to complete)bull An IRLC hedged with Best Efforts is a derivativebull An IRLC hedged with a short MBS is a derivativebull The hedge strategy does not change the derivative
bull Derivatives under GAAPbull Recorded at Fair Value
bull Best Efforts Commitmentsbull Do not have a penalty for legitimate cancelationbull If loan is not closed the BE is canceled without costbull Avoidance of pair-off risk is not a derivative (most agree)bull Optional derivative under ASC 825-10-25
bull If IRLC is MTM and BE locks are not MTM bull Potential misrepresentation of gain positionbull Recommend all commitments are DerivativesMTM
ASC 815 ndash Hedge Accounting
The Interest Rate Lock Commitments ndash IRLC ndashbull IRLCs are initially issued to generate a profitbull The imbedded profit is valued at each reporting period bull The resulting gain is recorded as a Derivative Asset
bull It is very unlikely an IRLC will be a Derivative Liability
Hedge Positionbull TBA-MBS can generate a gain or loss
bull depending upon price movement since the date of salebull gain is reported as a Derivative Assetbull loss is reported as a Derivative Liability
+25 IRLCDerivative Asset Margin
Preservation
-50 TBADerivative Liability
+130 TBADerivative Asset
+70 IRLCDerivative Asset
Always consider loan gain with hedge gain or loss
Hedging Journal Entries
Warehouse bull The warehouse is comprised of two segments
ndash Committed or Allocated to Mandatory Commitmentndash Uncommitted or Hedged with Short TBA-MBS
bull The month-end MTM of the LHFS adjusts the basis of the LHFS creating a gain or loss in the PampL
Pipeline Hedgebull The month-end open TBA position MTM gain or loss is
posted to a Derivative Asset or Derivative Liability and a MTM gain or loss in PampL
Allocated and Unallocated LHFS
Secondary Marketing Data
You must get this informationhellipbull Do you Believe the numbers
(Mandatory Commitment MTM off-setting LHFS excluded in example)
WH Committed not in TBA Hedge- Valued based on purchase priceWH Uncommitted is in TBA Hedge- Valued by hedge advisor
MTM JE
bull Reverse the prior month MTM
bull Post Pair-Off AP or ARbull Post current month MTM
bull Significant changes in volume can impact the PampL
bull If hedge was gain Derivative Asset
bull Confirm everything with your Auditorbull All external reports must be GAAP
Derivative Asset increases CapitalWe Create a Derivative Asset bybull DR Derivative Asset CR Income
bull What happens to IRLC Income ndash Becomes Capital
IMBs want more Capitalbull More IRLC means more Incomebull More Income means more Capitalbull More Capital means more Warehouse borrowingbull More Capital means qualifying for FHA amp Agencybull More IRLC means more Capital
Derivative Asset
Is Confusing to Business Ownersand leads to bad decisions
Capital Accounts with Derivative AssetThe Derivative Asset is not carried at Fair Value because the Derivative Asset cannot be sold for the carrying value
During 2018 several companies failed Capital = $2 million Derivative Asset = $2 million
The Owner did not understand why they were insolvent
Disclose the Impact of the Derivative Asset in Capital Accountsbull Common Stockbull Paid In Capitalbull Distributionsbull Retained Earnings (Move IRLC MTM impact from NI to Unrealized Gain)bull Unrealized Gain(Loss)
Thanks to Oystein Konsmo CFO at Nova Financial for implementing this practice
Derivative Asset Characteristics
What is the Locked Pipeline
bull IRLC is a lock commitments issued to borrowers bull They are ldquoApplications in Processrdquo bull IRLC are commitments ndash not Loans bull There is no active market for IRLCbull There is no Asset to basis adjust for MTM
bull Is a TBA-MBS tradeable in its current form YES
bull Is a IRLC tradeable in its current form NO
bull The IRLC must be Transformed into a loan then securitized to be valued as tradeable instrument
bull Transformational Costs are unavoidable and undeniable
bull IRLC is not pure derivative but is derivative under GAAP
bull Absorption Costing is a way to understand the basis for Transformational Costs = Work in Process but is it not perfect
bull I think MSR valuation of cash flow is a more accurate measure
Is an IRLC a Tradable Asset
How have CPAs Presented theDerivative Asset
INCONSISTANTLY
Derivative Asset vs Pipeline
Small Independent Large Public
Source ndash A Greer CPA
bull Warehouse Lenders Rely on CPA for GAAP Capitalbull Lenderrsquos Observe CPA Auditorshellip
ndash Overstate Capital with DAndash Under-apply Cost to Completendash Inconsistently apply Costs to Complete
bull Warehouse Lenders reduce Derivative Asset ndash Some arbitrarily reduce by 50ndash Some reduce based on Net Future Cash Flows
Warehouse Lenderrsquos Adjustment
What about GAAP
bull What does GAAP say about Transformation Costs
bull Direct Cost Deduction Method - direct costs only
bull Full Cost Absorption Method - direct and indirect costs
bull IRLC is a pure derivative - IRLC same as TBA-MBS
bull Net Future Cash Flow Valuation Method (discussed soon)
Transformation Costs or Cost to Completebull What is the value of the IRLC
bull Pull-thru adjusted MTM less Costs to Complete
bull What is the right amount of Transformation Costsbull Direct Cost Deduction Method - direct costs onlybull Full Cost Absorption Method - both direct and indirect costsbull IRLC is a pure derivative ndash no adjustment (IRLC = TBA-MBS)
bull Uncertainty Principalndash Exponential diminishing impact to closingndash You have it when you have it otherwise uncertainndash Day of Lock 99 uncertainty Day before closing 1 uncertainty
IMB Transformational Costs ndash Best PracticesDirect Expenses
bull LO commissions production commissionsbull Other Direct Production Costs
bull appraisals outsourcing courier credit reports other cosbull Other Direct Expenses
bull LO wages processors LOA bull underwriting funding disclosure and post closing
Indirect Expensesbull Allocated Production Rent Branch Rent Branch Overhead
Consequence of Ignoring Indirect Costs
Hawaii vs TexasHigh Balance vs Low Balance
Loan Size Matters
Loan Size Dynamics ndash One Loanbull ONE LOAN
bull High Balance low gainbull Low Balance high gain
bull Derivative Asset
bull Processing costs as of loan are different
bull Profit is same
Higher Gain
$50000000 Locked Pipeline
bull Texas lender is more than double Hawaii
bull Identical Cash Realization
bull Indirect Costs Matter
Direct Costs Only - Distort Results
Derivative Asset Value
View From Finance
Present Value of Net Future Cash Flow
Same as MSR
Derivative Asset OoopsMany CPAs firms have issued opinions on financial statements with derivative asset values I would challenge as not reasonable
Changing Presentation method now creates exposure to Opinion Risk
There is presently no consensus among CPA Auditors about how to apply GAAP
What is the Value of the IRLC - DA
Day of Lock Day Before Closing
High ProbabilityRevenue less Commission
Value is approaching Revenue
UnIncurred Costs Decrease as Percentage of Completion Increases
Low ProbabilityRevenue less all Costs
Value is approaching Zero
What is the value of an Intangible Asset
The Derivative Asset is an Intangible Asset
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
Objective is Recognition of Future Cash-Flows
PV of Discounted NET Future Cash-flows
Amortization Method or Fair Value MethodASC 860-50-35-9
IRLC under ASC 815An IRLC (Interest Rate Lock Commitment)
bull is an off balance sheet financial commitment bull subject to market risk and a bull derivative under SFAS 149 ASC 815 andbull subject MTM under SFAS 159 ASC 825
bull All IRLC are Derivatives (except for cost to complete)bull An IRLC hedged with Best Efforts is a derivativebull An IRLC hedged with a short MBS is a derivativebull The hedge strategy does not change the derivative
bull Derivatives under GAAPbull Recorded at Fair Value
bull Best Efforts Commitmentsbull Do not have a penalty for legitimate cancelationbull If loan is not closed the BE is canceled without costbull Avoidance of pair-off risk is not a derivative (most agree)bull Optional derivative under ASC 825-10-25
bull If IRLC is MTM and BE locks are not MTM bull Potential misrepresentation of gain positionbull Recommend all commitments are DerivativesMTM
ASC 815 ndash Hedge Accounting
The Interest Rate Lock Commitments ndash IRLC ndashbull IRLCs are initially issued to generate a profitbull The imbedded profit is valued at each reporting period bull The resulting gain is recorded as a Derivative Asset
bull It is very unlikely an IRLC will be a Derivative Liability
Hedge Positionbull TBA-MBS can generate a gain or loss
bull depending upon price movement since the date of salebull gain is reported as a Derivative Assetbull loss is reported as a Derivative Liability
+25 IRLCDerivative Asset Margin
Preservation
-50 TBADerivative Liability
+130 TBADerivative Asset
+70 IRLCDerivative Asset
Always consider loan gain with hedge gain or loss
Hedging Journal Entries
Warehouse bull The warehouse is comprised of two segments
ndash Committed or Allocated to Mandatory Commitmentndash Uncommitted or Hedged with Short TBA-MBS
bull The month-end MTM of the LHFS adjusts the basis of the LHFS creating a gain or loss in the PampL
Pipeline Hedgebull The month-end open TBA position MTM gain or loss is
posted to a Derivative Asset or Derivative Liability and a MTM gain or loss in PampL
Allocated and Unallocated LHFS
Secondary Marketing Data
You must get this informationhellipbull Do you Believe the numbers
(Mandatory Commitment MTM off-setting LHFS excluded in example)
WH Committed not in TBA Hedge- Valued based on purchase priceWH Uncommitted is in TBA Hedge- Valued by hedge advisor
MTM JE
bull Reverse the prior month MTM
bull Post Pair-Off AP or ARbull Post current month MTM
bull Significant changes in volume can impact the PampL
bull If hedge was gain Derivative Asset
bull Confirm everything with your Auditorbull All external reports must be GAAP
Derivative Asset increases CapitalWe Create a Derivative Asset bybull DR Derivative Asset CR Income
bull What happens to IRLC Income ndash Becomes Capital
IMBs want more Capitalbull More IRLC means more Incomebull More Income means more Capitalbull More Capital means more Warehouse borrowingbull More Capital means qualifying for FHA amp Agencybull More IRLC means more Capital
Derivative Asset
Is Confusing to Business Ownersand leads to bad decisions
Capital Accounts with Derivative AssetThe Derivative Asset is not carried at Fair Value because the Derivative Asset cannot be sold for the carrying value
During 2018 several companies failed Capital = $2 million Derivative Asset = $2 million
The Owner did not understand why they were insolvent
Disclose the Impact of the Derivative Asset in Capital Accountsbull Common Stockbull Paid In Capitalbull Distributionsbull Retained Earnings (Move IRLC MTM impact from NI to Unrealized Gain)bull Unrealized Gain(Loss)
Thanks to Oystein Konsmo CFO at Nova Financial for implementing this practice
Derivative Asset Characteristics
What is the Locked Pipeline
bull IRLC is a lock commitments issued to borrowers bull They are ldquoApplications in Processrdquo bull IRLC are commitments ndash not Loans bull There is no active market for IRLCbull There is no Asset to basis adjust for MTM
bull Is a TBA-MBS tradeable in its current form YES
bull Is a IRLC tradeable in its current form NO
bull The IRLC must be Transformed into a loan then securitized to be valued as tradeable instrument
bull Transformational Costs are unavoidable and undeniable
bull IRLC is not pure derivative but is derivative under GAAP
bull Absorption Costing is a way to understand the basis for Transformational Costs = Work in Process but is it not perfect
bull I think MSR valuation of cash flow is a more accurate measure
Is an IRLC a Tradable Asset
How have CPAs Presented theDerivative Asset
INCONSISTANTLY
Derivative Asset vs Pipeline
Small Independent Large Public
Source ndash A Greer CPA
bull Warehouse Lenders Rely on CPA for GAAP Capitalbull Lenderrsquos Observe CPA Auditorshellip
ndash Overstate Capital with DAndash Under-apply Cost to Completendash Inconsistently apply Costs to Complete
bull Warehouse Lenders reduce Derivative Asset ndash Some arbitrarily reduce by 50ndash Some reduce based on Net Future Cash Flows
Warehouse Lenderrsquos Adjustment
What about GAAP
bull What does GAAP say about Transformation Costs
bull Direct Cost Deduction Method - direct costs only
bull Full Cost Absorption Method - direct and indirect costs
bull IRLC is a pure derivative - IRLC same as TBA-MBS
bull Net Future Cash Flow Valuation Method (discussed soon)
Transformation Costs or Cost to Completebull What is the value of the IRLC
bull Pull-thru adjusted MTM less Costs to Complete
bull What is the right amount of Transformation Costsbull Direct Cost Deduction Method - direct costs onlybull Full Cost Absorption Method - both direct and indirect costsbull IRLC is a pure derivative ndash no adjustment (IRLC = TBA-MBS)
bull Uncertainty Principalndash Exponential diminishing impact to closingndash You have it when you have it otherwise uncertainndash Day of Lock 99 uncertainty Day before closing 1 uncertainty
IMB Transformational Costs ndash Best PracticesDirect Expenses
bull LO commissions production commissionsbull Other Direct Production Costs
bull appraisals outsourcing courier credit reports other cosbull Other Direct Expenses
bull LO wages processors LOA bull underwriting funding disclosure and post closing
Indirect Expensesbull Allocated Production Rent Branch Rent Branch Overhead
Consequence of Ignoring Indirect Costs
Hawaii vs TexasHigh Balance vs Low Balance
Loan Size Matters
Loan Size Dynamics ndash One Loanbull ONE LOAN
bull High Balance low gainbull Low Balance high gain
bull Derivative Asset
bull Processing costs as of loan are different
bull Profit is same
Higher Gain
$50000000 Locked Pipeline
bull Texas lender is more than double Hawaii
bull Identical Cash Realization
bull Indirect Costs Matter
Direct Costs Only - Distort Results
Derivative Asset Value
View From Finance
Present Value of Net Future Cash Flow
Same as MSR
Derivative Asset OoopsMany CPAs firms have issued opinions on financial statements with derivative asset values I would challenge as not reasonable
Changing Presentation method now creates exposure to Opinion Risk
There is presently no consensus among CPA Auditors about how to apply GAAP
What is the Value of the IRLC - DA
Day of Lock Day Before Closing
High ProbabilityRevenue less Commission
Value is approaching Revenue
UnIncurred Costs Decrease as Percentage of Completion Increases
Low ProbabilityRevenue less all Costs
Value is approaching Zero
What is the value of an Intangible Asset
The Derivative Asset is an Intangible Asset
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
Objective is Recognition of Future Cash-Flows
PV of Discounted NET Future Cash-flows
Amortization Method or Fair Value MethodASC 860-50-35-9
IRLC under ASC 815An IRLC (Interest Rate Lock Commitment)
bull is an off balance sheet financial commitment bull subject to market risk and a bull derivative under SFAS 149 ASC 815 andbull subject MTM under SFAS 159 ASC 825
bull All IRLC are Derivatives (except for cost to complete)bull An IRLC hedged with Best Efforts is a derivativebull An IRLC hedged with a short MBS is a derivativebull The hedge strategy does not change the derivative
bull Derivatives under GAAPbull Recorded at Fair Value
bull Best Efforts Commitmentsbull Do not have a penalty for legitimate cancelationbull If loan is not closed the BE is canceled without costbull Avoidance of pair-off risk is not a derivative (most agree)bull Optional derivative under ASC 825-10-25
bull If IRLC is MTM and BE locks are not MTM bull Potential misrepresentation of gain positionbull Recommend all commitments are DerivativesMTM
ASC 815 ndash Hedge Accounting
The Interest Rate Lock Commitments ndash IRLC ndashbull IRLCs are initially issued to generate a profitbull The imbedded profit is valued at each reporting period bull The resulting gain is recorded as a Derivative Asset
bull It is very unlikely an IRLC will be a Derivative Liability
Hedge Positionbull TBA-MBS can generate a gain or loss
bull depending upon price movement since the date of salebull gain is reported as a Derivative Assetbull loss is reported as a Derivative Liability
+25 IRLCDerivative Asset Margin
Preservation
-50 TBADerivative Liability
+130 TBADerivative Asset
+70 IRLCDerivative Asset
Always consider loan gain with hedge gain or loss
Hedging Journal Entries
Warehouse bull The warehouse is comprised of two segments
ndash Committed or Allocated to Mandatory Commitmentndash Uncommitted or Hedged with Short TBA-MBS
bull The month-end MTM of the LHFS adjusts the basis of the LHFS creating a gain or loss in the PampL
Pipeline Hedgebull The month-end open TBA position MTM gain or loss is
posted to a Derivative Asset or Derivative Liability and a MTM gain or loss in PampL
Allocated and Unallocated LHFS
Secondary Marketing Data
You must get this informationhellipbull Do you Believe the numbers
(Mandatory Commitment MTM off-setting LHFS excluded in example)
WH Committed not in TBA Hedge- Valued based on purchase priceWH Uncommitted is in TBA Hedge- Valued by hedge advisor
MTM JE
bull Reverse the prior month MTM
bull Post Pair-Off AP or ARbull Post current month MTM
bull Significant changes in volume can impact the PampL
bull If hedge was gain Derivative Asset
bull Confirm everything with your Auditorbull All external reports must be GAAP
Derivative Asset increases CapitalWe Create a Derivative Asset bybull DR Derivative Asset CR Income
bull What happens to IRLC Income ndash Becomes Capital
IMBs want more Capitalbull More IRLC means more Incomebull More Income means more Capitalbull More Capital means more Warehouse borrowingbull More Capital means qualifying for FHA amp Agencybull More IRLC means more Capital
Derivative Asset
Is Confusing to Business Ownersand leads to bad decisions
Capital Accounts with Derivative AssetThe Derivative Asset is not carried at Fair Value because the Derivative Asset cannot be sold for the carrying value
During 2018 several companies failed Capital = $2 million Derivative Asset = $2 million
The Owner did not understand why they were insolvent
Disclose the Impact of the Derivative Asset in Capital Accountsbull Common Stockbull Paid In Capitalbull Distributionsbull Retained Earnings (Move IRLC MTM impact from NI to Unrealized Gain)bull Unrealized Gain(Loss)
Thanks to Oystein Konsmo CFO at Nova Financial for implementing this practice
Derivative Asset Characteristics
What is the Locked Pipeline
bull IRLC is a lock commitments issued to borrowers bull They are ldquoApplications in Processrdquo bull IRLC are commitments ndash not Loans bull There is no active market for IRLCbull There is no Asset to basis adjust for MTM
bull Is a TBA-MBS tradeable in its current form YES
bull Is a IRLC tradeable in its current form NO
bull The IRLC must be Transformed into a loan then securitized to be valued as tradeable instrument
bull Transformational Costs are unavoidable and undeniable
bull IRLC is not pure derivative but is derivative under GAAP
bull Absorption Costing is a way to understand the basis for Transformational Costs = Work in Process but is it not perfect
bull I think MSR valuation of cash flow is a more accurate measure
Is an IRLC a Tradable Asset
How have CPAs Presented theDerivative Asset
INCONSISTANTLY
Derivative Asset vs Pipeline
Small Independent Large Public
Source ndash A Greer CPA
bull Warehouse Lenders Rely on CPA for GAAP Capitalbull Lenderrsquos Observe CPA Auditorshellip
ndash Overstate Capital with DAndash Under-apply Cost to Completendash Inconsistently apply Costs to Complete
bull Warehouse Lenders reduce Derivative Asset ndash Some arbitrarily reduce by 50ndash Some reduce based on Net Future Cash Flows
Warehouse Lenderrsquos Adjustment
What about GAAP
bull What does GAAP say about Transformation Costs
bull Direct Cost Deduction Method - direct costs only
bull Full Cost Absorption Method - direct and indirect costs
bull IRLC is a pure derivative - IRLC same as TBA-MBS
bull Net Future Cash Flow Valuation Method (discussed soon)
Transformation Costs or Cost to Completebull What is the value of the IRLC
bull Pull-thru adjusted MTM less Costs to Complete
bull What is the right amount of Transformation Costsbull Direct Cost Deduction Method - direct costs onlybull Full Cost Absorption Method - both direct and indirect costsbull IRLC is a pure derivative ndash no adjustment (IRLC = TBA-MBS)
bull Uncertainty Principalndash Exponential diminishing impact to closingndash You have it when you have it otherwise uncertainndash Day of Lock 99 uncertainty Day before closing 1 uncertainty
IMB Transformational Costs ndash Best PracticesDirect Expenses
bull LO commissions production commissionsbull Other Direct Production Costs
bull appraisals outsourcing courier credit reports other cosbull Other Direct Expenses
bull LO wages processors LOA bull underwriting funding disclosure and post closing
Indirect Expensesbull Allocated Production Rent Branch Rent Branch Overhead
Consequence of Ignoring Indirect Costs
Hawaii vs TexasHigh Balance vs Low Balance
Loan Size Matters
Loan Size Dynamics ndash One Loanbull ONE LOAN
bull High Balance low gainbull Low Balance high gain
bull Derivative Asset
bull Processing costs as of loan are different
bull Profit is same
Higher Gain
$50000000 Locked Pipeline
bull Texas lender is more than double Hawaii
bull Identical Cash Realization
bull Indirect Costs Matter
Direct Costs Only - Distort Results
Derivative Asset Value
View From Finance
Present Value of Net Future Cash Flow
Same as MSR
Derivative Asset OoopsMany CPAs firms have issued opinions on financial statements with derivative asset values I would challenge as not reasonable
Changing Presentation method now creates exposure to Opinion Risk
There is presently no consensus among CPA Auditors about how to apply GAAP
What is the Value of the IRLC - DA
Day of Lock Day Before Closing
High ProbabilityRevenue less Commission
Value is approaching Revenue
UnIncurred Costs Decrease as Percentage of Completion Increases
Low ProbabilityRevenue less all Costs
Value is approaching Zero
What is the value of an Intangible Asset
The Derivative Asset is an Intangible Asset
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
Objective is Recognition of Future Cash-Flows
PV of Discounted NET Future Cash-flows
Amortization Method or Fair Value MethodASC 860-50-35-9
IRLC under ASC 815An IRLC (Interest Rate Lock Commitment)
bull is an off balance sheet financial commitment bull subject to market risk and a bull derivative under SFAS 149 ASC 815 andbull subject MTM under SFAS 159 ASC 825
bull All IRLC are Derivatives (except for cost to complete)bull An IRLC hedged with Best Efforts is a derivativebull An IRLC hedged with a short MBS is a derivativebull The hedge strategy does not change the derivative
bull Derivatives under GAAPbull Recorded at Fair Value
bull Best Efforts Commitmentsbull Do not have a penalty for legitimate cancelationbull If loan is not closed the BE is canceled without costbull Avoidance of pair-off risk is not a derivative (most agree)bull Optional derivative under ASC 825-10-25
bull If IRLC is MTM and BE locks are not MTM bull Potential misrepresentation of gain positionbull Recommend all commitments are DerivativesMTM
ASC 815 ndash Hedge Accounting
The Interest Rate Lock Commitments ndash IRLC ndashbull IRLCs are initially issued to generate a profitbull The imbedded profit is valued at each reporting period bull The resulting gain is recorded as a Derivative Asset
bull It is very unlikely an IRLC will be a Derivative Liability
Hedge Positionbull TBA-MBS can generate a gain or loss
bull depending upon price movement since the date of salebull gain is reported as a Derivative Assetbull loss is reported as a Derivative Liability
+25 IRLCDerivative Asset Margin
Preservation
-50 TBADerivative Liability
+130 TBADerivative Asset
+70 IRLCDerivative Asset
Always consider loan gain with hedge gain or loss
Hedging Journal Entries
Warehouse bull The warehouse is comprised of two segments
ndash Committed or Allocated to Mandatory Commitmentndash Uncommitted or Hedged with Short TBA-MBS
bull The month-end MTM of the LHFS adjusts the basis of the LHFS creating a gain or loss in the PampL
Pipeline Hedgebull The month-end open TBA position MTM gain or loss is
posted to a Derivative Asset or Derivative Liability and a MTM gain or loss in PampL
Allocated and Unallocated LHFS
Secondary Marketing Data
You must get this informationhellipbull Do you Believe the numbers
(Mandatory Commitment MTM off-setting LHFS excluded in example)
WH Committed not in TBA Hedge- Valued based on purchase priceWH Uncommitted is in TBA Hedge- Valued by hedge advisor
MTM JE
bull Reverse the prior month MTM
bull Post Pair-Off AP or ARbull Post current month MTM
bull Significant changes in volume can impact the PampL
bull If hedge was gain Derivative Asset
bull Confirm everything with your Auditorbull All external reports must be GAAP
Derivative Asset increases CapitalWe Create a Derivative Asset bybull DR Derivative Asset CR Income
bull What happens to IRLC Income ndash Becomes Capital
IMBs want more Capitalbull More IRLC means more Incomebull More Income means more Capitalbull More Capital means more Warehouse borrowingbull More Capital means qualifying for FHA amp Agencybull More IRLC means more Capital
Derivative Asset
Is Confusing to Business Ownersand leads to bad decisions
Capital Accounts with Derivative AssetThe Derivative Asset is not carried at Fair Value because the Derivative Asset cannot be sold for the carrying value
During 2018 several companies failed Capital = $2 million Derivative Asset = $2 million
The Owner did not understand why they were insolvent
Disclose the Impact of the Derivative Asset in Capital Accountsbull Common Stockbull Paid In Capitalbull Distributionsbull Retained Earnings (Move IRLC MTM impact from NI to Unrealized Gain)bull Unrealized Gain(Loss)
Thanks to Oystein Konsmo CFO at Nova Financial for implementing this practice
Derivative Asset Characteristics
What is the Locked Pipeline
bull IRLC is a lock commitments issued to borrowers bull They are ldquoApplications in Processrdquo bull IRLC are commitments ndash not Loans bull There is no active market for IRLCbull There is no Asset to basis adjust for MTM
bull Is a TBA-MBS tradeable in its current form YES
bull Is a IRLC tradeable in its current form NO
bull The IRLC must be Transformed into a loan then securitized to be valued as tradeable instrument
bull Transformational Costs are unavoidable and undeniable
bull IRLC is not pure derivative but is derivative under GAAP
bull Absorption Costing is a way to understand the basis for Transformational Costs = Work in Process but is it not perfect
bull I think MSR valuation of cash flow is a more accurate measure
Is an IRLC a Tradable Asset
How have CPAs Presented theDerivative Asset
INCONSISTANTLY
Derivative Asset vs Pipeline
Small Independent Large Public
Source ndash A Greer CPA
bull Warehouse Lenders Rely on CPA for GAAP Capitalbull Lenderrsquos Observe CPA Auditorshellip
ndash Overstate Capital with DAndash Under-apply Cost to Completendash Inconsistently apply Costs to Complete
bull Warehouse Lenders reduce Derivative Asset ndash Some arbitrarily reduce by 50ndash Some reduce based on Net Future Cash Flows
Warehouse Lenderrsquos Adjustment
What about GAAP
bull What does GAAP say about Transformation Costs
bull Direct Cost Deduction Method - direct costs only
bull Full Cost Absorption Method - direct and indirect costs
bull IRLC is a pure derivative - IRLC same as TBA-MBS
bull Net Future Cash Flow Valuation Method (discussed soon)
Transformation Costs or Cost to Completebull What is the value of the IRLC
bull Pull-thru adjusted MTM less Costs to Complete
bull What is the right amount of Transformation Costsbull Direct Cost Deduction Method - direct costs onlybull Full Cost Absorption Method - both direct and indirect costsbull IRLC is a pure derivative ndash no adjustment (IRLC = TBA-MBS)
bull Uncertainty Principalndash Exponential diminishing impact to closingndash You have it when you have it otherwise uncertainndash Day of Lock 99 uncertainty Day before closing 1 uncertainty
IMB Transformational Costs ndash Best PracticesDirect Expenses
bull LO commissions production commissionsbull Other Direct Production Costs
bull appraisals outsourcing courier credit reports other cosbull Other Direct Expenses
bull LO wages processors LOA bull underwriting funding disclosure and post closing
Indirect Expensesbull Allocated Production Rent Branch Rent Branch Overhead
Consequence of Ignoring Indirect Costs
Hawaii vs TexasHigh Balance vs Low Balance
Loan Size Matters
Loan Size Dynamics ndash One Loanbull ONE LOAN
bull High Balance low gainbull Low Balance high gain
bull Derivative Asset
bull Processing costs as of loan are different
bull Profit is same
Higher Gain
$50000000 Locked Pipeline
bull Texas lender is more than double Hawaii
bull Identical Cash Realization
bull Indirect Costs Matter
Direct Costs Only - Distort Results
Derivative Asset Value
View From Finance
Present Value of Net Future Cash Flow
Same as MSR
Derivative Asset OoopsMany CPAs firms have issued opinions on financial statements with derivative asset values I would challenge as not reasonable
Changing Presentation method now creates exposure to Opinion Risk
There is presently no consensus among CPA Auditors about how to apply GAAP
What is the Value of the IRLC - DA
Day of Lock Day Before Closing
High ProbabilityRevenue less Commission
Value is approaching Revenue
UnIncurred Costs Decrease as Percentage of Completion Increases
Low ProbabilityRevenue less all Costs
Value is approaching Zero
What is the value of an Intangible Asset
The Derivative Asset is an Intangible Asset
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
Objective is Recognition of Future Cash-Flows
PV of Discounted NET Future Cash-flows
Amortization Method or Fair Value MethodASC 860-50-35-9
IRLC under ASC 815An IRLC (Interest Rate Lock Commitment)
bull is an off balance sheet financial commitment bull subject to market risk and a bull derivative under SFAS 149 ASC 815 andbull subject MTM under SFAS 159 ASC 825
bull All IRLC are Derivatives (except for cost to complete)bull An IRLC hedged with Best Efforts is a derivativebull An IRLC hedged with a short MBS is a derivativebull The hedge strategy does not change the derivative
bull Derivatives under GAAPbull Recorded at Fair Value
bull Best Efforts Commitmentsbull Do not have a penalty for legitimate cancelationbull If loan is not closed the BE is canceled without costbull Avoidance of pair-off risk is not a derivative (most agree)bull Optional derivative under ASC 825-10-25
bull If IRLC is MTM and BE locks are not MTM bull Potential misrepresentation of gain positionbull Recommend all commitments are DerivativesMTM
ASC 815 ndash Hedge Accounting
The Interest Rate Lock Commitments ndash IRLC ndashbull IRLCs are initially issued to generate a profitbull The imbedded profit is valued at each reporting period bull The resulting gain is recorded as a Derivative Asset
bull It is very unlikely an IRLC will be a Derivative Liability
Hedge Positionbull TBA-MBS can generate a gain or loss
bull depending upon price movement since the date of salebull gain is reported as a Derivative Assetbull loss is reported as a Derivative Liability
+25 IRLCDerivative Asset Margin
Preservation
-50 TBADerivative Liability
+130 TBADerivative Asset
+70 IRLCDerivative Asset
Always consider loan gain with hedge gain or loss
Hedging Journal Entries
Warehouse bull The warehouse is comprised of two segments
ndash Committed or Allocated to Mandatory Commitmentndash Uncommitted or Hedged with Short TBA-MBS
bull The month-end MTM of the LHFS adjusts the basis of the LHFS creating a gain or loss in the PampL
Pipeline Hedgebull The month-end open TBA position MTM gain or loss is
posted to a Derivative Asset or Derivative Liability and a MTM gain or loss in PampL
Allocated and Unallocated LHFS
Secondary Marketing Data
You must get this informationhellipbull Do you Believe the numbers
(Mandatory Commitment MTM off-setting LHFS excluded in example)
WH Committed not in TBA Hedge- Valued based on purchase priceWH Uncommitted is in TBA Hedge- Valued by hedge advisor
MTM JE
bull Reverse the prior month MTM
bull Post Pair-Off AP or ARbull Post current month MTM
bull Significant changes in volume can impact the PampL
bull If hedge was gain Derivative Asset
bull Confirm everything with your Auditorbull All external reports must be GAAP
Derivative Asset increases CapitalWe Create a Derivative Asset bybull DR Derivative Asset CR Income
bull What happens to IRLC Income ndash Becomes Capital
IMBs want more Capitalbull More IRLC means more Incomebull More Income means more Capitalbull More Capital means more Warehouse borrowingbull More Capital means qualifying for FHA amp Agencybull More IRLC means more Capital
Derivative Asset
Is Confusing to Business Ownersand leads to bad decisions
Capital Accounts with Derivative AssetThe Derivative Asset is not carried at Fair Value because the Derivative Asset cannot be sold for the carrying value
During 2018 several companies failed Capital = $2 million Derivative Asset = $2 million
The Owner did not understand why they were insolvent
Disclose the Impact of the Derivative Asset in Capital Accountsbull Common Stockbull Paid In Capitalbull Distributionsbull Retained Earnings (Move IRLC MTM impact from NI to Unrealized Gain)bull Unrealized Gain(Loss)
Thanks to Oystein Konsmo CFO at Nova Financial for implementing this practice
Derivative Asset Characteristics
What is the Locked Pipeline
bull IRLC is a lock commitments issued to borrowers bull They are ldquoApplications in Processrdquo bull IRLC are commitments ndash not Loans bull There is no active market for IRLCbull There is no Asset to basis adjust for MTM
bull Is a TBA-MBS tradeable in its current form YES
bull Is a IRLC tradeable in its current form NO
bull The IRLC must be Transformed into a loan then securitized to be valued as tradeable instrument
bull Transformational Costs are unavoidable and undeniable
bull IRLC is not pure derivative but is derivative under GAAP
bull Absorption Costing is a way to understand the basis for Transformational Costs = Work in Process but is it not perfect
bull I think MSR valuation of cash flow is a more accurate measure
Is an IRLC a Tradable Asset
How have CPAs Presented theDerivative Asset
INCONSISTANTLY
Derivative Asset vs Pipeline
Small Independent Large Public
Source ndash A Greer CPA
bull Warehouse Lenders Rely on CPA for GAAP Capitalbull Lenderrsquos Observe CPA Auditorshellip
ndash Overstate Capital with DAndash Under-apply Cost to Completendash Inconsistently apply Costs to Complete
bull Warehouse Lenders reduce Derivative Asset ndash Some arbitrarily reduce by 50ndash Some reduce based on Net Future Cash Flows
Warehouse Lenderrsquos Adjustment
What about GAAP
bull What does GAAP say about Transformation Costs
bull Direct Cost Deduction Method - direct costs only
bull Full Cost Absorption Method - direct and indirect costs
bull IRLC is a pure derivative - IRLC same as TBA-MBS
bull Net Future Cash Flow Valuation Method (discussed soon)
Transformation Costs or Cost to Completebull What is the value of the IRLC
bull Pull-thru adjusted MTM less Costs to Complete
bull What is the right amount of Transformation Costsbull Direct Cost Deduction Method - direct costs onlybull Full Cost Absorption Method - both direct and indirect costsbull IRLC is a pure derivative ndash no adjustment (IRLC = TBA-MBS)
bull Uncertainty Principalndash Exponential diminishing impact to closingndash You have it when you have it otherwise uncertainndash Day of Lock 99 uncertainty Day before closing 1 uncertainty
IMB Transformational Costs ndash Best PracticesDirect Expenses
bull LO commissions production commissionsbull Other Direct Production Costs
bull appraisals outsourcing courier credit reports other cosbull Other Direct Expenses
bull LO wages processors LOA bull underwriting funding disclosure and post closing
Indirect Expensesbull Allocated Production Rent Branch Rent Branch Overhead
Consequence of Ignoring Indirect Costs
Hawaii vs TexasHigh Balance vs Low Balance
Loan Size Matters
Loan Size Dynamics ndash One Loanbull ONE LOAN
bull High Balance low gainbull Low Balance high gain
bull Derivative Asset
bull Processing costs as of loan are different
bull Profit is same
Higher Gain
$50000000 Locked Pipeline
bull Texas lender is more than double Hawaii
bull Identical Cash Realization
bull Indirect Costs Matter
Direct Costs Only - Distort Results
Derivative Asset Value
View From Finance
Present Value of Net Future Cash Flow
Same as MSR
Derivative Asset OoopsMany CPAs firms have issued opinions on financial statements with derivative asset values I would challenge as not reasonable
Changing Presentation method now creates exposure to Opinion Risk
There is presently no consensus among CPA Auditors about how to apply GAAP
What is the Value of the IRLC - DA
Day of Lock Day Before Closing
High ProbabilityRevenue less Commission
Value is approaching Revenue
UnIncurred Costs Decrease as Percentage of Completion Increases
Low ProbabilityRevenue less all Costs
Value is approaching Zero
What is the value of an Intangible Asset
The Derivative Asset is an Intangible Asset
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
Objective is Recognition of Future Cash-Flows
PV of Discounted NET Future Cash-flows
Amortization Method or Fair Value MethodASC 860-50-35-9
IRLC under ASC 815An IRLC (Interest Rate Lock Commitment)
bull is an off balance sheet financial commitment bull subject to market risk and a bull derivative under SFAS 149 ASC 815 andbull subject MTM under SFAS 159 ASC 825
bull All IRLC are Derivatives (except for cost to complete)bull An IRLC hedged with Best Efforts is a derivativebull An IRLC hedged with a short MBS is a derivativebull The hedge strategy does not change the derivative
bull Derivatives under GAAPbull Recorded at Fair Value
bull Best Efforts Commitmentsbull Do not have a penalty for legitimate cancelationbull If loan is not closed the BE is canceled without costbull Avoidance of pair-off risk is not a derivative (most agree)bull Optional derivative under ASC 825-10-25
bull If IRLC is MTM and BE locks are not MTM bull Potential misrepresentation of gain positionbull Recommend all commitments are DerivativesMTM
ASC 815 ndash Hedge Accounting
The Interest Rate Lock Commitments ndash IRLC ndashbull IRLCs are initially issued to generate a profitbull The imbedded profit is valued at each reporting period bull The resulting gain is recorded as a Derivative Asset
bull It is very unlikely an IRLC will be a Derivative Liability
Hedge Positionbull TBA-MBS can generate a gain or loss
bull depending upon price movement since the date of salebull gain is reported as a Derivative Assetbull loss is reported as a Derivative Liability
+25 IRLCDerivative Asset Margin
Preservation
-50 TBADerivative Liability
+130 TBADerivative Asset
+70 IRLCDerivative Asset
Always consider loan gain with hedge gain or loss
Hedging Journal Entries
Warehouse bull The warehouse is comprised of two segments
ndash Committed or Allocated to Mandatory Commitmentndash Uncommitted or Hedged with Short TBA-MBS
bull The month-end MTM of the LHFS adjusts the basis of the LHFS creating a gain or loss in the PampL
Pipeline Hedgebull The month-end open TBA position MTM gain or loss is
posted to a Derivative Asset or Derivative Liability and a MTM gain or loss in PampL
Allocated and Unallocated LHFS
Secondary Marketing Data
You must get this informationhellipbull Do you Believe the numbers
(Mandatory Commitment MTM off-setting LHFS excluded in example)
WH Committed not in TBA Hedge- Valued based on purchase priceWH Uncommitted is in TBA Hedge- Valued by hedge advisor
MTM JE
bull Reverse the prior month MTM
bull Post Pair-Off AP or ARbull Post current month MTM
bull Significant changes in volume can impact the PampL
bull If hedge was gain Derivative Asset
bull Confirm everything with your Auditorbull All external reports must be GAAP
Derivative Asset increases CapitalWe Create a Derivative Asset bybull DR Derivative Asset CR Income
bull What happens to IRLC Income ndash Becomes Capital
IMBs want more Capitalbull More IRLC means more Incomebull More Income means more Capitalbull More Capital means more Warehouse borrowingbull More Capital means qualifying for FHA amp Agencybull More IRLC means more Capital
Derivative Asset
Is Confusing to Business Ownersand leads to bad decisions
Capital Accounts with Derivative AssetThe Derivative Asset is not carried at Fair Value because the Derivative Asset cannot be sold for the carrying value
During 2018 several companies failed Capital = $2 million Derivative Asset = $2 million
The Owner did not understand why they were insolvent
Disclose the Impact of the Derivative Asset in Capital Accountsbull Common Stockbull Paid In Capitalbull Distributionsbull Retained Earnings (Move IRLC MTM impact from NI to Unrealized Gain)bull Unrealized Gain(Loss)
Thanks to Oystein Konsmo CFO at Nova Financial for implementing this practice
Derivative Asset Characteristics
What is the Locked Pipeline
bull IRLC is a lock commitments issued to borrowers bull They are ldquoApplications in Processrdquo bull IRLC are commitments ndash not Loans bull There is no active market for IRLCbull There is no Asset to basis adjust for MTM
bull Is a TBA-MBS tradeable in its current form YES
bull Is a IRLC tradeable in its current form NO
bull The IRLC must be Transformed into a loan then securitized to be valued as tradeable instrument
bull Transformational Costs are unavoidable and undeniable
bull IRLC is not pure derivative but is derivative under GAAP
bull Absorption Costing is a way to understand the basis for Transformational Costs = Work in Process but is it not perfect
bull I think MSR valuation of cash flow is a more accurate measure
Is an IRLC a Tradable Asset
How have CPAs Presented theDerivative Asset
INCONSISTANTLY
Derivative Asset vs Pipeline
Small Independent Large Public
Source ndash A Greer CPA
bull Warehouse Lenders Rely on CPA for GAAP Capitalbull Lenderrsquos Observe CPA Auditorshellip
ndash Overstate Capital with DAndash Under-apply Cost to Completendash Inconsistently apply Costs to Complete
bull Warehouse Lenders reduce Derivative Asset ndash Some arbitrarily reduce by 50ndash Some reduce based on Net Future Cash Flows
Warehouse Lenderrsquos Adjustment
What about GAAP
bull What does GAAP say about Transformation Costs
bull Direct Cost Deduction Method - direct costs only
bull Full Cost Absorption Method - direct and indirect costs
bull IRLC is a pure derivative - IRLC same as TBA-MBS
bull Net Future Cash Flow Valuation Method (discussed soon)
Transformation Costs or Cost to Completebull What is the value of the IRLC
bull Pull-thru adjusted MTM less Costs to Complete
bull What is the right amount of Transformation Costsbull Direct Cost Deduction Method - direct costs onlybull Full Cost Absorption Method - both direct and indirect costsbull IRLC is a pure derivative ndash no adjustment (IRLC = TBA-MBS)
bull Uncertainty Principalndash Exponential diminishing impact to closingndash You have it when you have it otherwise uncertainndash Day of Lock 99 uncertainty Day before closing 1 uncertainty
IMB Transformational Costs ndash Best PracticesDirect Expenses
bull LO commissions production commissionsbull Other Direct Production Costs
bull appraisals outsourcing courier credit reports other cosbull Other Direct Expenses
bull LO wages processors LOA bull underwriting funding disclosure and post closing
Indirect Expensesbull Allocated Production Rent Branch Rent Branch Overhead
Consequence of Ignoring Indirect Costs
Hawaii vs TexasHigh Balance vs Low Balance
Loan Size Matters
Loan Size Dynamics ndash One Loanbull ONE LOAN
bull High Balance low gainbull Low Balance high gain
bull Derivative Asset
bull Processing costs as of loan are different
bull Profit is same
Higher Gain
$50000000 Locked Pipeline
bull Texas lender is more than double Hawaii
bull Identical Cash Realization
bull Indirect Costs Matter
Direct Costs Only - Distort Results
Derivative Asset Value
View From Finance
Present Value of Net Future Cash Flow
Same as MSR
Derivative Asset OoopsMany CPAs firms have issued opinions on financial statements with derivative asset values I would challenge as not reasonable
Changing Presentation method now creates exposure to Opinion Risk
There is presently no consensus among CPA Auditors about how to apply GAAP
What is the Value of the IRLC - DA
Day of Lock Day Before Closing
High ProbabilityRevenue less Commission
Value is approaching Revenue
UnIncurred Costs Decrease as Percentage of Completion Increases
Low ProbabilityRevenue less all Costs
Value is approaching Zero
What is the value of an Intangible Asset
The Derivative Asset is an Intangible Asset
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
Objective is Recognition of Future Cash-Flows
PV of Discounted NET Future Cash-flows
Amortization Method or Fair Value MethodASC 860-50-35-9
IRLC under ASC 815An IRLC (Interest Rate Lock Commitment)
bull is an off balance sheet financial commitment bull subject to market risk and a bull derivative under SFAS 149 ASC 815 andbull subject MTM under SFAS 159 ASC 825
bull All IRLC are Derivatives (except for cost to complete)bull An IRLC hedged with Best Efforts is a derivativebull An IRLC hedged with a short MBS is a derivativebull The hedge strategy does not change the derivative
bull Derivatives under GAAPbull Recorded at Fair Value
bull Best Efforts Commitmentsbull Do not have a penalty for legitimate cancelationbull If loan is not closed the BE is canceled without costbull Avoidance of pair-off risk is not a derivative (most agree)bull Optional derivative under ASC 825-10-25
bull If IRLC is MTM and BE locks are not MTM bull Potential misrepresentation of gain positionbull Recommend all commitments are DerivativesMTM
ASC 815 ndash Hedge Accounting
The Interest Rate Lock Commitments ndash IRLC ndashbull IRLCs are initially issued to generate a profitbull The imbedded profit is valued at each reporting period bull The resulting gain is recorded as a Derivative Asset
bull It is very unlikely an IRLC will be a Derivative Liability
Hedge Positionbull TBA-MBS can generate a gain or loss
bull depending upon price movement since the date of salebull gain is reported as a Derivative Assetbull loss is reported as a Derivative Liability
+25 IRLCDerivative Asset Margin
Preservation
-50 TBADerivative Liability
+130 TBADerivative Asset
+70 IRLCDerivative Asset
Always consider loan gain with hedge gain or loss
Hedging Journal Entries
Warehouse bull The warehouse is comprised of two segments
ndash Committed or Allocated to Mandatory Commitmentndash Uncommitted or Hedged with Short TBA-MBS
bull The month-end MTM of the LHFS adjusts the basis of the LHFS creating a gain or loss in the PampL
Pipeline Hedgebull The month-end open TBA position MTM gain or loss is
posted to a Derivative Asset or Derivative Liability and a MTM gain or loss in PampL
Allocated and Unallocated LHFS
Secondary Marketing Data
You must get this informationhellipbull Do you Believe the numbers
(Mandatory Commitment MTM off-setting LHFS excluded in example)
WH Committed not in TBA Hedge- Valued based on purchase priceWH Uncommitted is in TBA Hedge- Valued by hedge advisor
MTM JE
bull Reverse the prior month MTM
bull Post Pair-Off AP or ARbull Post current month MTM
bull Significant changes in volume can impact the PampL
bull If hedge was gain Derivative Asset
bull Confirm everything with your Auditorbull All external reports must be GAAP
Derivative Asset increases CapitalWe Create a Derivative Asset bybull DR Derivative Asset CR Income
bull What happens to IRLC Income ndash Becomes Capital
IMBs want more Capitalbull More IRLC means more Incomebull More Income means more Capitalbull More Capital means more Warehouse borrowingbull More Capital means qualifying for FHA amp Agencybull More IRLC means more Capital
Derivative Asset
Is Confusing to Business Ownersand leads to bad decisions
Capital Accounts with Derivative AssetThe Derivative Asset is not carried at Fair Value because the Derivative Asset cannot be sold for the carrying value
During 2018 several companies failed Capital = $2 million Derivative Asset = $2 million
The Owner did not understand why they were insolvent
Disclose the Impact of the Derivative Asset in Capital Accountsbull Common Stockbull Paid In Capitalbull Distributionsbull Retained Earnings (Move IRLC MTM impact from NI to Unrealized Gain)bull Unrealized Gain(Loss)
Thanks to Oystein Konsmo CFO at Nova Financial for implementing this practice
Derivative Asset Characteristics
What is the Locked Pipeline
bull IRLC is a lock commitments issued to borrowers bull They are ldquoApplications in Processrdquo bull IRLC are commitments ndash not Loans bull There is no active market for IRLCbull There is no Asset to basis adjust for MTM
bull Is a TBA-MBS tradeable in its current form YES
bull Is a IRLC tradeable in its current form NO
bull The IRLC must be Transformed into a loan then securitized to be valued as tradeable instrument
bull Transformational Costs are unavoidable and undeniable
bull IRLC is not pure derivative but is derivative under GAAP
bull Absorption Costing is a way to understand the basis for Transformational Costs = Work in Process but is it not perfect
bull I think MSR valuation of cash flow is a more accurate measure
Is an IRLC a Tradable Asset
How have CPAs Presented theDerivative Asset
INCONSISTANTLY
Derivative Asset vs Pipeline
Small Independent Large Public
Source ndash A Greer CPA
bull Warehouse Lenders Rely on CPA for GAAP Capitalbull Lenderrsquos Observe CPA Auditorshellip
ndash Overstate Capital with DAndash Under-apply Cost to Completendash Inconsistently apply Costs to Complete
bull Warehouse Lenders reduce Derivative Asset ndash Some arbitrarily reduce by 50ndash Some reduce based on Net Future Cash Flows
Warehouse Lenderrsquos Adjustment
What about GAAP
bull What does GAAP say about Transformation Costs
bull Direct Cost Deduction Method - direct costs only
bull Full Cost Absorption Method - direct and indirect costs
bull IRLC is a pure derivative - IRLC same as TBA-MBS
bull Net Future Cash Flow Valuation Method (discussed soon)
Transformation Costs or Cost to Completebull What is the value of the IRLC
bull Pull-thru adjusted MTM less Costs to Complete
bull What is the right amount of Transformation Costsbull Direct Cost Deduction Method - direct costs onlybull Full Cost Absorption Method - both direct and indirect costsbull IRLC is a pure derivative ndash no adjustment (IRLC = TBA-MBS)
bull Uncertainty Principalndash Exponential diminishing impact to closingndash You have it when you have it otherwise uncertainndash Day of Lock 99 uncertainty Day before closing 1 uncertainty
IMB Transformational Costs ndash Best PracticesDirect Expenses
bull LO commissions production commissionsbull Other Direct Production Costs
bull appraisals outsourcing courier credit reports other cosbull Other Direct Expenses
bull LO wages processors LOA bull underwriting funding disclosure and post closing
Indirect Expensesbull Allocated Production Rent Branch Rent Branch Overhead
Consequence of Ignoring Indirect Costs
Hawaii vs TexasHigh Balance vs Low Balance
Loan Size Matters
Loan Size Dynamics ndash One Loanbull ONE LOAN
bull High Balance low gainbull Low Balance high gain
bull Derivative Asset
bull Processing costs as of loan are different
bull Profit is same
Higher Gain
$50000000 Locked Pipeline
bull Texas lender is more than double Hawaii
bull Identical Cash Realization
bull Indirect Costs Matter
Direct Costs Only - Distort Results
Derivative Asset Value
View From Finance
Present Value of Net Future Cash Flow
Same as MSR
Derivative Asset OoopsMany CPAs firms have issued opinions on financial statements with derivative asset values I would challenge as not reasonable
Changing Presentation method now creates exposure to Opinion Risk
There is presently no consensus among CPA Auditors about how to apply GAAP
What is the Value of the IRLC - DA
Day of Lock Day Before Closing
High ProbabilityRevenue less Commission
Value is approaching Revenue
UnIncurred Costs Decrease as Percentage of Completion Increases
Low ProbabilityRevenue less all Costs
Value is approaching Zero
What is the value of an Intangible Asset
The Derivative Asset is an Intangible Asset
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
Objective is Recognition of Future Cash-Flows
PV of Discounted NET Future Cash-flows
Amortization Method or Fair Value MethodASC 860-50-35-9
IRLC under ASC 815An IRLC (Interest Rate Lock Commitment)
bull is an off balance sheet financial commitment bull subject to market risk and a bull derivative under SFAS 149 ASC 815 andbull subject MTM under SFAS 159 ASC 825
bull All IRLC are Derivatives (except for cost to complete)bull An IRLC hedged with Best Efforts is a derivativebull An IRLC hedged with a short MBS is a derivativebull The hedge strategy does not change the derivative
bull Derivatives under GAAPbull Recorded at Fair Value
bull Best Efforts Commitmentsbull Do not have a penalty for legitimate cancelationbull If loan is not closed the BE is canceled without costbull Avoidance of pair-off risk is not a derivative (most agree)bull Optional derivative under ASC 825-10-25
bull If IRLC is MTM and BE locks are not MTM bull Potential misrepresentation of gain positionbull Recommend all commitments are DerivativesMTM
ASC 815 ndash Hedge Accounting
The Interest Rate Lock Commitments ndash IRLC ndashbull IRLCs are initially issued to generate a profitbull The imbedded profit is valued at each reporting period bull The resulting gain is recorded as a Derivative Asset
bull It is very unlikely an IRLC will be a Derivative Liability
Hedge Positionbull TBA-MBS can generate a gain or loss
bull depending upon price movement since the date of salebull gain is reported as a Derivative Assetbull loss is reported as a Derivative Liability
+25 IRLCDerivative Asset Margin
Preservation
-50 TBADerivative Liability
+130 TBADerivative Asset
+70 IRLCDerivative Asset
Always consider loan gain with hedge gain or loss
Hedging Journal Entries
Warehouse bull The warehouse is comprised of two segments
ndash Committed or Allocated to Mandatory Commitmentndash Uncommitted or Hedged with Short TBA-MBS
bull The month-end MTM of the LHFS adjusts the basis of the LHFS creating a gain or loss in the PampL
Pipeline Hedgebull The month-end open TBA position MTM gain or loss is
posted to a Derivative Asset or Derivative Liability and a MTM gain or loss in PampL
Allocated and Unallocated LHFS
Secondary Marketing Data
You must get this informationhellipbull Do you Believe the numbers
(Mandatory Commitment MTM off-setting LHFS excluded in example)
WH Committed not in TBA Hedge- Valued based on purchase priceWH Uncommitted is in TBA Hedge- Valued by hedge advisor
MTM JE
bull Reverse the prior month MTM
bull Post Pair-Off AP or ARbull Post current month MTM
bull Significant changes in volume can impact the PampL
bull If hedge was gain Derivative Asset
bull Confirm everything with your Auditorbull All external reports must be GAAP
Derivative Asset increases CapitalWe Create a Derivative Asset bybull DR Derivative Asset CR Income
bull What happens to IRLC Income ndash Becomes Capital
IMBs want more Capitalbull More IRLC means more Incomebull More Income means more Capitalbull More Capital means more Warehouse borrowingbull More Capital means qualifying for FHA amp Agencybull More IRLC means more Capital
Derivative Asset
Is Confusing to Business Ownersand leads to bad decisions
Capital Accounts with Derivative AssetThe Derivative Asset is not carried at Fair Value because the Derivative Asset cannot be sold for the carrying value
During 2018 several companies failed Capital = $2 million Derivative Asset = $2 million
The Owner did not understand why they were insolvent
Disclose the Impact of the Derivative Asset in Capital Accountsbull Common Stockbull Paid In Capitalbull Distributionsbull Retained Earnings (Move IRLC MTM impact from NI to Unrealized Gain)bull Unrealized Gain(Loss)
Thanks to Oystein Konsmo CFO at Nova Financial for implementing this practice
Derivative Asset Characteristics
What is the Locked Pipeline
bull IRLC is a lock commitments issued to borrowers bull They are ldquoApplications in Processrdquo bull IRLC are commitments ndash not Loans bull There is no active market for IRLCbull There is no Asset to basis adjust for MTM
bull Is a TBA-MBS tradeable in its current form YES
bull Is a IRLC tradeable in its current form NO
bull The IRLC must be Transformed into a loan then securitized to be valued as tradeable instrument
bull Transformational Costs are unavoidable and undeniable
bull IRLC is not pure derivative but is derivative under GAAP
bull Absorption Costing is a way to understand the basis for Transformational Costs = Work in Process but is it not perfect
bull I think MSR valuation of cash flow is a more accurate measure
Is an IRLC a Tradable Asset
How have CPAs Presented theDerivative Asset
INCONSISTANTLY
Derivative Asset vs Pipeline
Small Independent Large Public
Source ndash A Greer CPA
bull Warehouse Lenders Rely on CPA for GAAP Capitalbull Lenderrsquos Observe CPA Auditorshellip
ndash Overstate Capital with DAndash Under-apply Cost to Completendash Inconsistently apply Costs to Complete
bull Warehouse Lenders reduce Derivative Asset ndash Some arbitrarily reduce by 50ndash Some reduce based on Net Future Cash Flows
Warehouse Lenderrsquos Adjustment
What about GAAP
bull What does GAAP say about Transformation Costs
bull Direct Cost Deduction Method - direct costs only
bull Full Cost Absorption Method - direct and indirect costs
bull IRLC is a pure derivative - IRLC same as TBA-MBS
bull Net Future Cash Flow Valuation Method (discussed soon)
Transformation Costs or Cost to Completebull What is the value of the IRLC
bull Pull-thru adjusted MTM less Costs to Complete
bull What is the right amount of Transformation Costsbull Direct Cost Deduction Method - direct costs onlybull Full Cost Absorption Method - both direct and indirect costsbull IRLC is a pure derivative ndash no adjustment (IRLC = TBA-MBS)
bull Uncertainty Principalndash Exponential diminishing impact to closingndash You have it when you have it otherwise uncertainndash Day of Lock 99 uncertainty Day before closing 1 uncertainty
IMB Transformational Costs ndash Best PracticesDirect Expenses
bull LO commissions production commissionsbull Other Direct Production Costs
bull appraisals outsourcing courier credit reports other cosbull Other Direct Expenses
bull LO wages processors LOA bull underwriting funding disclosure and post closing
Indirect Expensesbull Allocated Production Rent Branch Rent Branch Overhead
Consequence of Ignoring Indirect Costs
Hawaii vs TexasHigh Balance vs Low Balance
Loan Size Matters
Loan Size Dynamics ndash One Loanbull ONE LOAN
bull High Balance low gainbull Low Balance high gain
bull Derivative Asset
bull Processing costs as of loan are different
bull Profit is same
Higher Gain
$50000000 Locked Pipeline
bull Texas lender is more than double Hawaii
bull Identical Cash Realization
bull Indirect Costs Matter
Direct Costs Only - Distort Results
Derivative Asset Value
View From Finance
Present Value of Net Future Cash Flow
Same as MSR
Derivative Asset OoopsMany CPAs firms have issued opinions on financial statements with derivative asset values I would challenge as not reasonable
Changing Presentation method now creates exposure to Opinion Risk
There is presently no consensus among CPA Auditors about how to apply GAAP
What is the Value of the IRLC - DA
Day of Lock Day Before Closing
High ProbabilityRevenue less Commission
Value is approaching Revenue
UnIncurred Costs Decrease as Percentage of Completion Increases
Low ProbabilityRevenue less all Costs
Value is approaching Zero
What is the value of an Intangible Asset
The Derivative Asset is an Intangible Asset
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
Objective is Recognition of Future Cash-Flows
PV of Discounted NET Future Cash-flows
Amortization Method or Fair Value MethodASC 860-50-35-9
IRLC under ASC 815An IRLC (Interest Rate Lock Commitment)
bull is an off balance sheet financial commitment bull subject to market risk and a bull derivative under SFAS 149 ASC 815 andbull subject MTM under SFAS 159 ASC 825
bull All IRLC are Derivatives (except for cost to complete)bull An IRLC hedged with Best Efforts is a derivativebull An IRLC hedged with a short MBS is a derivativebull The hedge strategy does not change the derivative
bull Derivatives under GAAPbull Recorded at Fair Value
bull Best Efforts Commitmentsbull Do not have a penalty for legitimate cancelationbull If loan is not closed the BE is canceled without costbull Avoidance of pair-off risk is not a derivative (most agree)bull Optional derivative under ASC 825-10-25
bull If IRLC is MTM and BE locks are not MTM bull Potential misrepresentation of gain positionbull Recommend all commitments are DerivativesMTM
ASC 815 ndash Hedge Accounting
The Interest Rate Lock Commitments ndash IRLC ndashbull IRLCs are initially issued to generate a profitbull The imbedded profit is valued at each reporting period bull The resulting gain is recorded as a Derivative Asset
bull It is very unlikely an IRLC will be a Derivative Liability
Hedge Positionbull TBA-MBS can generate a gain or loss
bull depending upon price movement since the date of salebull gain is reported as a Derivative Assetbull loss is reported as a Derivative Liability
+25 IRLCDerivative Asset Margin
Preservation
-50 TBADerivative Liability
+130 TBADerivative Asset
+70 IRLCDerivative Asset
Always consider loan gain with hedge gain or loss
Hedging Journal Entries
Warehouse bull The warehouse is comprised of two segments
ndash Committed or Allocated to Mandatory Commitmentndash Uncommitted or Hedged with Short TBA-MBS
bull The month-end MTM of the LHFS adjusts the basis of the LHFS creating a gain or loss in the PampL
Pipeline Hedgebull The month-end open TBA position MTM gain or loss is
posted to a Derivative Asset or Derivative Liability and a MTM gain or loss in PampL
Allocated and Unallocated LHFS
Secondary Marketing Data
You must get this informationhellipbull Do you Believe the numbers
(Mandatory Commitment MTM off-setting LHFS excluded in example)
WH Committed not in TBA Hedge- Valued based on purchase priceWH Uncommitted is in TBA Hedge- Valued by hedge advisor
MTM JE
bull Reverse the prior month MTM
bull Post Pair-Off AP or ARbull Post current month MTM
bull Significant changes in volume can impact the PampL
bull If hedge was gain Derivative Asset
bull Confirm everything with your Auditorbull All external reports must be GAAP
Derivative Asset increases CapitalWe Create a Derivative Asset bybull DR Derivative Asset CR Income
bull What happens to IRLC Income ndash Becomes Capital
IMBs want more Capitalbull More IRLC means more Incomebull More Income means more Capitalbull More Capital means more Warehouse borrowingbull More Capital means qualifying for FHA amp Agencybull More IRLC means more Capital
Derivative Asset
Is Confusing to Business Ownersand leads to bad decisions
Capital Accounts with Derivative AssetThe Derivative Asset is not carried at Fair Value because the Derivative Asset cannot be sold for the carrying value
During 2018 several companies failed Capital = $2 million Derivative Asset = $2 million
The Owner did not understand why they were insolvent
Disclose the Impact of the Derivative Asset in Capital Accountsbull Common Stockbull Paid In Capitalbull Distributionsbull Retained Earnings (Move IRLC MTM impact from NI to Unrealized Gain)bull Unrealized Gain(Loss)
Thanks to Oystein Konsmo CFO at Nova Financial for implementing this practice
Derivative Asset Characteristics
What is the Locked Pipeline
bull IRLC is a lock commitments issued to borrowers bull They are ldquoApplications in Processrdquo bull IRLC are commitments ndash not Loans bull There is no active market for IRLCbull There is no Asset to basis adjust for MTM
bull Is a TBA-MBS tradeable in its current form YES
bull Is a IRLC tradeable in its current form NO
bull The IRLC must be Transformed into a loan then securitized to be valued as tradeable instrument
bull Transformational Costs are unavoidable and undeniable
bull IRLC is not pure derivative but is derivative under GAAP
bull Absorption Costing is a way to understand the basis for Transformational Costs = Work in Process but is it not perfect
bull I think MSR valuation of cash flow is a more accurate measure
Is an IRLC a Tradable Asset
How have CPAs Presented theDerivative Asset
INCONSISTANTLY
Derivative Asset vs Pipeline
Small Independent Large Public
Source ndash A Greer CPA
bull Warehouse Lenders Rely on CPA for GAAP Capitalbull Lenderrsquos Observe CPA Auditorshellip
ndash Overstate Capital with DAndash Under-apply Cost to Completendash Inconsistently apply Costs to Complete
bull Warehouse Lenders reduce Derivative Asset ndash Some arbitrarily reduce by 50ndash Some reduce based on Net Future Cash Flows
Warehouse Lenderrsquos Adjustment
What about GAAP
bull What does GAAP say about Transformation Costs
bull Direct Cost Deduction Method - direct costs only
bull Full Cost Absorption Method - direct and indirect costs
bull IRLC is a pure derivative - IRLC same as TBA-MBS
bull Net Future Cash Flow Valuation Method (discussed soon)
Transformation Costs or Cost to Completebull What is the value of the IRLC
bull Pull-thru adjusted MTM less Costs to Complete
bull What is the right amount of Transformation Costsbull Direct Cost Deduction Method - direct costs onlybull Full Cost Absorption Method - both direct and indirect costsbull IRLC is a pure derivative ndash no adjustment (IRLC = TBA-MBS)
bull Uncertainty Principalndash Exponential diminishing impact to closingndash You have it when you have it otherwise uncertainndash Day of Lock 99 uncertainty Day before closing 1 uncertainty
IMB Transformational Costs ndash Best PracticesDirect Expenses
bull LO commissions production commissionsbull Other Direct Production Costs
bull appraisals outsourcing courier credit reports other cosbull Other Direct Expenses
bull LO wages processors LOA bull underwriting funding disclosure and post closing
Indirect Expensesbull Allocated Production Rent Branch Rent Branch Overhead
Consequence of Ignoring Indirect Costs
Hawaii vs TexasHigh Balance vs Low Balance
Loan Size Matters
Loan Size Dynamics ndash One Loanbull ONE LOAN
bull High Balance low gainbull Low Balance high gain
bull Derivative Asset
bull Processing costs as of loan are different
bull Profit is same
Higher Gain
$50000000 Locked Pipeline
bull Texas lender is more than double Hawaii
bull Identical Cash Realization
bull Indirect Costs Matter
Direct Costs Only - Distort Results
Derivative Asset Value
View From Finance
Present Value of Net Future Cash Flow
Same as MSR
Derivative Asset OoopsMany CPAs firms have issued opinions on financial statements with derivative asset values I would challenge as not reasonable
Changing Presentation method now creates exposure to Opinion Risk
There is presently no consensus among CPA Auditors about how to apply GAAP
What is the Value of the IRLC - DA
Day of Lock Day Before Closing
High ProbabilityRevenue less Commission
Value is approaching Revenue
UnIncurred Costs Decrease as Percentage of Completion Increases
Low ProbabilityRevenue less all Costs
Value is approaching Zero
What is the value of an Intangible Asset
The Derivative Asset is an Intangible Asset
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
Objective is Recognition of Future Cash-Flows
PV of Discounted NET Future Cash-flows
Amortization Method or Fair Value MethodASC 860-50-35-9
IRLC under ASC 815An IRLC (Interest Rate Lock Commitment)
bull is an off balance sheet financial commitment bull subject to market risk and a bull derivative under SFAS 149 ASC 815 andbull subject MTM under SFAS 159 ASC 825
bull All IRLC are Derivatives (except for cost to complete)bull An IRLC hedged with Best Efforts is a derivativebull An IRLC hedged with a short MBS is a derivativebull The hedge strategy does not change the derivative
bull Derivatives under GAAPbull Recorded at Fair Value
bull Best Efforts Commitmentsbull Do not have a penalty for legitimate cancelationbull If loan is not closed the BE is canceled without costbull Avoidance of pair-off risk is not a derivative (most agree)bull Optional derivative under ASC 825-10-25
bull If IRLC is MTM and BE locks are not MTM bull Potential misrepresentation of gain positionbull Recommend all commitments are DerivativesMTM
ASC 815 ndash Hedge Accounting
The Interest Rate Lock Commitments ndash IRLC ndashbull IRLCs are initially issued to generate a profitbull The imbedded profit is valued at each reporting period bull The resulting gain is recorded as a Derivative Asset
bull It is very unlikely an IRLC will be a Derivative Liability
Hedge Positionbull TBA-MBS can generate a gain or loss
bull depending upon price movement since the date of salebull gain is reported as a Derivative Assetbull loss is reported as a Derivative Liability
+25 IRLCDerivative Asset Margin
Preservation
-50 TBADerivative Liability
+130 TBADerivative Asset
+70 IRLCDerivative Asset
Always consider loan gain with hedge gain or loss
Hedging Journal Entries
Warehouse bull The warehouse is comprised of two segments
ndash Committed or Allocated to Mandatory Commitmentndash Uncommitted or Hedged with Short TBA-MBS
bull The month-end MTM of the LHFS adjusts the basis of the LHFS creating a gain or loss in the PampL
Pipeline Hedgebull The month-end open TBA position MTM gain or loss is
posted to a Derivative Asset or Derivative Liability and a MTM gain or loss in PampL
Allocated and Unallocated LHFS
Secondary Marketing Data
You must get this informationhellipbull Do you Believe the numbers
(Mandatory Commitment MTM off-setting LHFS excluded in example)
WH Committed not in TBA Hedge- Valued based on purchase priceWH Uncommitted is in TBA Hedge- Valued by hedge advisor
MTM JE
bull Reverse the prior month MTM
bull Post Pair-Off AP or ARbull Post current month MTM
bull Significant changes in volume can impact the PampL
bull If hedge was gain Derivative Asset
bull Confirm everything with your Auditorbull All external reports must be GAAP
Derivative Asset increases CapitalWe Create a Derivative Asset bybull DR Derivative Asset CR Income
bull What happens to IRLC Income ndash Becomes Capital
IMBs want more Capitalbull More IRLC means more Incomebull More Income means more Capitalbull More Capital means more Warehouse borrowingbull More Capital means qualifying for FHA amp Agencybull More IRLC means more Capital
Derivative Asset
Is Confusing to Business Ownersand leads to bad decisions
Capital Accounts with Derivative AssetThe Derivative Asset is not carried at Fair Value because the Derivative Asset cannot be sold for the carrying value
During 2018 several companies failed Capital = $2 million Derivative Asset = $2 million
The Owner did not understand why they were insolvent
Disclose the Impact of the Derivative Asset in Capital Accountsbull Common Stockbull Paid In Capitalbull Distributionsbull Retained Earnings (Move IRLC MTM impact from NI to Unrealized Gain)bull Unrealized Gain(Loss)
Thanks to Oystein Konsmo CFO at Nova Financial for implementing this practice
Derivative Asset Characteristics
What is the Locked Pipeline
bull IRLC is a lock commitments issued to borrowers bull They are ldquoApplications in Processrdquo bull IRLC are commitments ndash not Loans bull There is no active market for IRLCbull There is no Asset to basis adjust for MTM
bull Is a TBA-MBS tradeable in its current form YES
bull Is a IRLC tradeable in its current form NO
bull The IRLC must be Transformed into a loan then securitized to be valued as tradeable instrument
bull Transformational Costs are unavoidable and undeniable
bull IRLC is not pure derivative but is derivative under GAAP
bull Absorption Costing is a way to understand the basis for Transformational Costs = Work in Process but is it not perfect
bull I think MSR valuation of cash flow is a more accurate measure
Is an IRLC a Tradable Asset
How have CPAs Presented theDerivative Asset
INCONSISTANTLY
Derivative Asset vs Pipeline
Small Independent Large Public
Source ndash A Greer CPA
bull Warehouse Lenders Rely on CPA for GAAP Capitalbull Lenderrsquos Observe CPA Auditorshellip
ndash Overstate Capital with DAndash Under-apply Cost to Completendash Inconsistently apply Costs to Complete
bull Warehouse Lenders reduce Derivative Asset ndash Some arbitrarily reduce by 50ndash Some reduce based on Net Future Cash Flows
Warehouse Lenderrsquos Adjustment
What about GAAP
bull What does GAAP say about Transformation Costs
bull Direct Cost Deduction Method - direct costs only
bull Full Cost Absorption Method - direct and indirect costs
bull IRLC is a pure derivative - IRLC same as TBA-MBS
bull Net Future Cash Flow Valuation Method (discussed soon)
Transformation Costs or Cost to Completebull What is the value of the IRLC
bull Pull-thru adjusted MTM less Costs to Complete
bull What is the right amount of Transformation Costsbull Direct Cost Deduction Method - direct costs onlybull Full Cost Absorption Method - both direct and indirect costsbull IRLC is a pure derivative ndash no adjustment (IRLC = TBA-MBS)
bull Uncertainty Principalndash Exponential diminishing impact to closingndash You have it when you have it otherwise uncertainndash Day of Lock 99 uncertainty Day before closing 1 uncertainty
IMB Transformational Costs ndash Best PracticesDirect Expenses
bull LO commissions production commissionsbull Other Direct Production Costs
bull appraisals outsourcing courier credit reports other cosbull Other Direct Expenses
bull LO wages processors LOA bull underwriting funding disclosure and post closing
Indirect Expensesbull Allocated Production Rent Branch Rent Branch Overhead
Consequence of Ignoring Indirect Costs
Hawaii vs TexasHigh Balance vs Low Balance
Loan Size Matters
Loan Size Dynamics ndash One Loanbull ONE LOAN
bull High Balance low gainbull Low Balance high gain
bull Derivative Asset
bull Processing costs as of loan are different
bull Profit is same
Higher Gain
$50000000 Locked Pipeline
bull Texas lender is more than double Hawaii
bull Identical Cash Realization
bull Indirect Costs Matter
Direct Costs Only - Distort Results
Derivative Asset Value
View From Finance
Present Value of Net Future Cash Flow
Same as MSR
Derivative Asset OoopsMany CPAs firms have issued opinions on financial statements with derivative asset values I would challenge as not reasonable
Changing Presentation method now creates exposure to Opinion Risk
There is presently no consensus among CPA Auditors about how to apply GAAP
What is the Value of the IRLC - DA
Day of Lock Day Before Closing
High ProbabilityRevenue less Commission
Value is approaching Revenue
UnIncurred Costs Decrease as Percentage of Completion Increases
Low ProbabilityRevenue less all Costs
Value is approaching Zero
What is the value of an Intangible Asset
The Derivative Asset is an Intangible Asset
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
Objective is Recognition of Future Cash-Flows
PV of Discounted NET Future Cash-flows
Amortization Method or Fair Value MethodASC 860-50-35-9
IRLC under ASC 815An IRLC (Interest Rate Lock Commitment)
bull is an off balance sheet financial commitment bull subject to market risk and a bull derivative under SFAS 149 ASC 815 andbull subject MTM under SFAS 159 ASC 825
bull All IRLC are Derivatives (except for cost to complete)bull An IRLC hedged with Best Efforts is a derivativebull An IRLC hedged with a short MBS is a derivativebull The hedge strategy does not change the derivative
bull Derivatives under GAAPbull Recorded at Fair Value
bull Best Efforts Commitmentsbull Do not have a penalty for legitimate cancelationbull If loan is not closed the BE is canceled without costbull Avoidance of pair-off risk is not a derivative (most agree)bull Optional derivative under ASC 825-10-25
bull If IRLC is MTM and BE locks are not MTM bull Potential misrepresentation of gain positionbull Recommend all commitments are DerivativesMTM
ASC 815 ndash Hedge Accounting
The Interest Rate Lock Commitments ndash IRLC ndashbull IRLCs are initially issued to generate a profitbull The imbedded profit is valued at each reporting period bull The resulting gain is recorded as a Derivative Asset
bull It is very unlikely an IRLC will be a Derivative Liability
Hedge Positionbull TBA-MBS can generate a gain or loss
bull depending upon price movement since the date of salebull gain is reported as a Derivative Assetbull loss is reported as a Derivative Liability
+25 IRLCDerivative Asset Margin
Preservation
-50 TBADerivative Liability
+130 TBADerivative Asset
+70 IRLCDerivative Asset
Always consider loan gain with hedge gain or loss
Hedging Journal Entries
Warehouse bull The warehouse is comprised of two segments
ndash Committed or Allocated to Mandatory Commitmentndash Uncommitted or Hedged with Short TBA-MBS
bull The month-end MTM of the LHFS adjusts the basis of the LHFS creating a gain or loss in the PampL
Pipeline Hedgebull The month-end open TBA position MTM gain or loss is
posted to a Derivative Asset or Derivative Liability and a MTM gain or loss in PampL
Allocated and Unallocated LHFS
Secondary Marketing Data
You must get this informationhellipbull Do you Believe the numbers
(Mandatory Commitment MTM off-setting LHFS excluded in example)
WH Committed not in TBA Hedge- Valued based on purchase priceWH Uncommitted is in TBA Hedge- Valued by hedge advisor
MTM JE
bull Reverse the prior month MTM
bull Post Pair-Off AP or ARbull Post current month MTM
bull Significant changes in volume can impact the PampL
bull If hedge was gain Derivative Asset
bull Confirm everything with your Auditorbull All external reports must be GAAP
Derivative Asset increases CapitalWe Create a Derivative Asset bybull DR Derivative Asset CR Income
bull What happens to IRLC Income ndash Becomes Capital
IMBs want more Capitalbull More IRLC means more Incomebull More Income means more Capitalbull More Capital means more Warehouse borrowingbull More Capital means qualifying for FHA amp Agencybull More IRLC means more Capital
Derivative Asset
Is Confusing to Business Ownersand leads to bad decisions
Capital Accounts with Derivative AssetThe Derivative Asset is not carried at Fair Value because the Derivative Asset cannot be sold for the carrying value
During 2018 several companies failed Capital = $2 million Derivative Asset = $2 million
The Owner did not understand why they were insolvent
Disclose the Impact of the Derivative Asset in Capital Accountsbull Common Stockbull Paid In Capitalbull Distributionsbull Retained Earnings (Move IRLC MTM impact from NI to Unrealized Gain)bull Unrealized Gain(Loss)
Thanks to Oystein Konsmo CFO at Nova Financial for implementing this practice
Derivative Asset Characteristics
What is the Locked Pipeline
bull IRLC is a lock commitments issued to borrowers bull They are ldquoApplications in Processrdquo bull IRLC are commitments ndash not Loans bull There is no active market for IRLCbull There is no Asset to basis adjust for MTM
bull Is a TBA-MBS tradeable in its current form YES
bull Is a IRLC tradeable in its current form NO
bull The IRLC must be Transformed into a loan then securitized to be valued as tradeable instrument
bull Transformational Costs are unavoidable and undeniable
bull IRLC is not pure derivative but is derivative under GAAP
bull Absorption Costing is a way to understand the basis for Transformational Costs = Work in Process but is it not perfect
bull I think MSR valuation of cash flow is a more accurate measure
Is an IRLC a Tradable Asset
How have CPAs Presented theDerivative Asset
INCONSISTANTLY
Derivative Asset vs Pipeline
Small Independent Large Public
Source ndash A Greer CPA
bull Warehouse Lenders Rely on CPA for GAAP Capitalbull Lenderrsquos Observe CPA Auditorshellip
ndash Overstate Capital with DAndash Under-apply Cost to Completendash Inconsistently apply Costs to Complete
bull Warehouse Lenders reduce Derivative Asset ndash Some arbitrarily reduce by 50ndash Some reduce based on Net Future Cash Flows
Warehouse Lenderrsquos Adjustment
What about GAAP
bull What does GAAP say about Transformation Costs
bull Direct Cost Deduction Method - direct costs only
bull Full Cost Absorption Method - direct and indirect costs
bull IRLC is a pure derivative - IRLC same as TBA-MBS
bull Net Future Cash Flow Valuation Method (discussed soon)
Transformation Costs or Cost to Completebull What is the value of the IRLC
bull Pull-thru adjusted MTM less Costs to Complete
bull What is the right amount of Transformation Costsbull Direct Cost Deduction Method - direct costs onlybull Full Cost Absorption Method - both direct and indirect costsbull IRLC is a pure derivative ndash no adjustment (IRLC = TBA-MBS)
bull Uncertainty Principalndash Exponential diminishing impact to closingndash You have it when you have it otherwise uncertainndash Day of Lock 99 uncertainty Day before closing 1 uncertainty
IMB Transformational Costs ndash Best PracticesDirect Expenses
bull LO commissions production commissionsbull Other Direct Production Costs
bull appraisals outsourcing courier credit reports other cosbull Other Direct Expenses
bull LO wages processors LOA bull underwriting funding disclosure and post closing
Indirect Expensesbull Allocated Production Rent Branch Rent Branch Overhead
Consequence of Ignoring Indirect Costs
Hawaii vs TexasHigh Balance vs Low Balance
Loan Size Matters
Loan Size Dynamics ndash One Loanbull ONE LOAN
bull High Balance low gainbull Low Balance high gain
bull Derivative Asset
bull Processing costs as of loan are different
bull Profit is same
Higher Gain
$50000000 Locked Pipeline
bull Texas lender is more than double Hawaii
bull Identical Cash Realization
bull Indirect Costs Matter
Direct Costs Only - Distort Results
Derivative Asset Value
View From Finance
Present Value of Net Future Cash Flow
Same as MSR
Derivative Asset OoopsMany CPAs firms have issued opinions on financial statements with derivative asset values I would challenge as not reasonable
Changing Presentation method now creates exposure to Opinion Risk
There is presently no consensus among CPA Auditors about how to apply GAAP
What is the Value of the IRLC - DA
Day of Lock Day Before Closing
High ProbabilityRevenue less Commission
Value is approaching Revenue
UnIncurred Costs Decrease as Percentage of Completion Increases
Low ProbabilityRevenue less all Costs
Value is approaching Zero
What is the value of an Intangible Asset
The Derivative Asset is an Intangible Asset
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
Objective is Recognition of Future Cash-Flows
PV of Discounted NET Future Cash-flows
Amortization Method or Fair Value MethodASC 860-50-35-9
IRLC under ASC 815An IRLC (Interest Rate Lock Commitment)
bull is an off balance sheet financial commitment bull subject to market risk and a bull derivative under SFAS 149 ASC 815 andbull subject MTM under SFAS 159 ASC 825
bull All IRLC are Derivatives (except for cost to complete)bull An IRLC hedged with Best Efforts is a derivativebull An IRLC hedged with a short MBS is a derivativebull The hedge strategy does not change the derivative
bull Derivatives under GAAPbull Recorded at Fair Value
bull Best Efforts Commitmentsbull Do not have a penalty for legitimate cancelationbull If loan is not closed the BE is canceled without costbull Avoidance of pair-off risk is not a derivative (most agree)bull Optional derivative under ASC 825-10-25
bull If IRLC is MTM and BE locks are not MTM bull Potential misrepresentation of gain positionbull Recommend all commitments are DerivativesMTM
ASC 815 ndash Hedge Accounting
The Interest Rate Lock Commitments ndash IRLC ndashbull IRLCs are initially issued to generate a profitbull The imbedded profit is valued at each reporting period bull The resulting gain is recorded as a Derivative Asset
bull It is very unlikely an IRLC will be a Derivative Liability
Hedge Positionbull TBA-MBS can generate a gain or loss
bull depending upon price movement since the date of salebull gain is reported as a Derivative Assetbull loss is reported as a Derivative Liability
+25 IRLCDerivative Asset Margin
Preservation
-50 TBADerivative Liability
+130 TBADerivative Asset
+70 IRLCDerivative Asset
Always consider loan gain with hedge gain or loss
Hedging Journal Entries
Warehouse bull The warehouse is comprised of two segments
ndash Committed or Allocated to Mandatory Commitmentndash Uncommitted or Hedged with Short TBA-MBS
bull The month-end MTM of the LHFS adjusts the basis of the LHFS creating a gain or loss in the PampL
Pipeline Hedgebull The month-end open TBA position MTM gain or loss is
posted to a Derivative Asset or Derivative Liability and a MTM gain or loss in PampL
Allocated and Unallocated LHFS
Secondary Marketing Data
You must get this informationhellipbull Do you Believe the numbers
(Mandatory Commitment MTM off-setting LHFS excluded in example)
WH Committed not in TBA Hedge- Valued based on purchase priceWH Uncommitted is in TBA Hedge- Valued by hedge advisor
MTM JE
bull Reverse the prior month MTM
bull Post Pair-Off AP or ARbull Post current month MTM
bull Significant changes in volume can impact the PampL
bull If hedge was gain Derivative Asset
bull Confirm everything with your Auditorbull All external reports must be GAAP
Derivative Asset increases CapitalWe Create a Derivative Asset bybull DR Derivative Asset CR Income
bull What happens to IRLC Income ndash Becomes Capital
IMBs want more Capitalbull More IRLC means more Incomebull More Income means more Capitalbull More Capital means more Warehouse borrowingbull More Capital means qualifying for FHA amp Agencybull More IRLC means more Capital
Derivative Asset
Is Confusing to Business Ownersand leads to bad decisions
Capital Accounts with Derivative AssetThe Derivative Asset is not carried at Fair Value because the Derivative Asset cannot be sold for the carrying value
During 2018 several companies failed Capital = $2 million Derivative Asset = $2 million
The Owner did not understand why they were insolvent
Disclose the Impact of the Derivative Asset in Capital Accountsbull Common Stockbull Paid In Capitalbull Distributionsbull Retained Earnings (Move IRLC MTM impact from NI to Unrealized Gain)bull Unrealized Gain(Loss)
Thanks to Oystein Konsmo CFO at Nova Financial for implementing this practice
Derivative Asset Characteristics
What is the Locked Pipeline
bull IRLC is a lock commitments issued to borrowers bull They are ldquoApplications in Processrdquo bull IRLC are commitments ndash not Loans bull There is no active market for IRLCbull There is no Asset to basis adjust for MTM
bull Is a TBA-MBS tradeable in its current form YES
bull Is a IRLC tradeable in its current form NO
bull The IRLC must be Transformed into a loan then securitized to be valued as tradeable instrument
bull Transformational Costs are unavoidable and undeniable
bull IRLC is not pure derivative but is derivative under GAAP
bull Absorption Costing is a way to understand the basis for Transformational Costs = Work in Process but is it not perfect
bull I think MSR valuation of cash flow is a more accurate measure
Is an IRLC a Tradable Asset
How have CPAs Presented theDerivative Asset
INCONSISTANTLY
Derivative Asset vs Pipeline
Small Independent Large Public
Source ndash A Greer CPA
bull Warehouse Lenders Rely on CPA for GAAP Capitalbull Lenderrsquos Observe CPA Auditorshellip
ndash Overstate Capital with DAndash Under-apply Cost to Completendash Inconsistently apply Costs to Complete
bull Warehouse Lenders reduce Derivative Asset ndash Some arbitrarily reduce by 50ndash Some reduce based on Net Future Cash Flows
Warehouse Lenderrsquos Adjustment
What about GAAP
bull What does GAAP say about Transformation Costs
bull Direct Cost Deduction Method - direct costs only
bull Full Cost Absorption Method - direct and indirect costs
bull IRLC is a pure derivative - IRLC same as TBA-MBS
bull Net Future Cash Flow Valuation Method (discussed soon)
Transformation Costs or Cost to Completebull What is the value of the IRLC
bull Pull-thru adjusted MTM less Costs to Complete
bull What is the right amount of Transformation Costsbull Direct Cost Deduction Method - direct costs onlybull Full Cost Absorption Method - both direct and indirect costsbull IRLC is a pure derivative ndash no adjustment (IRLC = TBA-MBS)
bull Uncertainty Principalndash Exponential diminishing impact to closingndash You have it when you have it otherwise uncertainndash Day of Lock 99 uncertainty Day before closing 1 uncertainty
IMB Transformational Costs ndash Best PracticesDirect Expenses
bull LO commissions production commissionsbull Other Direct Production Costs
bull appraisals outsourcing courier credit reports other cosbull Other Direct Expenses
bull LO wages processors LOA bull underwriting funding disclosure and post closing
Indirect Expensesbull Allocated Production Rent Branch Rent Branch Overhead
Consequence of Ignoring Indirect Costs
Hawaii vs TexasHigh Balance vs Low Balance
Loan Size Matters
Loan Size Dynamics ndash One Loanbull ONE LOAN
bull High Balance low gainbull Low Balance high gain
bull Derivative Asset
bull Processing costs as of loan are different
bull Profit is same
Higher Gain
$50000000 Locked Pipeline
bull Texas lender is more than double Hawaii
bull Identical Cash Realization
bull Indirect Costs Matter
Direct Costs Only - Distort Results
Derivative Asset Value
View From Finance
Present Value of Net Future Cash Flow
Same as MSR
Derivative Asset OoopsMany CPAs firms have issued opinions on financial statements with derivative asset values I would challenge as not reasonable
Changing Presentation method now creates exposure to Opinion Risk
There is presently no consensus among CPA Auditors about how to apply GAAP
What is the Value of the IRLC - DA
Day of Lock Day Before Closing
High ProbabilityRevenue less Commission
Value is approaching Revenue
UnIncurred Costs Decrease as Percentage of Completion Increases
Low ProbabilityRevenue less all Costs
Value is approaching Zero
What is the value of an Intangible Asset
The Derivative Asset is an Intangible Asset
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
Objective is Recognition of Future Cash-Flows
PV of Discounted NET Future Cash-flows
Amortization Method or Fair Value MethodASC 860-50-35-9
IRLC under ASC 815An IRLC (Interest Rate Lock Commitment)
bull is an off balance sheet financial commitment bull subject to market risk and a bull derivative under SFAS 149 ASC 815 andbull subject MTM under SFAS 159 ASC 825
bull All IRLC are Derivatives (except for cost to complete)bull An IRLC hedged with Best Efforts is a derivativebull An IRLC hedged with a short MBS is a derivativebull The hedge strategy does not change the derivative
bull Derivatives under GAAPbull Recorded at Fair Value
bull Best Efforts Commitmentsbull Do not have a penalty for legitimate cancelationbull If loan is not closed the BE is canceled without costbull Avoidance of pair-off risk is not a derivative (most agree)bull Optional derivative under ASC 825-10-25
bull If IRLC is MTM and BE locks are not MTM bull Potential misrepresentation of gain positionbull Recommend all commitments are DerivativesMTM
ASC 815 ndash Hedge Accounting
The Interest Rate Lock Commitments ndash IRLC ndashbull IRLCs are initially issued to generate a profitbull The imbedded profit is valued at each reporting period bull The resulting gain is recorded as a Derivative Asset
bull It is very unlikely an IRLC will be a Derivative Liability
Hedge Positionbull TBA-MBS can generate a gain or loss
bull depending upon price movement since the date of salebull gain is reported as a Derivative Assetbull loss is reported as a Derivative Liability
+25 IRLCDerivative Asset Margin
Preservation
-50 TBADerivative Liability
+130 TBADerivative Asset
+70 IRLCDerivative Asset
Always consider loan gain with hedge gain or loss
Hedging Journal Entries
Warehouse bull The warehouse is comprised of two segments
ndash Committed or Allocated to Mandatory Commitmentndash Uncommitted or Hedged with Short TBA-MBS
bull The month-end MTM of the LHFS adjusts the basis of the LHFS creating a gain or loss in the PampL
Pipeline Hedgebull The month-end open TBA position MTM gain or loss is
posted to a Derivative Asset or Derivative Liability and a MTM gain or loss in PampL
Allocated and Unallocated LHFS
Secondary Marketing Data
You must get this informationhellipbull Do you Believe the numbers
(Mandatory Commitment MTM off-setting LHFS excluded in example)
WH Committed not in TBA Hedge- Valued based on purchase priceWH Uncommitted is in TBA Hedge- Valued by hedge advisor
MTM JE
bull Reverse the prior month MTM
bull Post Pair-Off AP or ARbull Post current month MTM
bull Significant changes in volume can impact the PampL
bull If hedge was gain Derivative Asset
bull Confirm everything with your Auditorbull All external reports must be GAAP
Derivative Asset increases CapitalWe Create a Derivative Asset bybull DR Derivative Asset CR Income
bull What happens to IRLC Income ndash Becomes Capital
IMBs want more Capitalbull More IRLC means more Incomebull More Income means more Capitalbull More Capital means more Warehouse borrowingbull More Capital means qualifying for FHA amp Agencybull More IRLC means more Capital
Derivative Asset
Is Confusing to Business Ownersand leads to bad decisions
Capital Accounts with Derivative AssetThe Derivative Asset is not carried at Fair Value because the Derivative Asset cannot be sold for the carrying value
During 2018 several companies failed Capital = $2 million Derivative Asset = $2 million
The Owner did not understand why they were insolvent
Disclose the Impact of the Derivative Asset in Capital Accountsbull Common Stockbull Paid In Capitalbull Distributionsbull Retained Earnings (Move IRLC MTM impact from NI to Unrealized Gain)bull Unrealized Gain(Loss)
Thanks to Oystein Konsmo CFO at Nova Financial for implementing this practice
Derivative Asset Characteristics
What is the Locked Pipeline
bull IRLC is a lock commitments issued to borrowers bull They are ldquoApplications in Processrdquo bull IRLC are commitments ndash not Loans bull There is no active market for IRLCbull There is no Asset to basis adjust for MTM
bull Is a TBA-MBS tradeable in its current form YES
bull Is a IRLC tradeable in its current form NO
bull The IRLC must be Transformed into a loan then securitized to be valued as tradeable instrument
bull Transformational Costs are unavoidable and undeniable
bull IRLC is not pure derivative but is derivative under GAAP
bull Absorption Costing is a way to understand the basis for Transformational Costs = Work in Process but is it not perfect
bull I think MSR valuation of cash flow is a more accurate measure
Is an IRLC a Tradable Asset
How have CPAs Presented theDerivative Asset
INCONSISTANTLY
Derivative Asset vs Pipeline
Small Independent Large Public
Source ndash A Greer CPA
bull Warehouse Lenders Rely on CPA for GAAP Capitalbull Lenderrsquos Observe CPA Auditorshellip
ndash Overstate Capital with DAndash Under-apply Cost to Completendash Inconsistently apply Costs to Complete
bull Warehouse Lenders reduce Derivative Asset ndash Some arbitrarily reduce by 50ndash Some reduce based on Net Future Cash Flows
Warehouse Lenderrsquos Adjustment
What about GAAP
bull What does GAAP say about Transformation Costs
bull Direct Cost Deduction Method - direct costs only
bull Full Cost Absorption Method - direct and indirect costs
bull IRLC is a pure derivative - IRLC same as TBA-MBS
bull Net Future Cash Flow Valuation Method (discussed soon)
Transformation Costs or Cost to Completebull What is the value of the IRLC
bull Pull-thru adjusted MTM less Costs to Complete
bull What is the right amount of Transformation Costsbull Direct Cost Deduction Method - direct costs onlybull Full Cost Absorption Method - both direct and indirect costsbull IRLC is a pure derivative ndash no adjustment (IRLC = TBA-MBS)
bull Uncertainty Principalndash Exponential diminishing impact to closingndash You have it when you have it otherwise uncertainndash Day of Lock 99 uncertainty Day before closing 1 uncertainty
IMB Transformational Costs ndash Best PracticesDirect Expenses
bull LO commissions production commissionsbull Other Direct Production Costs
bull appraisals outsourcing courier credit reports other cosbull Other Direct Expenses
bull LO wages processors LOA bull underwriting funding disclosure and post closing
Indirect Expensesbull Allocated Production Rent Branch Rent Branch Overhead
Consequence of Ignoring Indirect Costs
Hawaii vs TexasHigh Balance vs Low Balance
Loan Size Matters
Loan Size Dynamics ndash One Loanbull ONE LOAN
bull High Balance low gainbull Low Balance high gain
bull Derivative Asset
bull Processing costs as of loan are different
bull Profit is same
Higher Gain
$50000000 Locked Pipeline
bull Texas lender is more than double Hawaii
bull Identical Cash Realization
bull Indirect Costs Matter
Direct Costs Only - Distort Results
Derivative Asset Value
View From Finance
Present Value of Net Future Cash Flow
Same as MSR
Derivative Asset OoopsMany CPAs firms have issued opinions on financial statements with derivative asset values I would challenge as not reasonable
Changing Presentation method now creates exposure to Opinion Risk
There is presently no consensus among CPA Auditors about how to apply GAAP
What is the Value of the IRLC - DA
Day of Lock Day Before Closing
High ProbabilityRevenue less Commission
Value is approaching Revenue
UnIncurred Costs Decrease as Percentage of Completion Increases
Low ProbabilityRevenue less all Costs
Value is approaching Zero
What is the value of an Intangible Asset
The Derivative Asset is an Intangible Asset
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
Objective is Recognition of Future Cash-Flows
PV of Discounted NET Future Cash-flows
Amortization Method or Fair Value MethodASC 860-50-35-9
IRLC under ASC 815An IRLC (Interest Rate Lock Commitment)
bull is an off balance sheet financial commitment bull subject to market risk and a bull derivative under SFAS 149 ASC 815 andbull subject MTM under SFAS 159 ASC 825
bull All IRLC are Derivatives (except for cost to complete)bull An IRLC hedged with Best Efforts is a derivativebull An IRLC hedged with a short MBS is a derivativebull The hedge strategy does not change the derivative
bull Derivatives under GAAPbull Recorded at Fair Value
bull Best Efforts Commitmentsbull Do not have a penalty for legitimate cancelationbull If loan is not closed the BE is canceled without costbull Avoidance of pair-off risk is not a derivative (most agree)bull Optional derivative under ASC 825-10-25
bull If IRLC is MTM and BE locks are not MTM bull Potential misrepresentation of gain positionbull Recommend all commitments are DerivativesMTM
ASC 815 ndash Hedge Accounting
The Interest Rate Lock Commitments ndash IRLC ndashbull IRLCs are initially issued to generate a profitbull The imbedded profit is valued at each reporting period bull The resulting gain is recorded as a Derivative Asset
bull It is very unlikely an IRLC will be a Derivative Liability
Hedge Positionbull TBA-MBS can generate a gain or loss
bull depending upon price movement since the date of salebull gain is reported as a Derivative Assetbull loss is reported as a Derivative Liability
+25 IRLCDerivative Asset Margin
Preservation
-50 TBADerivative Liability
+130 TBADerivative Asset
+70 IRLCDerivative Asset
Always consider loan gain with hedge gain or loss
Hedging Journal Entries
Warehouse bull The warehouse is comprised of two segments
ndash Committed or Allocated to Mandatory Commitmentndash Uncommitted or Hedged with Short TBA-MBS
bull The month-end MTM of the LHFS adjusts the basis of the LHFS creating a gain or loss in the PampL
Pipeline Hedgebull The month-end open TBA position MTM gain or loss is
posted to a Derivative Asset or Derivative Liability and a MTM gain or loss in PampL
Allocated and Unallocated LHFS
Secondary Marketing Data
You must get this informationhellipbull Do you Believe the numbers
(Mandatory Commitment MTM off-setting LHFS excluded in example)
WH Committed not in TBA Hedge- Valued based on purchase priceWH Uncommitted is in TBA Hedge- Valued by hedge advisor
MTM JE
bull Reverse the prior month MTM
bull Post Pair-Off AP or ARbull Post current month MTM
bull Significant changes in volume can impact the PampL
bull If hedge was gain Derivative Asset
bull Confirm everything with your Auditorbull All external reports must be GAAP
Derivative Asset increases CapitalWe Create a Derivative Asset bybull DR Derivative Asset CR Income
bull What happens to IRLC Income ndash Becomes Capital
IMBs want more Capitalbull More IRLC means more Incomebull More Income means more Capitalbull More Capital means more Warehouse borrowingbull More Capital means qualifying for FHA amp Agencybull More IRLC means more Capital
Derivative Asset
Is Confusing to Business Ownersand leads to bad decisions
Capital Accounts with Derivative AssetThe Derivative Asset is not carried at Fair Value because the Derivative Asset cannot be sold for the carrying value
During 2018 several companies failed Capital = $2 million Derivative Asset = $2 million
The Owner did not understand why they were insolvent
Disclose the Impact of the Derivative Asset in Capital Accountsbull Common Stockbull Paid In Capitalbull Distributionsbull Retained Earnings (Move IRLC MTM impact from NI to Unrealized Gain)bull Unrealized Gain(Loss)
Thanks to Oystein Konsmo CFO at Nova Financial for implementing this practice
Derivative Asset Characteristics
What is the Locked Pipeline
bull IRLC is a lock commitments issued to borrowers bull They are ldquoApplications in Processrdquo bull IRLC are commitments ndash not Loans bull There is no active market for IRLCbull There is no Asset to basis adjust for MTM
bull Is a TBA-MBS tradeable in its current form YES
bull Is a IRLC tradeable in its current form NO
bull The IRLC must be Transformed into a loan then securitized to be valued as tradeable instrument
bull Transformational Costs are unavoidable and undeniable
bull IRLC is not pure derivative but is derivative under GAAP
bull Absorption Costing is a way to understand the basis for Transformational Costs = Work in Process but is it not perfect
bull I think MSR valuation of cash flow is a more accurate measure
Is an IRLC a Tradable Asset
How have CPAs Presented theDerivative Asset
INCONSISTANTLY
Derivative Asset vs Pipeline
Small Independent Large Public
Source ndash A Greer CPA
bull Warehouse Lenders Rely on CPA for GAAP Capitalbull Lenderrsquos Observe CPA Auditorshellip
ndash Overstate Capital with DAndash Under-apply Cost to Completendash Inconsistently apply Costs to Complete
bull Warehouse Lenders reduce Derivative Asset ndash Some arbitrarily reduce by 50ndash Some reduce based on Net Future Cash Flows
Warehouse Lenderrsquos Adjustment
What about GAAP
bull What does GAAP say about Transformation Costs
bull Direct Cost Deduction Method - direct costs only
bull Full Cost Absorption Method - direct and indirect costs
bull IRLC is a pure derivative - IRLC same as TBA-MBS
bull Net Future Cash Flow Valuation Method (discussed soon)
Transformation Costs or Cost to Completebull What is the value of the IRLC
bull Pull-thru adjusted MTM less Costs to Complete
bull What is the right amount of Transformation Costsbull Direct Cost Deduction Method - direct costs onlybull Full Cost Absorption Method - both direct and indirect costsbull IRLC is a pure derivative ndash no adjustment (IRLC = TBA-MBS)
bull Uncertainty Principalndash Exponential diminishing impact to closingndash You have it when you have it otherwise uncertainndash Day of Lock 99 uncertainty Day before closing 1 uncertainty
IMB Transformational Costs ndash Best PracticesDirect Expenses
bull LO commissions production commissionsbull Other Direct Production Costs
bull appraisals outsourcing courier credit reports other cosbull Other Direct Expenses
bull LO wages processors LOA bull underwriting funding disclosure and post closing
Indirect Expensesbull Allocated Production Rent Branch Rent Branch Overhead
Consequence of Ignoring Indirect Costs
Hawaii vs TexasHigh Balance vs Low Balance
Loan Size Matters
Loan Size Dynamics ndash One Loanbull ONE LOAN
bull High Balance low gainbull Low Balance high gain
bull Derivative Asset
bull Processing costs as of loan are different
bull Profit is same
Higher Gain
$50000000 Locked Pipeline
bull Texas lender is more than double Hawaii
bull Identical Cash Realization
bull Indirect Costs Matter
Direct Costs Only - Distort Results
Derivative Asset Value
View From Finance
Present Value of Net Future Cash Flow
Same as MSR
Derivative Asset OoopsMany CPAs firms have issued opinions on financial statements with derivative asset values I would challenge as not reasonable
Changing Presentation method now creates exposure to Opinion Risk
There is presently no consensus among CPA Auditors about how to apply GAAP
What is the Value of the IRLC - DA
Day of Lock Day Before Closing
High ProbabilityRevenue less Commission
Value is approaching Revenue
UnIncurred Costs Decrease as Percentage of Completion Increases
Low ProbabilityRevenue less all Costs
Value is approaching Zero
What is the value of an Intangible Asset
The Derivative Asset is an Intangible Asset
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
Objective is Recognition of Future Cash-Flows
PV of Discounted NET Future Cash-flows
Amortization Method or Fair Value MethodASC 860-50-35-9
IRLC under ASC 815An IRLC (Interest Rate Lock Commitment)
bull is an off balance sheet financial commitment bull subject to market risk and a bull derivative under SFAS 149 ASC 815 andbull subject MTM under SFAS 159 ASC 825
bull All IRLC are Derivatives (except for cost to complete)bull An IRLC hedged with Best Efforts is a derivativebull An IRLC hedged with a short MBS is a derivativebull The hedge strategy does not change the derivative
bull Derivatives under GAAPbull Recorded at Fair Value
bull Best Efforts Commitmentsbull Do not have a penalty for legitimate cancelationbull If loan is not closed the BE is canceled without costbull Avoidance of pair-off risk is not a derivative (most agree)bull Optional derivative under ASC 825-10-25
bull If IRLC is MTM and BE locks are not MTM bull Potential misrepresentation of gain positionbull Recommend all commitments are DerivativesMTM
ASC 815 ndash Hedge Accounting
The Interest Rate Lock Commitments ndash IRLC ndashbull IRLCs are initially issued to generate a profitbull The imbedded profit is valued at each reporting period bull The resulting gain is recorded as a Derivative Asset
bull It is very unlikely an IRLC will be a Derivative Liability
Hedge Positionbull TBA-MBS can generate a gain or loss
bull depending upon price movement since the date of salebull gain is reported as a Derivative Assetbull loss is reported as a Derivative Liability
+25 IRLCDerivative Asset Margin
Preservation
-50 TBADerivative Liability
+130 TBADerivative Asset
+70 IRLCDerivative Asset
Always consider loan gain with hedge gain or loss
Hedging Journal Entries
Warehouse bull The warehouse is comprised of two segments
ndash Committed or Allocated to Mandatory Commitmentndash Uncommitted or Hedged with Short TBA-MBS
bull The month-end MTM of the LHFS adjusts the basis of the LHFS creating a gain or loss in the PampL
Pipeline Hedgebull The month-end open TBA position MTM gain or loss is
posted to a Derivative Asset or Derivative Liability and a MTM gain or loss in PampL
Allocated and Unallocated LHFS
Secondary Marketing Data
You must get this informationhellipbull Do you Believe the numbers
(Mandatory Commitment MTM off-setting LHFS excluded in example)
WH Committed not in TBA Hedge- Valued based on purchase priceWH Uncommitted is in TBA Hedge- Valued by hedge advisor
MTM JE
bull Reverse the prior month MTM
bull Post Pair-Off AP or ARbull Post current month MTM
bull Significant changes in volume can impact the PampL
bull If hedge was gain Derivative Asset
bull Confirm everything with your Auditorbull All external reports must be GAAP
Derivative Asset increases CapitalWe Create a Derivative Asset bybull DR Derivative Asset CR Income
bull What happens to IRLC Income ndash Becomes Capital
IMBs want more Capitalbull More IRLC means more Incomebull More Income means more Capitalbull More Capital means more Warehouse borrowingbull More Capital means qualifying for FHA amp Agencybull More IRLC means more Capital
Derivative Asset
Is Confusing to Business Ownersand leads to bad decisions
Capital Accounts with Derivative AssetThe Derivative Asset is not carried at Fair Value because the Derivative Asset cannot be sold for the carrying value
During 2018 several companies failed Capital = $2 million Derivative Asset = $2 million
The Owner did not understand why they were insolvent
Disclose the Impact of the Derivative Asset in Capital Accountsbull Common Stockbull Paid In Capitalbull Distributionsbull Retained Earnings (Move IRLC MTM impact from NI to Unrealized Gain)bull Unrealized Gain(Loss)
Thanks to Oystein Konsmo CFO at Nova Financial for implementing this practice
Derivative Asset Characteristics
What is the Locked Pipeline
bull IRLC is a lock commitments issued to borrowers bull They are ldquoApplications in Processrdquo bull IRLC are commitments ndash not Loans bull There is no active market for IRLCbull There is no Asset to basis adjust for MTM
bull Is a TBA-MBS tradeable in its current form YES
bull Is a IRLC tradeable in its current form NO
bull The IRLC must be Transformed into a loan then securitized to be valued as tradeable instrument
bull Transformational Costs are unavoidable and undeniable
bull IRLC is not pure derivative but is derivative under GAAP
bull Absorption Costing is a way to understand the basis for Transformational Costs = Work in Process but is it not perfect
bull I think MSR valuation of cash flow is a more accurate measure
Is an IRLC a Tradable Asset
How have CPAs Presented theDerivative Asset
INCONSISTANTLY
Derivative Asset vs Pipeline
Small Independent Large Public
Source ndash A Greer CPA
bull Warehouse Lenders Rely on CPA for GAAP Capitalbull Lenderrsquos Observe CPA Auditorshellip
ndash Overstate Capital with DAndash Under-apply Cost to Completendash Inconsistently apply Costs to Complete
bull Warehouse Lenders reduce Derivative Asset ndash Some arbitrarily reduce by 50ndash Some reduce based on Net Future Cash Flows
Warehouse Lenderrsquos Adjustment
What about GAAP
bull What does GAAP say about Transformation Costs
bull Direct Cost Deduction Method - direct costs only
bull Full Cost Absorption Method - direct and indirect costs
bull IRLC is a pure derivative - IRLC same as TBA-MBS
bull Net Future Cash Flow Valuation Method (discussed soon)
Transformation Costs or Cost to Completebull What is the value of the IRLC
bull Pull-thru adjusted MTM less Costs to Complete
bull What is the right amount of Transformation Costsbull Direct Cost Deduction Method - direct costs onlybull Full Cost Absorption Method - both direct and indirect costsbull IRLC is a pure derivative ndash no adjustment (IRLC = TBA-MBS)
bull Uncertainty Principalndash Exponential diminishing impact to closingndash You have it when you have it otherwise uncertainndash Day of Lock 99 uncertainty Day before closing 1 uncertainty
IMB Transformational Costs ndash Best PracticesDirect Expenses
bull LO commissions production commissionsbull Other Direct Production Costs
bull appraisals outsourcing courier credit reports other cosbull Other Direct Expenses
bull LO wages processors LOA bull underwriting funding disclosure and post closing
Indirect Expensesbull Allocated Production Rent Branch Rent Branch Overhead
Consequence of Ignoring Indirect Costs
Hawaii vs TexasHigh Balance vs Low Balance
Loan Size Matters
Loan Size Dynamics ndash One Loanbull ONE LOAN
bull High Balance low gainbull Low Balance high gain
bull Derivative Asset
bull Processing costs as of loan are different
bull Profit is same
Higher Gain
$50000000 Locked Pipeline
bull Texas lender is more than double Hawaii
bull Identical Cash Realization
bull Indirect Costs Matter
Direct Costs Only - Distort Results
Derivative Asset Value
View From Finance
Present Value of Net Future Cash Flow
Same as MSR
Derivative Asset OoopsMany CPAs firms have issued opinions on financial statements with derivative asset values I would challenge as not reasonable
Changing Presentation method now creates exposure to Opinion Risk
There is presently no consensus among CPA Auditors about how to apply GAAP
What is the Value of the IRLC - DA
Day of Lock Day Before Closing
High ProbabilityRevenue less Commission
Value is approaching Revenue
UnIncurred Costs Decrease as Percentage of Completion Increases
Low ProbabilityRevenue less all Costs
Value is approaching Zero
What is the value of an Intangible Asset
The Derivative Asset is an Intangible Asset
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
Objective is Recognition of Future Cash-Flows
PV of Discounted NET Future Cash-flows
Amortization Method or Fair Value MethodASC 860-50-35-9
IRLC under ASC 815An IRLC (Interest Rate Lock Commitment)
bull is an off balance sheet financial commitment bull subject to market risk and a bull derivative under SFAS 149 ASC 815 andbull subject MTM under SFAS 159 ASC 825
bull All IRLC are Derivatives (except for cost to complete)bull An IRLC hedged with Best Efforts is a derivativebull An IRLC hedged with a short MBS is a derivativebull The hedge strategy does not change the derivative
bull Derivatives under GAAPbull Recorded at Fair Value
bull Best Efforts Commitmentsbull Do not have a penalty for legitimate cancelationbull If loan is not closed the BE is canceled without costbull Avoidance of pair-off risk is not a derivative (most agree)bull Optional derivative under ASC 825-10-25
bull If IRLC is MTM and BE locks are not MTM bull Potential misrepresentation of gain positionbull Recommend all commitments are DerivativesMTM
ASC 815 ndash Hedge Accounting
The Interest Rate Lock Commitments ndash IRLC ndashbull IRLCs are initially issued to generate a profitbull The imbedded profit is valued at each reporting period bull The resulting gain is recorded as a Derivative Asset
bull It is very unlikely an IRLC will be a Derivative Liability
Hedge Positionbull TBA-MBS can generate a gain or loss
bull depending upon price movement since the date of salebull gain is reported as a Derivative Assetbull loss is reported as a Derivative Liability
+25 IRLCDerivative Asset Margin
Preservation
-50 TBADerivative Liability
+130 TBADerivative Asset
+70 IRLCDerivative Asset
Always consider loan gain with hedge gain or loss
Hedging Journal Entries
Warehouse bull The warehouse is comprised of two segments
ndash Committed or Allocated to Mandatory Commitmentndash Uncommitted or Hedged with Short TBA-MBS
bull The month-end MTM of the LHFS adjusts the basis of the LHFS creating a gain or loss in the PampL
Pipeline Hedgebull The month-end open TBA position MTM gain or loss is
posted to a Derivative Asset or Derivative Liability and a MTM gain or loss in PampL
Allocated and Unallocated LHFS
Secondary Marketing Data
You must get this informationhellipbull Do you Believe the numbers
(Mandatory Commitment MTM off-setting LHFS excluded in example)
WH Committed not in TBA Hedge- Valued based on purchase priceWH Uncommitted is in TBA Hedge- Valued by hedge advisor
MTM JE
bull Reverse the prior month MTM
bull Post Pair-Off AP or ARbull Post current month MTM
bull Significant changes in volume can impact the PampL
bull If hedge was gain Derivative Asset
bull Confirm everything with your Auditorbull All external reports must be GAAP
Derivative Asset increases CapitalWe Create a Derivative Asset bybull DR Derivative Asset CR Income
bull What happens to IRLC Income ndash Becomes Capital
IMBs want more Capitalbull More IRLC means more Incomebull More Income means more Capitalbull More Capital means more Warehouse borrowingbull More Capital means qualifying for FHA amp Agencybull More IRLC means more Capital
Derivative Asset
Is Confusing to Business Ownersand leads to bad decisions
Capital Accounts with Derivative AssetThe Derivative Asset is not carried at Fair Value because the Derivative Asset cannot be sold for the carrying value
During 2018 several companies failed Capital = $2 million Derivative Asset = $2 million
The Owner did not understand why they were insolvent
Disclose the Impact of the Derivative Asset in Capital Accountsbull Common Stockbull Paid In Capitalbull Distributionsbull Retained Earnings (Move IRLC MTM impact from NI to Unrealized Gain)bull Unrealized Gain(Loss)
Thanks to Oystein Konsmo CFO at Nova Financial for implementing this practice
Derivative Asset Characteristics
What is the Locked Pipeline
bull IRLC is a lock commitments issued to borrowers bull They are ldquoApplications in Processrdquo bull IRLC are commitments ndash not Loans bull There is no active market for IRLCbull There is no Asset to basis adjust for MTM
bull Is a TBA-MBS tradeable in its current form YES
bull Is a IRLC tradeable in its current form NO
bull The IRLC must be Transformed into a loan then securitized to be valued as tradeable instrument
bull Transformational Costs are unavoidable and undeniable
bull IRLC is not pure derivative but is derivative under GAAP
bull Absorption Costing is a way to understand the basis for Transformational Costs = Work in Process but is it not perfect
bull I think MSR valuation of cash flow is a more accurate measure
Is an IRLC a Tradable Asset
How have CPAs Presented theDerivative Asset
INCONSISTANTLY
Derivative Asset vs Pipeline
Small Independent Large Public
Source ndash A Greer CPA
bull Warehouse Lenders Rely on CPA for GAAP Capitalbull Lenderrsquos Observe CPA Auditorshellip
ndash Overstate Capital with DAndash Under-apply Cost to Completendash Inconsistently apply Costs to Complete
bull Warehouse Lenders reduce Derivative Asset ndash Some arbitrarily reduce by 50ndash Some reduce based on Net Future Cash Flows
Warehouse Lenderrsquos Adjustment
What about GAAP
bull What does GAAP say about Transformation Costs
bull Direct Cost Deduction Method - direct costs only
bull Full Cost Absorption Method - direct and indirect costs
bull IRLC is a pure derivative - IRLC same as TBA-MBS
bull Net Future Cash Flow Valuation Method (discussed soon)
Transformation Costs or Cost to Completebull What is the value of the IRLC
bull Pull-thru adjusted MTM less Costs to Complete
bull What is the right amount of Transformation Costsbull Direct Cost Deduction Method - direct costs onlybull Full Cost Absorption Method - both direct and indirect costsbull IRLC is a pure derivative ndash no adjustment (IRLC = TBA-MBS)
bull Uncertainty Principalndash Exponential diminishing impact to closingndash You have it when you have it otherwise uncertainndash Day of Lock 99 uncertainty Day before closing 1 uncertainty
IMB Transformational Costs ndash Best PracticesDirect Expenses
bull LO commissions production commissionsbull Other Direct Production Costs
bull appraisals outsourcing courier credit reports other cosbull Other Direct Expenses
bull LO wages processors LOA bull underwriting funding disclosure and post closing
Indirect Expensesbull Allocated Production Rent Branch Rent Branch Overhead
Consequence of Ignoring Indirect Costs
Hawaii vs TexasHigh Balance vs Low Balance
Loan Size Matters
Loan Size Dynamics ndash One Loanbull ONE LOAN
bull High Balance low gainbull Low Balance high gain
bull Derivative Asset
bull Processing costs as of loan are different
bull Profit is same
Higher Gain
$50000000 Locked Pipeline
bull Texas lender is more than double Hawaii
bull Identical Cash Realization
bull Indirect Costs Matter
Direct Costs Only - Distort Results
Derivative Asset Value
View From Finance
Present Value of Net Future Cash Flow
Same as MSR
Derivative Asset OoopsMany CPAs firms have issued opinions on financial statements with derivative asset values I would challenge as not reasonable
Changing Presentation method now creates exposure to Opinion Risk
There is presently no consensus among CPA Auditors about how to apply GAAP
What is the Value of the IRLC - DA
Day of Lock Day Before Closing
High ProbabilityRevenue less Commission
Value is approaching Revenue
UnIncurred Costs Decrease as Percentage of Completion Increases
Low ProbabilityRevenue less all Costs
Value is approaching Zero
What is the value of an Intangible Asset
The Derivative Asset is an Intangible Asset
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
IRLC under ASC 815
ASC 815 ndash Commitments
ASC 815 ndash Hedge Accounting
Slide Number 41
Slide Number 42
Slide Number 43
Slide Number 44
Slide Number 45
Slide Number 46
Slide Number 47
Derivative Asset increases Capital
Slide Number 49
Slide Number 50
Slide Number 51
What is the Locked Pipeline
Slide Number 53
Slide Number 54
Slide Number 55
Slide Number 56
What about GAAP
Transformation Costs or Cost to Complete
IMB Transformational Costs ndash Best Practices
Slide Number 60
Slide Number 61
Slide Number 62
Slide Number 63
Derivative Asset Ooops
What is the Value of the IRLC - DA
Slide Number 66
AICPA Valuation Services
AICPA - Discounted Future Benefit
Hedging Data for DA Valuation
Percentage of Completion by Status
Net Cash Flow Valuation Data
IRLC-DA Grows in Value as Costs Incurred
Lock to LHFS DA Value Accretion
Revenue Potential vs Derivative Asset
GAAP Methods Only Right Once
Slide Number 76
IRLC Value is What You Negotiate
Slide Number 78
Slide Number 79
FASB Board Meeting ndash 32818
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
Slide Number 83
IRLC is Taxable when Recorded - BUT
Slide Number 85
Slide Number 86
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
PampL - with and without IRLC
IRLC Revenue is Confusing
Slide Number 91
Slide Number 92
Slide Number 93
Slide Number 94
Slide Number 95
Slide Number 96
Balance Sheet or Commitment
Gain or (Loss)
Warehouse - committed
$1000000000
$10000000
(1)
Pair-Off trades - closed not settled
($800000)
(2)
Locked Pipeline (net of pull-thru)
$3000000000
$30000000
(3)
Warehouse ndash not committed
$45000000
$450000
(4)
Hedge
$2700000000
($27000000)
(5)
Balance Sheet amp Income Statement Accounts
Assets
Cash
$1000000
Loans Held for Sale
$10000000
Loans Held for Sale
$450000
Loans Held for Sale
$100000
(1)
Loans Held for Sale
$4500
(4)
AR Loan Sales (not GAAP)
AR Pair Off
Derivative Asset (MTM gains)
$300000
(3)
Liabilities
Warehouse loan
$10000000
AP Commission
AP Pair-Off
$8000
(2)
Borrower Escrow
$450000
Derivative Liability (MTM losses)
$270000
(5)
Capital
MTM valuation
Retained Earning
$1000000
Revenue
MTM Gain or Loss (gain)
$100000
(1)
MTM Gain or Loss (gain)
$300000
(3)
MTM Gain or Loss (gain)
$4500
(4)
Expense
Pair-Off Gain or Loss (loss)
$8000
(2)
MTM Gain or Loss (loss)
$270000
(5)
$12132500
$12132500
Journal Entries
Warehouse Loans with Purchase Commitment (value based on purchase commitment)
If gain
Debit Loans Held For Sale
$10000000
Credit MTM Gain or Loss
$10000000
If loss
Debit MTM Gain of Loss
$10000000
Credit Loans Held For Sale
$10000000
Pair-Offs (value based on closed trade)
If gain
Debit Pair-Off Receivable
$800000
Credit Pair-Off Gain or Loss
$800000
If loss
Debit Pair-Off Gain or Loss
$800000
Credit Pair-Off Payable
$800000
Warehouse Loans without Purchase Commitment MTM (value at month-end)
If gain
Debit Loans Held for Sale
$450000
Credit MTM Gain or Loss^
$450000
If loss
Debit MTM Gain or Loss^
$450000
Credit Loans Held for Sale
$450000
Locked Pipeline MTM (pull-thru adjusted)
If gain
Debit Derivative Asset
$30000000
Credit MTM Gain or Loss^
$30000000
If loss
Debit MTM Gain or Loss^
$30000000
Credit Derivative Liability
$30000000
Hedge MTM
If gain
Debit Derivative Asset
$27000000
Credit MTM Gain or Loss^
$27000000
If loss
Debit MTM Gain or Loss^
$27000000
Credit Derivative Liability
$27000000
or Gain on Sale for mgmt reporting (not GAAP)
^ or MTM valuation in Capital for mgmt reporting (not GAAP)
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
Objective is Recognition of Future Cash-Flows
PV of Discounted NET Future Cash-flows
Amortization Method or Fair Value MethodASC 860-50-35-9
IRLC under ASC 815An IRLC (Interest Rate Lock Commitment)
bull is an off balance sheet financial commitment bull subject to market risk and a bull derivative under SFAS 149 ASC 815 andbull subject MTM under SFAS 159 ASC 825
bull All IRLC are Derivatives (except for cost to complete)bull An IRLC hedged with Best Efforts is a derivativebull An IRLC hedged with a short MBS is a derivativebull The hedge strategy does not change the derivative
bull Derivatives under GAAPbull Recorded at Fair Value
bull Best Efforts Commitmentsbull Do not have a penalty for legitimate cancelationbull If loan is not closed the BE is canceled without costbull Avoidance of pair-off risk is not a derivative (most agree)bull Optional derivative under ASC 825-10-25
bull If IRLC is MTM and BE locks are not MTM bull Potential misrepresentation of gain positionbull Recommend all commitments are DerivativesMTM
ASC 815 ndash Hedge Accounting
The Interest Rate Lock Commitments ndash IRLC ndashbull IRLCs are initially issued to generate a profitbull The imbedded profit is valued at each reporting period bull The resulting gain is recorded as a Derivative Asset
bull It is very unlikely an IRLC will be a Derivative Liability
Hedge Positionbull TBA-MBS can generate a gain or loss
bull depending upon price movement since the date of salebull gain is reported as a Derivative Assetbull loss is reported as a Derivative Liability
+25 IRLCDerivative Asset Margin
Preservation
-50 TBADerivative Liability
+130 TBADerivative Asset
+70 IRLCDerivative Asset
Always consider loan gain with hedge gain or loss
Hedging Journal Entries
Warehouse bull The warehouse is comprised of two segments
ndash Committed or Allocated to Mandatory Commitmentndash Uncommitted or Hedged with Short TBA-MBS
bull The month-end MTM of the LHFS adjusts the basis of the LHFS creating a gain or loss in the PampL
Pipeline Hedgebull The month-end open TBA position MTM gain or loss is
posted to a Derivative Asset or Derivative Liability and a MTM gain or loss in PampL
Allocated and Unallocated LHFS
Secondary Marketing Data
You must get this informationhellipbull Do you Believe the numbers
(Mandatory Commitment MTM off-setting LHFS excluded in example)
WH Committed not in TBA Hedge- Valued based on purchase priceWH Uncommitted is in TBA Hedge- Valued by hedge advisor
MTM JE
bull Reverse the prior month MTM
bull Post Pair-Off AP or ARbull Post current month MTM
bull Significant changes in volume can impact the PampL
bull If hedge was gain Derivative Asset
bull Confirm everything with your Auditorbull All external reports must be GAAP
Derivative Asset increases CapitalWe Create a Derivative Asset bybull DR Derivative Asset CR Income
bull What happens to IRLC Income ndash Becomes Capital
IMBs want more Capitalbull More IRLC means more Incomebull More Income means more Capitalbull More Capital means more Warehouse borrowingbull More Capital means qualifying for FHA amp Agencybull More IRLC means more Capital
Derivative Asset
Is Confusing to Business Ownersand leads to bad decisions
Capital Accounts with Derivative AssetThe Derivative Asset is not carried at Fair Value because the Derivative Asset cannot be sold for the carrying value
During 2018 several companies failed Capital = $2 million Derivative Asset = $2 million
The Owner did not understand why they were insolvent
Disclose the Impact of the Derivative Asset in Capital Accountsbull Common Stockbull Paid In Capitalbull Distributionsbull Retained Earnings (Move IRLC MTM impact from NI to Unrealized Gain)bull Unrealized Gain(Loss)
Thanks to Oystein Konsmo CFO at Nova Financial for implementing this practice
Derivative Asset Characteristics
What is the Locked Pipeline
bull IRLC is a lock commitments issued to borrowers bull They are ldquoApplications in Processrdquo bull IRLC are commitments ndash not Loans bull There is no active market for IRLCbull There is no Asset to basis adjust for MTM
bull Is a TBA-MBS tradeable in its current form YES
bull Is a IRLC tradeable in its current form NO
bull The IRLC must be Transformed into a loan then securitized to be valued as tradeable instrument
bull Transformational Costs are unavoidable and undeniable
bull IRLC is not pure derivative but is derivative under GAAP
bull Absorption Costing is a way to understand the basis for Transformational Costs = Work in Process but is it not perfect
bull I think MSR valuation of cash flow is a more accurate measure
Is an IRLC a Tradable Asset
How have CPAs Presented theDerivative Asset
INCONSISTANTLY
Derivative Asset vs Pipeline
Small Independent Large Public
Source ndash A Greer CPA
bull Warehouse Lenders Rely on CPA for GAAP Capitalbull Lenderrsquos Observe CPA Auditorshellip
ndash Overstate Capital with DAndash Under-apply Cost to Completendash Inconsistently apply Costs to Complete
bull Warehouse Lenders reduce Derivative Asset ndash Some arbitrarily reduce by 50ndash Some reduce based on Net Future Cash Flows
Warehouse Lenderrsquos Adjustment
What about GAAP
bull What does GAAP say about Transformation Costs
bull Direct Cost Deduction Method - direct costs only
bull Full Cost Absorption Method - direct and indirect costs
bull IRLC is a pure derivative - IRLC same as TBA-MBS
bull Net Future Cash Flow Valuation Method (discussed soon)
Transformation Costs or Cost to Completebull What is the value of the IRLC
bull Pull-thru adjusted MTM less Costs to Complete
bull What is the right amount of Transformation Costsbull Direct Cost Deduction Method - direct costs onlybull Full Cost Absorption Method - both direct and indirect costsbull IRLC is a pure derivative ndash no adjustment (IRLC = TBA-MBS)
bull Uncertainty Principalndash Exponential diminishing impact to closingndash You have it when you have it otherwise uncertainndash Day of Lock 99 uncertainty Day before closing 1 uncertainty
IMB Transformational Costs ndash Best PracticesDirect Expenses
bull LO commissions production commissionsbull Other Direct Production Costs
bull appraisals outsourcing courier credit reports other cosbull Other Direct Expenses
bull LO wages processors LOA bull underwriting funding disclosure and post closing
Indirect Expensesbull Allocated Production Rent Branch Rent Branch Overhead
Consequence of Ignoring Indirect Costs
Hawaii vs TexasHigh Balance vs Low Balance
Loan Size Matters
Loan Size Dynamics ndash One Loanbull ONE LOAN
bull High Balance low gainbull Low Balance high gain
bull Derivative Asset
bull Processing costs as of loan are different
bull Profit is same
Higher Gain
$50000000 Locked Pipeline
bull Texas lender is more than double Hawaii
bull Identical Cash Realization
bull Indirect Costs Matter
Direct Costs Only - Distort Results
Derivative Asset Value
View From Finance
Present Value of Net Future Cash Flow
Same as MSR
Derivative Asset OoopsMany CPAs firms have issued opinions on financial statements with derivative asset values I would challenge as not reasonable
Changing Presentation method now creates exposure to Opinion Risk
There is presently no consensus among CPA Auditors about how to apply GAAP
What is the Value of the IRLC - DA
Day of Lock Day Before Closing
High ProbabilityRevenue less Commission
Value is approaching Revenue
UnIncurred Costs Decrease as Percentage of Completion Increases
Low ProbabilityRevenue less all Costs
Value is approaching Zero
What is the value of an Intangible Asset
The Derivative Asset is an Intangible Asset
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
IRLC under ASC 815
ASC 815 ndash Commitments
ASC 815 ndash Hedge Accounting
Slide Number 41
Slide Number 42
Slide Number 43
Slide Number 44
Slide Number 45
Slide Number 46
Slide Number 47
Derivative Asset increases Capital
Slide Number 49
Slide Number 50
Slide Number 51
What is the Locked Pipeline
Slide Number 53
Slide Number 54
Slide Number 55
Slide Number 56
What about GAAP
Transformation Costs or Cost to Complete
IMB Transformational Costs ndash Best Practices
Slide Number 60
Slide Number 61
Slide Number 62
Slide Number 63
Derivative Asset Ooops
What is the Value of the IRLC - DA
Slide Number 66
AICPA Valuation Services
AICPA - Discounted Future Benefit
Hedging Data for DA Valuation
Percentage of Completion by Status
Net Cash Flow Valuation Data
IRLC-DA Grows in Value as Costs Incurred
Lock to LHFS DA Value Accretion
Revenue Potential vs Derivative Asset
GAAP Methods Only Right Once
Slide Number 76
IRLC Value is What You Negotiate
Slide Number 78
Slide Number 79
FASB Board Meeting ndash 32818
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
Slide Number 83
IRLC is Taxable when Recorded - BUT
Slide Number 85
Slide Number 86
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
PampL - with and without IRLC
IRLC Revenue is Confusing
Slide Number 91
Slide Number 92
Slide Number 93
Slide Number 94
Slide Number 95
Slide Number 96
Balance Sheet or Commitment
Gain or (Loss)
Warehouse - committed
$1000000000
$10000000
(1)
Pair-Off trades - closed not settled
($800000)
(2)
Locked Pipeline (net of pull-thru)
$3000000000
$30000000
(3)
Warehouse ndash not committed
$45000000
$450000
(4)
Hedge
$2700000000
($27000000)
(5)
Balance Sheet amp Income Statement Accounts
Assets
Cash
$1000000
Loans Held for Sale
$10000000
Loans Held for Sale
$450000
Loans Held for Sale
$100000
(1)
Loans Held for Sale
$4500
(4)
AR Loan Sales (not GAAP)
AR Pair Off
Derivative Asset (MTM gains)
$300000
(3)
Liabilities
Warehouse loan
$10000000
AP Commission
AP Pair-Off
$8000
(2)
Borrower Escrow
$450000
Derivative Liability (MTM losses)
$270000
(5)
Capital
MTM valuation
Retained Earning
$1000000
Revenue
MTM Gain or Loss (gain)
$100000
(1)
MTM Gain or Loss (gain)
$300000
(3)
MTM Gain or Loss (gain)
$4500
(4)
Expense
Pair-Off Gain or Loss (loss)
$8000
(2)
MTM Gain or Loss (loss)
$270000
(5)
$12132500
$12132500
Journal Entries
Warehouse Loans with Purchase Commitment (value based on purchase commitment)
If gain
Debit Loans Held For Sale
$10000000
Credit MTM Gain or Loss
$10000000
If loss
Debit MTM Gain of Loss
$10000000
Credit Loans Held For Sale
$10000000
Pair-Offs (value based on closed trade)
If gain
Debit Pair-Off Receivable
$800000
Credit Pair-Off Gain or Loss
$800000
If loss
Debit Pair-Off Gain or Loss
$800000
Credit Pair-Off Payable
$800000
Warehouse Loans without Purchase Commitment MTM (value at month-end)
If gain
Debit Loans Held for Sale
$450000
Credit MTM Gain or Loss^
$450000
If loss
Debit MTM Gain or Loss^
$450000
Credit Loans Held for Sale
$450000
Locked Pipeline MTM (pull-thru adjusted)
If gain
Debit Derivative Asset
$30000000
Credit MTM Gain or Loss^
$30000000
If loss
Debit MTM Gain or Loss^
$30000000
Credit Derivative Liability
$30000000
Hedge MTM
If gain
Debit Derivative Asset
$27000000
Credit MTM Gain or Loss^
$27000000
If loss
Debit MTM Gain or Loss^
$27000000
Credit Derivative Liability
$27000000
or Gain on Sale for mgmt reporting (not GAAP)
^ or MTM valuation in Capital for mgmt reporting (not GAAP)
IRLC under ASC 815An IRLC (Interest Rate Lock Commitment)
bull is an off balance sheet financial commitment bull subject to market risk and a bull derivative under SFAS 149 ASC 815 andbull subject MTM under SFAS 159 ASC 825
bull All IRLC are Derivatives (except for cost to complete)bull An IRLC hedged with Best Efforts is a derivativebull An IRLC hedged with a short MBS is a derivativebull The hedge strategy does not change the derivative
bull Derivatives under GAAPbull Recorded at Fair Value
bull Best Efforts Commitmentsbull Do not have a penalty for legitimate cancelationbull If loan is not closed the BE is canceled without costbull Avoidance of pair-off risk is not a derivative (most agree)bull Optional derivative under ASC 825-10-25
bull If IRLC is MTM and BE locks are not MTM bull Potential misrepresentation of gain positionbull Recommend all commitments are DerivativesMTM
ASC 815 ndash Hedge Accounting
The Interest Rate Lock Commitments ndash IRLC ndashbull IRLCs are initially issued to generate a profitbull The imbedded profit is valued at each reporting period bull The resulting gain is recorded as a Derivative Asset
bull It is very unlikely an IRLC will be a Derivative Liability
Hedge Positionbull TBA-MBS can generate a gain or loss
bull depending upon price movement since the date of salebull gain is reported as a Derivative Assetbull loss is reported as a Derivative Liability
+25 IRLCDerivative Asset Margin
Preservation
-50 TBADerivative Liability
+130 TBADerivative Asset
+70 IRLCDerivative Asset
Always consider loan gain with hedge gain or loss
Hedging Journal Entries
Warehouse bull The warehouse is comprised of two segments
ndash Committed or Allocated to Mandatory Commitmentndash Uncommitted or Hedged with Short TBA-MBS
bull The month-end MTM of the LHFS adjusts the basis of the LHFS creating a gain or loss in the PampL
Pipeline Hedgebull The month-end open TBA position MTM gain or loss is
posted to a Derivative Asset or Derivative Liability and a MTM gain or loss in PampL
Allocated and Unallocated LHFS
Secondary Marketing Data
You must get this informationhellipbull Do you Believe the numbers
(Mandatory Commitment MTM off-setting LHFS excluded in example)
WH Committed not in TBA Hedge- Valued based on purchase priceWH Uncommitted is in TBA Hedge- Valued by hedge advisor
MTM JE
bull Reverse the prior month MTM
bull Post Pair-Off AP or ARbull Post current month MTM
bull Significant changes in volume can impact the PampL
bull If hedge was gain Derivative Asset
bull Confirm everything with your Auditorbull All external reports must be GAAP
Derivative Asset increases CapitalWe Create a Derivative Asset bybull DR Derivative Asset CR Income
bull What happens to IRLC Income ndash Becomes Capital
IMBs want more Capitalbull More IRLC means more Incomebull More Income means more Capitalbull More Capital means more Warehouse borrowingbull More Capital means qualifying for FHA amp Agencybull More IRLC means more Capital
Derivative Asset
Is Confusing to Business Ownersand leads to bad decisions
Capital Accounts with Derivative AssetThe Derivative Asset is not carried at Fair Value because the Derivative Asset cannot be sold for the carrying value
During 2018 several companies failed Capital = $2 million Derivative Asset = $2 million
The Owner did not understand why they were insolvent
Disclose the Impact of the Derivative Asset in Capital Accountsbull Common Stockbull Paid In Capitalbull Distributionsbull Retained Earnings (Move IRLC MTM impact from NI to Unrealized Gain)bull Unrealized Gain(Loss)
Thanks to Oystein Konsmo CFO at Nova Financial for implementing this practice
Derivative Asset Characteristics
What is the Locked Pipeline
bull IRLC is a lock commitments issued to borrowers bull They are ldquoApplications in Processrdquo bull IRLC are commitments ndash not Loans bull There is no active market for IRLCbull There is no Asset to basis adjust for MTM
bull Is a TBA-MBS tradeable in its current form YES
bull Is a IRLC tradeable in its current form NO
bull The IRLC must be Transformed into a loan then securitized to be valued as tradeable instrument
bull Transformational Costs are unavoidable and undeniable
bull IRLC is not pure derivative but is derivative under GAAP
bull Absorption Costing is a way to understand the basis for Transformational Costs = Work in Process but is it not perfect
bull I think MSR valuation of cash flow is a more accurate measure
Is an IRLC a Tradable Asset
How have CPAs Presented theDerivative Asset
INCONSISTANTLY
Derivative Asset vs Pipeline
Small Independent Large Public
Source ndash A Greer CPA
bull Warehouse Lenders Rely on CPA for GAAP Capitalbull Lenderrsquos Observe CPA Auditorshellip
ndash Overstate Capital with DAndash Under-apply Cost to Completendash Inconsistently apply Costs to Complete
bull Warehouse Lenders reduce Derivative Asset ndash Some arbitrarily reduce by 50ndash Some reduce based on Net Future Cash Flows
Warehouse Lenderrsquos Adjustment
What about GAAP
bull What does GAAP say about Transformation Costs
bull Direct Cost Deduction Method - direct costs only
bull Full Cost Absorption Method - direct and indirect costs
bull IRLC is a pure derivative - IRLC same as TBA-MBS
bull Net Future Cash Flow Valuation Method (discussed soon)
Transformation Costs or Cost to Completebull What is the value of the IRLC
bull Pull-thru adjusted MTM less Costs to Complete
bull What is the right amount of Transformation Costsbull Direct Cost Deduction Method - direct costs onlybull Full Cost Absorption Method - both direct and indirect costsbull IRLC is a pure derivative ndash no adjustment (IRLC = TBA-MBS)
bull Uncertainty Principalndash Exponential diminishing impact to closingndash You have it when you have it otherwise uncertainndash Day of Lock 99 uncertainty Day before closing 1 uncertainty
IMB Transformational Costs ndash Best PracticesDirect Expenses
bull LO commissions production commissionsbull Other Direct Production Costs
bull appraisals outsourcing courier credit reports other cosbull Other Direct Expenses
bull LO wages processors LOA bull underwriting funding disclosure and post closing
Indirect Expensesbull Allocated Production Rent Branch Rent Branch Overhead
Consequence of Ignoring Indirect Costs
Hawaii vs TexasHigh Balance vs Low Balance
Loan Size Matters
Loan Size Dynamics ndash One Loanbull ONE LOAN
bull High Balance low gainbull Low Balance high gain
bull Derivative Asset
bull Processing costs as of loan are different
bull Profit is same
Higher Gain
$50000000 Locked Pipeline
bull Texas lender is more than double Hawaii
bull Identical Cash Realization
bull Indirect Costs Matter
Direct Costs Only - Distort Results
Derivative Asset Value
View From Finance
Present Value of Net Future Cash Flow
Same as MSR
Derivative Asset OoopsMany CPAs firms have issued opinions on financial statements with derivative asset values I would challenge as not reasonable
Changing Presentation method now creates exposure to Opinion Risk
There is presently no consensus among CPA Auditors about how to apply GAAP
What is the Value of the IRLC - DA
Day of Lock Day Before Closing
High ProbabilityRevenue less Commission
Value is approaching Revenue
UnIncurred Costs Decrease as Percentage of Completion Increases
Low ProbabilityRevenue less all Costs
Value is approaching Zero
What is the value of an Intangible Asset
The Derivative Asset is an Intangible Asset
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
bull Derivatives under GAAPbull Recorded at Fair Value
bull Best Efforts Commitmentsbull Do not have a penalty for legitimate cancelationbull If loan is not closed the BE is canceled without costbull Avoidance of pair-off risk is not a derivative (most agree)bull Optional derivative under ASC 825-10-25
bull If IRLC is MTM and BE locks are not MTM bull Potential misrepresentation of gain positionbull Recommend all commitments are DerivativesMTM
ASC 815 ndash Hedge Accounting
The Interest Rate Lock Commitments ndash IRLC ndashbull IRLCs are initially issued to generate a profitbull The imbedded profit is valued at each reporting period bull The resulting gain is recorded as a Derivative Asset
bull It is very unlikely an IRLC will be a Derivative Liability
Hedge Positionbull TBA-MBS can generate a gain or loss
bull depending upon price movement since the date of salebull gain is reported as a Derivative Assetbull loss is reported as a Derivative Liability
+25 IRLCDerivative Asset Margin
Preservation
-50 TBADerivative Liability
+130 TBADerivative Asset
+70 IRLCDerivative Asset
Always consider loan gain with hedge gain or loss
Hedging Journal Entries
Warehouse bull The warehouse is comprised of two segments
ndash Committed or Allocated to Mandatory Commitmentndash Uncommitted or Hedged with Short TBA-MBS
bull The month-end MTM of the LHFS adjusts the basis of the LHFS creating a gain or loss in the PampL
Pipeline Hedgebull The month-end open TBA position MTM gain or loss is
posted to a Derivative Asset or Derivative Liability and a MTM gain or loss in PampL
Allocated and Unallocated LHFS
Secondary Marketing Data
You must get this informationhellipbull Do you Believe the numbers
(Mandatory Commitment MTM off-setting LHFS excluded in example)
WH Committed not in TBA Hedge- Valued based on purchase priceWH Uncommitted is in TBA Hedge- Valued by hedge advisor
MTM JE
bull Reverse the prior month MTM
bull Post Pair-Off AP or ARbull Post current month MTM
bull Significant changes in volume can impact the PampL
bull If hedge was gain Derivative Asset
bull Confirm everything with your Auditorbull All external reports must be GAAP
Derivative Asset increases CapitalWe Create a Derivative Asset bybull DR Derivative Asset CR Income
bull What happens to IRLC Income ndash Becomes Capital
IMBs want more Capitalbull More IRLC means more Incomebull More Income means more Capitalbull More Capital means more Warehouse borrowingbull More Capital means qualifying for FHA amp Agencybull More IRLC means more Capital
Derivative Asset
Is Confusing to Business Ownersand leads to bad decisions
Capital Accounts with Derivative AssetThe Derivative Asset is not carried at Fair Value because the Derivative Asset cannot be sold for the carrying value
During 2018 several companies failed Capital = $2 million Derivative Asset = $2 million
The Owner did not understand why they were insolvent
Disclose the Impact of the Derivative Asset in Capital Accountsbull Common Stockbull Paid In Capitalbull Distributionsbull Retained Earnings (Move IRLC MTM impact from NI to Unrealized Gain)bull Unrealized Gain(Loss)
Thanks to Oystein Konsmo CFO at Nova Financial for implementing this practice
Derivative Asset Characteristics
What is the Locked Pipeline
bull IRLC is a lock commitments issued to borrowers bull They are ldquoApplications in Processrdquo bull IRLC are commitments ndash not Loans bull There is no active market for IRLCbull There is no Asset to basis adjust for MTM
bull Is a TBA-MBS tradeable in its current form YES
bull Is a IRLC tradeable in its current form NO
bull The IRLC must be Transformed into a loan then securitized to be valued as tradeable instrument
bull Transformational Costs are unavoidable and undeniable
bull IRLC is not pure derivative but is derivative under GAAP
bull Absorption Costing is a way to understand the basis for Transformational Costs = Work in Process but is it not perfect
bull I think MSR valuation of cash flow is a more accurate measure
Is an IRLC a Tradable Asset
How have CPAs Presented theDerivative Asset
INCONSISTANTLY
Derivative Asset vs Pipeline
Small Independent Large Public
Source ndash A Greer CPA
bull Warehouse Lenders Rely on CPA for GAAP Capitalbull Lenderrsquos Observe CPA Auditorshellip
ndash Overstate Capital with DAndash Under-apply Cost to Completendash Inconsistently apply Costs to Complete
bull Warehouse Lenders reduce Derivative Asset ndash Some arbitrarily reduce by 50ndash Some reduce based on Net Future Cash Flows
Warehouse Lenderrsquos Adjustment
What about GAAP
bull What does GAAP say about Transformation Costs
bull Direct Cost Deduction Method - direct costs only
bull Full Cost Absorption Method - direct and indirect costs
bull IRLC is a pure derivative - IRLC same as TBA-MBS
bull Net Future Cash Flow Valuation Method (discussed soon)
Transformation Costs or Cost to Completebull What is the value of the IRLC
bull Pull-thru adjusted MTM less Costs to Complete
bull What is the right amount of Transformation Costsbull Direct Cost Deduction Method - direct costs onlybull Full Cost Absorption Method - both direct and indirect costsbull IRLC is a pure derivative ndash no adjustment (IRLC = TBA-MBS)
bull Uncertainty Principalndash Exponential diminishing impact to closingndash You have it when you have it otherwise uncertainndash Day of Lock 99 uncertainty Day before closing 1 uncertainty
IMB Transformational Costs ndash Best PracticesDirect Expenses
bull LO commissions production commissionsbull Other Direct Production Costs
bull appraisals outsourcing courier credit reports other cosbull Other Direct Expenses
bull LO wages processors LOA bull underwriting funding disclosure and post closing
Indirect Expensesbull Allocated Production Rent Branch Rent Branch Overhead
Consequence of Ignoring Indirect Costs
Hawaii vs TexasHigh Balance vs Low Balance
Loan Size Matters
Loan Size Dynamics ndash One Loanbull ONE LOAN
bull High Balance low gainbull Low Balance high gain
bull Derivative Asset
bull Processing costs as of loan are different
bull Profit is same
Higher Gain
$50000000 Locked Pipeline
bull Texas lender is more than double Hawaii
bull Identical Cash Realization
bull Indirect Costs Matter
Direct Costs Only - Distort Results
Derivative Asset Value
View From Finance
Present Value of Net Future Cash Flow
Same as MSR
Derivative Asset OoopsMany CPAs firms have issued opinions on financial statements with derivative asset values I would challenge as not reasonable
Changing Presentation method now creates exposure to Opinion Risk
There is presently no consensus among CPA Auditors about how to apply GAAP
What is the Value of the IRLC - DA
Day of Lock Day Before Closing
High ProbabilityRevenue less Commission
Value is approaching Revenue
UnIncurred Costs Decrease as Percentage of Completion Increases
Low ProbabilityRevenue less all Costs
Value is approaching Zero
What is the value of an Intangible Asset
The Derivative Asset is an Intangible Asset
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
IRLC under ASC 815
ASC 815 ndash Commitments
ASC 815 ndash Hedge Accounting
Slide Number 41
Slide Number 42
Slide Number 43
Slide Number 44
Slide Number 45
Slide Number 46
Slide Number 47
Derivative Asset increases Capital
Slide Number 49
Slide Number 50
Slide Number 51
What is the Locked Pipeline
Slide Number 53
Slide Number 54
Slide Number 55
Slide Number 56
What about GAAP
Transformation Costs or Cost to Complete
IMB Transformational Costs ndash Best Practices
Slide Number 60
Slide Number 61
Slide Number 62
Slide Number 63
Derivative Asset Ooops
What is the Value of the IRLC - DA
Slide Number 66
AICPA Valuation Services
AICPA - Discounted Future Benefit
Hedging Data for DA Valuation
Percentage of Completion by Status
Net Cash Flow Valuation Data
IRLC-DA Grows in Value as Costs Incurred
Lock to LHFS DA Value Accretion
Revenue Potential vs Derivative Asset
GAAP Methods Only Right Once
Slide Number 76
IRLC Value is What You Negotiate
Slide Number 78
Slide Number 79
FASB Board Meeting ndash 32818
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
Slide Number 83
IRLC is Taxable when Recorded - BUT
Slide Number 85
Slide Number 86
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
PampL - with and without IRLC
IRLC Revenue is Confusing
Slide Number 91
Slide Number 92
Slide Number 93
Slide Number 94
Slide Number 95
Slide Number 96
Balance Sheet or Commitment
Gain or (Loss)
Warehouse - committed
$1000000000
$10000000
(1)
Pair-Off trades - closed not settled
($800000)
(2)
Locked Pipeline (net of pull-thru)
$3000000000
$30000000
(3)
Warehouse ndash not committed
$45000000
$450000
(4)
Hedge
$2700000000
($27000000)
(5)
Balance Sheet amp Income Statement Accounts
Assets
Cash
$1000000
Loans Held for Sale
$10000000
Loans Held for Sale
$450000
Loans Held for Sale
$100000
(1)
Loans Held for Sale
$4500
(4)
AR Loan Sales (not GAAP)
AR Pair Off
Derivative Asset (MTM gains)
$300000
(3)
Liabilities
Warehouse loan
$10000000
AP Commission
AP Pair-Off
$8000
(2)
Borrower Escrow
$450000
Derivative Liability (MTM losses)
$270000
(5)
Capital
MTM valuation
Retained Earning
$1000000
Revenue
MTM Gain or Loss (gain)
$100000
(1)
MTM Gain or Loss (gain)
$300000
(3)
MTM Gain or Loss (gain)
$4500
(4)
Expense
Pair-Off Gain or Loss (loss)
$8000
(2)
MTM Gain or Loss (loss)
$270000
(5)
$12132500
$12132500
Journal Entries
Warehouse Loans with Purchase Commitment (value based on purchase commitment)
If gain
Debit Loans Held For Sale
$10000000
Credit MTM Gain or Loss
$10000000
If loss
Debit MTM Gain of Loss
$10000000
Credit Loans Held For Sale
$10000000
Pair-Offs (value based on closed trade)
If gain
Debit Pair-Off Receivable
$800000
Credit Pair-Off Gain or Loss
$800000
If loss
Debit Pair-Off Gain or Loss
$800000
Credit Pair-Off Payable
$800000
Warehouse Loans without Purchase Commitment MTM (value at month-end)
If gain
Debit Loans Held for Sale
$450000
Credit MTM Gain or Loss^
$450000
If loss
Debit MTM Gain or Loss^
$450000
Credit Loans Held for Sale
$450000
Locked Pipeline MTM (pull-thru adjusted)
If gain
Debit Derivative Asset
$30000000
Credit MTM Gain or Loss^
$30000000
If loss
Debit MTM Gain or Loss^
$30000000
Credit Derivative Liability
$30000000
Hedge MTM
If gain
Debit Derivative Asset
$27000000
Credit MTM Gain or Loss^
$27000000
If loss
Debit MTM Gain or Loss^
$27000000
Credit Derivative Liability
$27000000
or Gain on Sale for mgmt reporting (not GAAP)
^ or MTM valuation in Capital for mgmt reporting (not GAAP)
ASC 815 ndash Hedge Accounting
The Interest Rate Lock Commitments ndash IRLC ndashbull IRLCs are initially issued to generate a profitbull The imbedded profit is valued at each reporting period bull The resulting gain is recorded as a Derivative Asset
bull It is very unlikely an IRLC will be a Derivative Liability
Hedge Positionbull TBA-MBS can generate a gain or loss
bull depending upon price movement since the date of salebull gain is reported as a Derivative Assetbull loss is reported as a Derivative Liability
+25 IRLCDerivative Asset Margin
Preservation
-50 TBADerivative Liability
+130 TBADerivative Asset
+70 IRLCDerivative Asset
Always consider loan gain with hedge gain or loss
Hedging Journal Entries
Warehouse bull The warehouse is comprised of two segments
ndash Committed or Allocated to Mandatory Commitmentndash Uncommitted or Hedged with Short TBA-MBS
bull The month-end MTM of the LHFS adjusts the basis of the LHFS creating a gain or loss in the PampL
Pipeline Hedgebull The month-end open TBA position MTM gain or loss is
posted to a Derivative Asset or Derivative Liability and a MTM gain or loss in PampL
Allocated and Unallocated LHFS
Secondary Marketing Data
You must get this informationhellipbull Do you Believe the numbers
(Mandatory Commitment MTM off-setting LHFS excluded in example)
WH Committed not in TBA Hedge- Valued based on purchase priceWH Uncommitted is in TBA Hedge- Valued by hedge advisor
MTM JE
bull Reverse the prior month MTM
bull Post Pair-Off AP or ARbull Post current month MTM
bull Significant changes in volume can impact the PampL
bull If hedge was gain Derivative Asset
bull Confirm everything with your Auditorbull All external reports must be GAAP
Derivative Asset increases CapitalWe Create a Derivative Asset bybull DR Derivative Asset CR Income
bull What happens to IRLC Income ndash Becomes Capital
IMBs want more Capitalbull More IRLC means more Incomebull More Income means more Capitalbull More Capital means more Warehouse borrowingbull More Capital means qualifying for FHA amp Agencybull More IRLC means more Capital
Derivative Asset
Is Confusing to Business Ownersand leads to bad decisions
Capital Accounts with Derivative AssetThe Derivative Asset is not carried at Fair Value because the Derivative Asset cannot be sold for the carrying value
During 2018 several companies failed Capital = $2 million Derivative Asset = $2 million
The Owner did not understand why they were insolvent
Disclose the Impact of the Derivative Asset in Capital Accountsbull Common Stockbull Paid In Capitalbull Distributionsbull Retained Earnings (Move IRLC MTM impact from NI to Unrealized Gain)bull Unrealized Gain(Loss)
Thanks to Oystein Konsmo CFO at Nova Financial for implementing this practice
Derivative Asset Characteristics
What is the Locked Pipeline
bull IRLC is a lock commitments issued to borrowers bull They are ldquoApplications in Processrdquo bull IRLC are commitments ndash not Loans bull There is no active market for IRLCbull There is no Asset to basis adjust for MTM
bull Is a TBA-MBS tradeable in its current form YES
bull Is a IRLC tradeable in its current form NO
bull The IRLC must be Transformed into a loan then securitized to be valued as tradeable instrument
bull Transformational Costs are unavoidable and undeniable
bull IRLC is not pure derivative but is derivative under GAAP
bull Absorption Costing is a way to understand the basis for Transformational Costs = Work in Process but is it not perfect
bull I think MSR valuation of cash flow is a more accurate measure
Is an IRLC a Tradable Asset
How have CPAs Presented theDerivative Asset
INCONSISTANTLY
Derivative Asset vs Pipeline
Small Independent Large Public
Source ndash A Greer CPA
bull Warehouse Lenders Rely on CPA for GAAP Capitalbull Lenderrsquos Observe CPA Auditorshellip
ndash Overstate Capital with DAndash Under-apply Cost to Completendash Inconsistently apply Costs to Complete
bull Warehouse Lenders reduce Derivative Asset ndash Some arbitrarily reduce by 50ndash Some reduce based on Net Future Cash Flows
Warehouse Lenderrsquos Adjustment
What about GAAP
bull What does GAAP say about Transformation Costs
bull Direct Cost Deduction Method - direct costs only
bull Full Cost Absorption Method - direct and indirect costs
bull IRLC is a pure derivative - IRLC same as TBA-MBS
bull Net Future Cash Flow Valuation Method (discussed soon)
Transformation Costs or Cost to Completebull What is the value of the IRLC
bull Pull-thru adjusted MTM less Costs to Complete
bull What is the right amount of Transformation Costsbull Direct Cost Deduction Method - direct costs onlybull Full Cost Absorption Method - both direct and indirect costsbull IRLC is a pure derivative ndash no adjustment (IRLC = TBA-MBS)
bull Uncertainty Principalndash Exponential diminishing impact to closingndash You have it when you have it otherwise uncertainndash Day of Lock 99 uncertainty Day before closing 1 uncertainty
IMB Transformational Costs ndash Best PracticesDirect Expenses
bull LO commissions production commissionsbull Other Direct Production Costs
bull appraisals outsourcing courier credit reports other cosbull Other Direct Expenses
bull LO wages processors LOA bull underwriting funding disclosure and post closing
Indirect Expensesbull Allocated Production Rent Branch Rent Branch Overhead
Consequence of Ignoring Indirect Costs
Hawaii vs TexasHigh Balance vs Low Balance
Loan Size Matters
Loan Size Dynamics ndash One Loanbull ONE LOAN
bull High Balance low gainbull Low Balance high gain
bull Derivative Asset
bull Processing costs as of loan are different
bull Profit is same
Higher Gain
$50000000 Locked Pipeline
bull Texas lender is more than double Hawaii
bull Identical Cash Realization
bull Indirect Costs Matter
Direct Costs Only - Distort Results
Derivative Asset Value
View From Finance
Present Value of Net Future Cash Flow
Same as MSR
Derivative Asset OoopsMany CPAs firms have issued opinions on financial statements with derivative asset values I would challenge as not reasonable
Changing Presentation method now creates exposure to Opinion Risk
There is presently no consensus among CPA Auditors about how to apply GAAP
What is the Value of the IRLC - DA
Day of Lock Day Before Closing
High ProbabilityRevenue less Commission
Value is approaching Revenue
UnIncurred Costs Decrease as Percentage of Completion Increases
Low ProbabilityRevenue less all Costs
Value is approaching Zero
What is the value of an Intangible Asset
The Derivative Asset is an Intangible Asset
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
Derivative Asset increases CapitalWe Create a Derivative Asset bybull DR Derivative Asset CR Income
bull What happens to IRLC Income ndash Becomes Capital
IMBs want more Capitalbull More IRLC means more Incomebull More Income means more Capitalbull More Capital means more Warehouse borrowingbull More Capital means qualifying for FHA amp Agencybull More IRLC means more Capital
Derivative Asset
Is Confusing to Business Ownersand leads to bad decisions
Capital Accounts with Derivative AssetThe Derivative Asset is not carried at Fair Value because the Derivative Asset cannot be sold for the carrying value
During 2018 several companies failed Capital = $2 million Derivative Asset = $2 million
The Owner did not understand why they were insolvent
Disclose the Impact of the Derivative Asset in Capital Accountsbull Common Stockbull Paid In Capitalbull Distributionsbull Retained Earnings (Move IRLC MTM impact from NI to Unrealized Gain)bull Unrealized Gain(Loss)
Thanks to Oystein Konsmo CFO at Nova Financial for implementing this practice
Derivative Asset Characteristics
What is the Locked Pipeline
bull IRLC is a lock commitments issued to borrowers bull They are ldquoApplications in Processrdquo bull IRLC are commitments ndash not Loans bull There is no active market for IRLCbull There is no Asset to basis adjust for MTM
bull Is a TBA-MBS tradeable in its current form YES
bull Is a IRLC tradeable in its current form NO
bull The IRLC must be Transformed into a loan then securitized to be valued as tradeable instrument
bull Transformational Costs are unavoidable and undeniable
bull IRLC is not pure derivative but is derivative under GAAP
bull Absorption Costing is a way to understand the basis for Transformational Costs = Work in Process but is it not perfect
bull I think MSR valuation of cash flow is a more accurate measure
Is an IRLC a Tradable Asset
How have CPAs Presented theDerivative Asset
INCONSISTANTLY
Derivative Asset vs Pipeline
Small Independent Large Public
Source ndash A Greer CPA
bull Warehouse Lenders Rely on CPA for GAAP Capitalbull Lenderrsquos Observe CPA Auditorshellip
ndash Overstate Capital with DAndash Under-apply Cost to Completendash Inconsistently apply Costs to Complete
bull Warehouse Lenders reduce Derivative Asset ndash Some arbitrarily reduce by 50ndash Some reduce based on Net Future Cash Flows
Warehouse Lenderrsquos Adjustment
What about GAAP
bull What does GAAP say about Transformation Costs
bull Direct Cost Deduction Method - direct costs only
bull Full Cost Absorption Method - direct and indirect costs
bull IRLC is a pure derivative - IRLC same as TBA-MBS
bull Net Future Cash Flow Valuation Method (discussed soon)
Transformation Costs or Cost to Completebull What is the value of the IRLC
bull Pull-thru adjusted MTM less Costs to Complete
bull What is the right amount of Transformation Costsbull Direct Cost Deduction Method - direct costs onlybull Full Cost Absorption Method - both direct and indirect costsbull IRLC is a pure derivative ndash no adjustment (IRLC = TBA-MBS)
bull Uncertainty Principalndash Exponential diminishing impact to closingndash You have it when you have it otherwise uncertainndash Day of Lock 99 uncertainty Day before closing 1 uncertainty
IMB Transformational Costs ndash Best PracticesDirect Expenses
bull LO commissions production commissionsbull Other Direct Production Costs
bull appraisals outsourcing courier credit reports other cosbull Other Direct Expenses
bull LO wages processors LOA bull underwriting funding disclosure and post closing
Indirect Expensesbull Allocated Production Rent Branch Rent Branch Overhead
Consequence of Ignoring Indirect Costs
Hawaii vs TexasHigh Balance vs Low Balance
Loan Size Matters
Loan Size Dynamics ndash One Loanbull ONE LOAN
bull High Balance low gainbull Low Balance high gain
bull Derivative Asset
bull Processing costs as of loan are different
bull Profit is same
Higher Gain
$50000000 Locked Pipeline
bull Texas lender is more than double Hawaii
bull Identical Cash Realization
bull Indirect Costs Matter
Direct Costs Only - Distort Results
Derivative Asset Value
View From Finance
Present Value of Net Future Cash Flow
Same as MSR
Derivative Asset OoopsMany CPAs firms have issued opinions on financial statements with derivative asset values I would challenge as not reasonable
Changing Presentation method now creates exposure to Opinion Risk
There is presently no consensus among CPA Auditors about how to apply GAAP
What is the Value of the IRLC - DA
Day of Lock Day Before Closing
High ProbabilityRevenue less Commission
Value is approaching Revenue
UnIncurred Costs Decrease as Percentage of Completion Increases
Low ProbabilityRevenue less all Costs
Value is approaching Zero
What is the value of an Intangible Asset
The Derivative Asset is an Intangible Asset
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
Derivative Asset increases CapitalWe Create a Derivative Asset bybull DR Derivative Asset CR Income
bull What happens to IRLC Income ndash Becomes Capital
IMBs want more Capitalbull More IRLC means more Incomebull More Income means more Capitalbull More Capital means more Warehouse borrowingbull More Capital means qualifying for FHA amp Agencybull More IRLC means more Capital
Derivative Asset
Is Confusing to Business Ownersand leads to bad decisions
Capital Accounts with Derivative AssetThe Derivative Asset is not carried at Fair Value because the Derivative Asset cannot be sold for the carrying value
During 2018 several companies failed Capital = $2 million Derivative Asset = $2 million
The Owner did not understand why they were insolvent
Disclose the Impact of the Derivative Asset in Capital Accountsbull Common Stockbull Paid In Capitalbull Distributionsbull Retained Earnings (Move IRLC MTM impact from NI to Unrealized Gain)bull Unrealized Gain(Loss)
Thanks to Oystein Konsmo CFO at Nova Financial for implementing this practice
Derivative Asset Characteristics
What is the Locked Pipeline
bull IRLC is a lock commitments issued to borrowers bull They are ldquoApplications in Processrdquo bull IRLC are commitments ndash not Loans bull There is no active market for IRLCbull There is no Asset to basis adjust for MTM
bull Is a TBA-MBS tradeable in its current form YES
bull Is a IRLC tradeable in its current form NO
bull The IRLC must be Transformed into a loan then securitized to be valued as tradeable instrument
bull Transformational Costs are unavoidable and undeniable
bull IRLC is not pure derivative but is derivative under GAAP
bull Absorption Costing is a way to understand the basis for Transformational Costs = Work in Process but is it not perfect
bull I think MSR valuation of cash flow is a more accurate measure
Is an IRLC a Tradable Asset
How have CPAs Presented theDerivative Asset
INCONSISTANTLY
Derivative Asset vs Pipeline
Small Independent Large Public
Source ndash A Greer CPA
bull Warehouse Lenders Rely on CPA for GAAP Capitalbull Lenderrsquos Observe CPA Auditorshellip
ndash Overstate Capital with DAndash Under-apply Cost to Completendash Inconsistently apply Costs to Complete
bull Warehouse Lenders reduce Derivative Asset ndash Some arbitrarily reduce by 50ndash Some reduce based on Net Future Cash Flows
Warehouse Lenderrsquos Adjustment
What about GAAP
bull What does GAAP say about Transformation Costs
bull Direct Cost Deduction Method - direct costs only
bull Full Cost Absorption Method - direct and indirect costs
bull IRLC is a pure derivative - IRLC same as TBA-MBS
bull Net Future Cash Flow Valuation Method (discussed soon)
Transformation Costs or Cost to Completebull What is the value of the IRLC
bull Pull-thru adjusted MTM less Costs to Complete
bull What is the right amount of Transformation Costsbull Direct Cost Deduction Method - direct costs onlybull Full Cost Absorption Method - both direct and indirect costsbull IRLC is a pure derivative ndash no adjustment (IRLC = TBA-MBS)
bull Uncertainty Principalndash Exponential diminishing impact to closingndash You have it when you have it otherwise uncertainndash Day of Lock 99 uncertainty Day before closing 1 uncertainty
IMB Transformational Costs ndash Best PracticesDirect Expenses
bull LO commissions production commissionsbull Other Direct Production Costs
bull appraisals outsourcing courier credit reports other cosbull Other Direct Expenses
bull LO wages processors LOA bull underwriting funding disclosure and post closing
Indirect Expensesbull Allocated Production Rent Branch Rent Branch Overhead
Consequence of Ignoring Indirect Costs
Hawaii vs TexasHigh Balance vs Low Balance
Loan Size Matters
Loan Size Dynamics ndash One Loanbull ONE LOAN
bull High Balance low gainbull Low Balance high gain
bull Derivative Asset
bull Processing costs as of loan are different
bull Profit is same
Higher Gain
$50000000 Locked Pipeline
bull Texas lender is more than double Hawaii
bull Identical Cash Realization
bull Indirect Costs Matter
Direct Costs Only - Distort Results
Derivative Asset Value
View From Finance
Present Value of Net Future Cash Flow
Same as MSR
Derivative Asset OoopsMany CPAs firms have issued opinions on financial statements with derivative asset values I would challenge as not reasonable
Changing Presentation method now creates exposure to Opinion Risk
There is presently no consensus among CPA Auditors about how to apply GAAP
What is the Value of the IRLC - DA
Day of Lock Day Before Closing
High ProbabilityRevenue less Commission
Value is approaching Revenue
UnIncurred Costs Decrease as Percentage of Completion Increases
Low ProbabilityRevenue less all Costs
Value is approaching Zero
What is the value of an Intangible Asset
The Derivative Asset is an Intangible Asset
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
Derivative Asset increases CapitalWe Create a Derivative Asset bybull DR Derivative Asset CR Income
bull What happens to IRLC Income ndash Becomes Capital
IMBs want more Capitalbull More IRLC means more Incomebull More Income means more Capitalbull More Capital means more Warehouse borrowingbull More Capital means qualifying for FHA amp Agencybull More IRLC means more Capital
Derivative Asset
Is Confusing to Business Ownersand leads to bad decisions
Capital Accounts with Derivative AssetThe Derivative Asset is not carried at Fair Value because the Derivative Asset cannot be sold for the carrying value
During 2018 several companies failed Capital = $2 million Derivative Asset = $2 million
The Owner did not understand why they were insolvent
Disclose the Impact of the Derivative Asset in Capital Accountsbull Common Stockbull Paid In Capitalbull Distributionsbull Retained Earnings (Move IRLC MTM impact from NI to Unrealized Gain)bull Unrealized Gain(Loss)
Thanks to Oystein Konsmo CFO at Nova Financial for implementing this practice
Derivative Asset Characteristics
What is the Locked Pipeline
bull IRLC is a lock commitments issued to borrowers bull They are ldquoApplications in Processrdquo bull IRLC are commitments ndash not Loans bull There is no active market for IRLCbull There is no Asset to basis adjust for MTM
bull Is a TBA-MBS tradeable in its current form YES
bull Is a IRLC tradeable in its current form NO
bull The IRLC must be Transformed into a loan then securitized to be valued as tradeable instrument
bull Transformational Costs are unavoidable and undeniable
bull IRLC is not pure derivative but is derivative under GAAP
bull Absorption Costing is a way to understand the basis for Transformational Costs = Work in Process but is it not perfect
bull I think MSR valuation of cash flow is a more accurate measure
Is an IRLC a Tradable Asset
How have CPAs Presented theDerivative Asset
INCONSISTANTLY
Derivative Asset vs Pipeline
Small Independent Large Public
Source ndash A Greer CPA
bull Warehouse Lenders Rely on CPA for GAAP Capitalbull Lenderrsquos Observe CPA Auditorshellip
ndash Overstate Capital with DAndash Under-apply Cost to Completendash Inconsistently apply Costs to Complete
bull Warehouse Lenders reduce Derivative Asset ndash Some arbitrarily reduce by 50ndash Some reduce based on Net Future Cash Flows
Warehouse Lenderrsquos Adjustment
What about GAAP
bull What does GAAP say about Transformation Costs
bull Direct Cost Deduction Method - direct costs only
bull Full Cost Absorption Method - direct and indirect costs
bull IRLC is a pure derivative - IRLC same as TBA-MBS
bull Net Future Cash Flow Valuation Method (discussed soon)
Transformation Costs or Cost to Completebull What is the value of the IRLC
bull Pull-thru adjusted MTM less Costs to Complete
bull What is the right amount of Transformation Costsbull Direct Cost Deduction Method - direct costs onlybull Full Cost Absorption Method - both direct and indirect costsbull IRLC is a pure derivative ndash no adjustment (IRLC = TBA-MBS)
bull Uncertainty Principalndash Exponential diminishing impact to closingndash You have it when you have it otherwise uncertainndash Day of Lock 99 uncertainty Day before closing 1 uncertainty
IMB Transformational Costs ndash Best PracticesDirect Expenses
bull LO commissions production commissionsbull Other Direct Production Costs
bull appraisals outsourcing courier credit reports other cosbull Other Direct Expenses
bull LO wages processors LOA bull underwriting funding disclosure and post closing
Indirect Expensesbull Allocated Production Rent Branch Rent Branch Overhead
Consequence of Ignoring Indirect Costs
Hawaii vs TexasHigh Balance vs Low Balance
Loan Size Matters
Loan Size Dynamics ndash One Loanbull ONE LOAN
bull High Balance low gainbull Low Balance high gain
bull Derivative Asset
bull Processing costs as of loan are different
bull Profit is same
Higher Gain
$50000000 Locked Pipeline
bull Texas lender is more than double Hawaii
bull Identical Cash Realization
bull Indirect Costs Matter
Direct Costs Only - Distort Results
Derivative Asset Value
View From Finance
Present Value of Net Future Cash Flow
Same as MSR
Derivative Asset OoopsMany CPAs firms have issued opinions on financial statements with derivative asset values I would challenge as not reasonable
Changing Presentation method now creates exposure to Opinion Risk
There is presently no consensus among CPA Auditors about how to apply GAAP
What is the Value of the IRLC - DA
Day of Lock Day Before Closing
High ProbabilityRevenue less Commission
Value is approaching Revenue
UnIncurred Costs Decrease as Percentage of Completion Increases
Low ProbabilityRevenue less all Costs
Value is approaching Zero
What is the value of an Intangible Asset
The Derivative Asset is an Intangible Asset
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
Derivative Asset increases CapitalWe Create a Derivative Asset bybull DR Derivative Asset CR Income
bull What happens to IRLC Income ndash Becomes Capital
IMBs want more Capitalbull More IRLC means more Incomebull More Income means more Capitalbull More Capital means more Warehouse borrowingbull More Capital means qualifying for FHA amp Agencybull More IRLC means more Capital
Derivative Asset
Is Confusing to Business Ownersand leads to bad decisions
Capital Accounts with Derivative AssetThe Derivative Asset is not carried at Fair Value because the Derivative Asset cannot be sold for the carrying value
During 2018 several companies failed Capital = $2 million Derivative Asset = $2 million
The Owner did not understand why they were insolvent
Disclose the Impact of the Derivative Asset in Capital Accountsbull Common Stockbull Paid In Capitalbull Distributionsbull Retained Earnings (Move IRLC MTM impact from NI to Unrealized Gain)bull Unrealized Gain(Loss)
Thanks to Oystein Konsmo CFO at Nova Financial for implementing this practice
Derivative Asset Characteristics
What is the Locked Pipeline
bull IRLC is a lock commitments issued to borrowers bull They are ldquoApplications in Processrdquo bull IRLC are commitments ndash not Loans bull There is no active market for IRLCbull There is no Asset to basis adjust for MTM
bull Is a TBA-MBS tradeable in its current form YES
bull Is a IRLC tradeable in its current form NO
bull The IRLC must be Transformed into a loan then securitized to be valued as tradeable instrument
bull Transformational Costs are unavoidable and undeniable
bull IRLC is not pure derivative but is derivative under GAAP
bull Absorption Costing is a way to understand the basis for Transformational Costs = Work in Process but is it not perfect
bull I think MSR valuation of cash flow is a more accurate measure
Is an IRLC a Tradable Asset
How have CPAs Presented theDerivative Asset
INCONSISTANTLY
Derivative Asset vs Pipeline
Small Independent Large Public
Source ndash A Greer CPA
bull Warehouse Lenders Rely on CPA for GAAP Capitalbull Lenderrsquos Observe CPA Auditorshellip
ndash Overstate Capital with DAndash Under-apply Cost to Completendash Inconsistently apply Costs to Complete
bull Warehouse Lenders reduce Derivative Asset ndash Some arbitrarily reduce by 50ndash Some reduce based on Net Future Cash Flows
Warehouse Lenderrsquos Adjustment
What about GAAP
bull What does GAAP say about Transformation Costs
bull Direct Cost Deduction Method - direct costs only
bull Full Cost Absorption Method - direct and indirect costs
bull IRLC is a pure derivative - IRLC same as TBA-MBS
bull Net Future Cash Flow Valuation Method (discussed soon)
Transformation Costs or Cost to Completebull What is the value of the IRLC
bull Pull-thru adjusted MTM less Costs to Complete
bull What is the right amount of Transformation Costsbull Direct Cost Deduction Method - direct costs onlybull Full Cost Absorption Method - both direct and indirect costsbull IRLC is a pure derivative ndash no adjustment (IRLC = TBA-MBS)
bull Uncertainty Principalndash Exponential diminishing impact to closingndash You have it when you have it otherwise uncertainndash Day of Lock 99 uncertainty Day before closing 1 uncertainty
IMB Transformational Costs ndash Best PracticesDirect Expenses
bull LO commissions production commissionsbull Other Direct Production Costs
bull appraisals outsourcing courier credit reports other cosbull Other Direct Expenses
bull LO wages processors LOA bull underwriting funding disclosure and post closing
Indirect Expensesbull Allocated Production Rent Branch Rent Branch Overhead
Consequence of Ignoring Indirect Costs
Hawaii vs TexasHigh Balance vs Low Balance
Loan Size Matters
Loan Size Dynamics ndash One Loanbull ONE LOAN
bull High Balance low gainbull Low Balance high gain
bull Derivative Asset
bull Processing costs as of loan are different
bull Profit is same
Higher Gain
$50000000 Locked Pipeline
bull Texas lender is more than double Hawaii
bull Identical Cash Realization
bull Indirect Costs Matter
Direct Costs Only - Distort Results
Derivative Asset Value
View From Finance
Present Value of Net Future Cash Flow
Same as MSR
Derivative Asset OoopsMany CPAs firms have issued opinions on financial statements with derivative asset values I would challenge as not reasonable
Changing Presentation method now creates exposure to Opinion Risk
There is presently no consensus among CPA Auditors about how to apply GAAP
What is the Value of the IRLC - DA
Day of Lock Day Before Closing
High ProbabilityRevenue less Commission
Value is approaching Revenue
UnIncurred Costs Decrease as Percentage of Completion Increases
Low ProbabilityRevenue less all Costs
Value is approaching Zero
What is the value of an Intangible Asset
The Derivative Asset is an Intangible Asset
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
Derivative Asset increases CapitalWe Create a Derivative Asset bybull DR Derivative Asset CR Income
bull What happens to IRLC Income ndash Becomes Capital
IMBs want more Capitalbull More IRLC means more Incomebull More Income means more Capitalbull More Capital means more Warehouse borrowingbull More Capital means qualifying for FHA amp Agencybull More IRLC means more Capital
Derivative Asset
Is Confusing to Business Ownersand leads to bad decisions
Capital Accounts with Derivative AssetThe Derivative Asset is not carried at Fair Value because the Derivative Asset cannot be sold for the carrying value
During 2018 several companies failed Capital = $2 million Derivative Asset = $2 million
The Owner did not understand why they were insolvent
Disclose the Impact of the Derivative Asset in Capital Accountsbull Common Stockbull Paid In Capitalbull Distributionsbull Retained Earnings (Move IRLC MTM impact from NI to Unrealized Gain)bull Unrealized Gain(Loss)
Thanks to Oystein Konsmo CFO at Nova Financial for implementing this practice
Derivative Asset Characteristics
What is the Locked Pipeline
bull IRLC is a lock commitments issued to borrowers bull They are ldquoApplications in Processrdquo bull IRLC are commitments ndash not Loans bull There is no active market for IRLCbull There is no Asset to basis adjust for MTM
bull Is a TBA-MBS tradeable in its current form YES
bull Is a IRLC tradeable in its current form NO
bull The IRLC must be Transformed into a loan then securitized to be valued as tradeable instrument
bull Transformational Costs are unavoidable and undeniable
bull IRLC is not pure derivative but is derivative under GAAP
bull Absorption Costing is a way to understand the basis for Transformational Costs = Work in Process but is it not perfect
bull I think MSR valuation of cash flow is a more accurate measure
Is an IRLC a Tradable Asset
How have CPAs Presented theDerivative Asset
INCONSISTANTLY
Derivative Asset vs Pipeline
Small Independent Large Public
Source ndash A Greer CPA
bull Warehouse Lenders Rely on CPA for GAAP Capitalbull Lenderrsquos Observe CPA Auditorshellip
ndash Overstate Capital with DAndash Under-apply Cost to Completendash Inconsistently apply Costs to Complete
bull Warehouse Lenders reduce Derivative Asset ndash Some arbitrarily reduce by 50ndash Some reduce based on Net Future Cash Flows
Warehouse Lenderrsquos Adjustment
What about GAAP
bull What does GAAP say about Transformation Costs
bull Direct Cost Deduction Method - direct costs only
bull Full Cost Absorption Method - direct and indirect costs
bull IRLC is a pure derivative - IRLC same as TBA-MBS
bull Net Future Cash Flow Valuation Method (discussed soon)
Transformation Costs or Cost to Completebull What is the value of the IRLC
bull Pull-thru adjusted MTM less Costs to Complete
bull What is the right amount of Transformation Costsbull Direct Cost Deduction Method - direct costs onlybull Full Cost Absorption Method - both direct and indirect costsbull IRLC is a pure derivative ndash no adjustment (IRLC = TBA-MBS)
bull Uncertainty Principalndash Exponential diminishing impact to closingndash You have it when you have it otherwise uncertainndash Day of Lock 99 uncertainty Day before closing 1 uncertainty
IMB Transformational Costs ndash Best PracticesDirect Expenses
bull LO commissions production commissionsbull Other Direct Production Costs
bull appraisals outsourcing courier credit reports other cosbull Other Direct Expenses
bull LO wages processors LOA bull underwriting funding disclosure and post closing
Indirect Expensesbull Allocated Production Rent Branch Rent Branch Overhead
Consequence of Ignoring Indirect Costs
Hawaii vs TexasHigh Balance vs Low Balance
Loan Size Matters
Loan Size Dynamics ndash One Loanbull ONE LOAN
bull High Balance low gainbull Low Balance high gain
bull Derivative Asset
bull Processing costs as of loan are different
bull Profit is same
Higher Gain
$50000000 Locked Pipeline
bull Texas lender is more than double Hawaii
bull Identical Cash Realization
bull Indirect Costs Matter
Direct Costs Only - Distort Results
Derivative Asset Value
View From Finance
Present Value of Net Future Cash Flow
Same as MSR
Derivative Asset OoopsMany CPAs firms have issued opinions on financial statements with derivative asset values I would challenge as not reasonable
Changing Presentation method now creates exposure to Opinion Risk
There is presently no consensus among CPA Auditors about how to apply GAAP
What is the Value of the IRLC - DA
Day of Lock Day Before Closing
High ProbabilityRevenue less Commission
Value is approaching Revenue
UnIncurred Costs Decrease as Percentage of Completion Increases
Low ProbabilityRevenue less all Costs
Value is approaching Zero
What is the value of an Intangible Asset
The Derivative Asset is an Intangible Asset
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
Derivative Asset increases CapitalWe Create a Derivative Asset bybull DR Derivative Asset CR Income
bull What happens to IRLC Income ndash Becomes Capital
IMBs want more Capitalbull More IRLC means more Incomebull More Income means more Capitalbull More Capital means more Warehouse borrowingbull More Capital means qualifying for FHA amp Agencybull More IRLC means more Capital
Derivative Asset
Is Confusing to Business Ownersand leads to bad decisions
Capital Accounts with Derivative AssetThe Derivative Asset is not carried at Fair Value because the Derivative Asset cannot be sold for the carrying value
During 2018 several companies failed Capital = $2 million Derivative Asset = $2 million
The Owner did not understand why they were insolvent
Disclose the Impact of the Derivative Asset in Capital Accountsbull Common Stockbull Paid In Capitalbull Distributionsbull Retained Earnings (Move IRLC MTM impact from NI to Unrealized Gain)bull Unrealized Gain(Loss)
Thanks to Oystein Konsmo CFO at Nova Financial for implementing this practice
Derivative Asset Characteristics
What is the Locked Pipeline
bull IRLC is a lock commitments issued to borrowers bull They are ldquoApplications in Processrdquo bull IRLC are commitments ndash not Loans bull There is no active market for IRLCbull There is no Asset to basis adjust for MTM
bull Is a TBA-MBS tradeable in its current form YES
bull Is a IRLC tradeable in its current form NO
bull The IRLC must be Transformed into a loan then securitized to be valued as tradeable instrument
bull Transformational Costs are unavoidable and undeniable
bull IRLC is not pure derivative but is derivative under GAAP
bull Absorption Costing is a way to understand the basis for Transformational Costs = Work in Process but is it not perfect
bull I think MSR valuation of cash flow is a more accurate measure
Is an IRLC a Tradable Asset
How have CPAs Presented theDerivative Asset
INCONSISTANTLY
Derivative Asset vs Pipeline
Small Independent Large Public
Source ndash A Greer CPA
bull Warehouse Lenders Rely on CPA for GAAP Capitalbull Lenderrsquos Observe CPA Auditorshellip
ndash Overstate Capital with DAndash Under-apply Cost to Completendash Inconsistently apply Costs to Complete
bull Warehouse Lenders reduce Derivative Asset ndash Some arbitrarily reduce by 50ndash Some reduce based on Net Future Cash Flows
Warehouse Lenderrsquos Adjustment
What about GAAP
bull What does GAAP say about Transformation Costs
bull Direct Cost Deduction Method - direct costs only
bull Full Cost Absorption Method - direct and indirect costs
bull IRLC is a pure derivative - IRLC same as TBA-MBS
bull Net Future Cash Flow Valuation Method (discussed soon)
Transformation Costs or Cost to Completebull What is the value of the IRLC
bull Pull-thru adjusted MTM less Costs to Complete
bull What is the right amount of Transformation Costsbull Direct Cost Deduction Method - direct costs onlybull Full Cost Absorption Method - both direct and indirect costsbull IRLC is a pure derivative ndash no adjustment (IRLC = TBA-MBS)
bull Uncertainty Principalndash Exponential diminishing impact to closingndash You have it when you have it otherwise uncertainndash Day of Lock 99 uncertainty Day before closing 1 uncertainty
IMB Transformational Costs ndash Best PracticesDirect Expenses
bull LO commissions production commissionsbull Other Direct Production Costs
bull appraisals outsourcing courier credit reports other cosbull Other Direct Expenses
bull LO wages processors LOA bull underwriting funding disclosure and post closing
Indirect Expensesbull Allocated Production Rent Branch Rent Branch Overhead
Consequence of Ignoring Indirect Costs
Hawaii vs TexasHigh Balance vs Low Balance
Loan Size Matters
Loan Size Dynamics ndash One Loanbull ONE LOAN
bull High Balance low gainbull Low Balance high gain
bull Derivative Asset
bull Processing costs as of loan are different
bull Profit is same
Higher Gain
$50000000 Locked Pipeline
bull Texas lender is more than double Hawaii
bull Identical Cash Realization
bull Indirect Costs Matter
Direct Costs Only - Distort Results
Derivative Asset Value
View From Finance
Present Value of Net Future Cash Flow
Same as MSR
Derivative Asset OoopsMany CPAs firms have issued opinions on financial statements with derivative asset values I would challenge as not reasonable
Changing Presentation method now creates exposure to Opinion Risk
There is presently no consensus among CPA Auditors about how to apply GAAP
What is the Value of the IRLC - DA
Day of Lock Day Before Closing
High ProbabilityRevenue less Commission
Value is approaching Revenue
UnIncurred Costs Decrease as Percentage of Completion Increases
Low ProbabilityRevenue less all Costs
Value is approaching Zero
What is the value of an Intangible Asset
The Derivative Asset is an Intangible Asset
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
IRLC under ASC 815
ASC 815 ndash Commitments
ASC 815 ndash Hedge Accounting
Slide Number 41
Slide Number 42
Slide Number 43
Slide Number 44
Slide Number 45
Slide Number 46
Slide Number 47
Derivative Asset increases Capital
Slide Number 49
Slide Number 50
Slide Number 51
What is the Locked Pipeline
Slide Number 53
Slide Number 54
Slide Number 55
Slide Number 56
What about GAAP
Transformation Costs or Cost to Complete
IMB Transformational Costs ndash Best Practices
Slide Number 60
Slide Number 61
Slide Number 62
Slide Number 63
Derivative Asset Ooops
What is the Value of the IRLC - DA
Slide Number 66
AICPA Valuation Services
AICPA - Discounted Future Benefit
Hedging Data for DA Valuation
Percentage of Completion by Status
Net Cash Flow Valuation Data
IRLC-DA Grows in Value as Costs Incurred
Lock to LHFS DA Value Accretion
Revenue Potential vs Derivative Asset
GAAP Methods Only Right Once
Slide Number 76
IRLC Value is What You Negotiate
Slide Number 78
Slide Number 79
FASB Board Meeting ndash 32818
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
Slide Number 83
IRLC is Taxable when Recorded - BUT
Slide Number 85
Slide Number 86
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
PampL - with and without IRLC
IRLC Revenue is Confusing
Slide Number 91
Slide Number 92
Slide Number 93
Slide Number 94
Slide Number 95
Slide Number 96
What is the Value of the Unrealized Gain in the
Interest Rate Lock Commitments
Derivative Asset increases CapitalWe Create a Derivative Asset bybull DR Derivative Asset CR Income
bull What happens to IRLC Income ndash Becomes Capital
IMBs want more Capitalbull More IRLC means more Incomebull More Income means more Capitalbull More Capital means more Warehouse borrowingbull More Capital means qualifying for FHA amp Agencybull More IRLC means more Capital
Derivative Asset
Is Confusing to Business Ownersand leads to bad decisions
Capital Accounts with Derivative AssetThe Derivative Asset is not carried at Fair Value because the Derivative Asset cannot be sold for the carrying value
During 2018 several companies failed Capital = $2 million Derivative Asset = $2 million
The Owner did not understand why they were insolvent
Disclose the Impact of the Derivative Asset in Capital Accountsbull Common Stockbull Paid In Capitalbull Distributionsbull Retained Earnings (Move IRLC MTM impact from NI to Unrealized Gain)bull Unrealized Gain(Loss)
Thanks to Oystein Konsmo CFO at Nova Financial for implementing this practice
Derivative Asset Characteristics
What is the Locked Pipeline
bull IRLC is a lock commitments issued to borrowers bull They are ldquoApplications in Processrdquo bull IRLC are commitments ndash not Loans bull There is no active market for IRLCbull There is no Asset to basis adjust for MTM
bull Is a TBA-MBS tradeable in its current form YES
bull Is a IRLC tradeable in its current form NO
bull The IRLC must be Transformed into a loan then securitized to be valued as tradeable instrument
bull Transformational Costs are unavoidable and undeniable
bull IRLC is not pure derivative but is derivative under GAAP
bull Absorption Costing is a way to understand the basis for Transformational Costs = Work in Process but is it not perfect
bull I think MSR valuation of cash flow is a more accurate measure
Is an IRLC a Tradable Asset
How have CPAs Presented theDerivative Asset
INCONSISTANTLY
Derivative Asset vs Pipeline
Small Independent Large Public
Source ndash A Greer CPA
bull Warehouse Lenders Rely on CPA for GAAP Capitalbull Lenderrsquos Observe CPA Auditorshellip
ndash Overstate Capital with DAndash Under-apply Cost to Completendash Inconsistently apply Costs to Complete
bull Warehouse Lenders reduce Derivative Asset ndash Some arbitrarily reduce by 50ndash Some reduce based on Net Future Cash Flows
Warehouse Lenderrsquos Adjustment
What about GAAP
bull What does GAAP say about Transformation Costs
bull Direct Cost Deduction Method - direct costs only
bull Full Cost Absorption Method - direct and indirect costs
bull IRLC is a pure derivative - IRLC same as TBA-MBS
bull Net Future Cash Flow Valuation Method (discussed soon)
Transformation Costs or Cost to Completebull What is the value of the IRLC
bull Pull-thru adjusted MTM less Costs to Complete
bull What is the right amount of Transformation Costsbull Direct Cost Deduction Method - direct costs onlybull Full Cost Absorption Method - both direct and indirect costsbull IRLC is a pure derivative ndash no adjustment (IRLC = TBA-MBS)
bull Uncertainty Principalndash Exponential diminishing impact to closingndash You have it when you have it otherwise uncertainndash Day of Lock 99 uncertainty Day before closing 1 uncertainty
IMB Transformational Costs ndash Best PracticesDirect Expenses
bull LO commissions production commissionsbull Other Direct Production Costs
bull appraisals outsourcing courier credit reports other cosbull Other Direct Expenses
bull LO wages processors LOA bull underwriting funding disclosure and post closing
Indirect Expensesbull Allocated Production Rent Branch Rent Branch Overhead
Consequence of Ignoring Indirect Costs
Hawaii vs TexasHigh Balance vs Low Balance
Loan Size Matters
Loan Size Dynamics ndash One Loanbull ONE LOAN
bull High Balance low gainbull Low Balance high gain
bull Derivative Asset
bull Processing costs as of loan are different
bull Profit is same
Higher Gain
$50000000 Locked Pipeline
bull Texas lender is more than double Hawaii
bull Identical Cash Realization
bull Indirect Costs Matter
Direct Costs Only - Distort Results
Derivative Asset Value
View From Finance
Present Value of Net Future Cash Flow
Same as MSR
Derivative Asset OoopsMany CPAs firms have issued opinions on financial statements with derivative asset values I would challenge as not reasonable
Changing Presentation method now creates exposure to Opinion Risk
There is presently no consensus among CPA Auditors about how to apply GAAP
What is the Value of the IRLC - DA
Day of Lock Day Before Closing
High ProbabilityRevenue less Commission
Value is approaching Revenue
UnIncurred Costs Decrease as Percentage of Completion Increases
Low ProbabilityRevenue less all Costs
Value is approaching Zero
What is the value of an Intangible Asset
The Derivative Asset is an Intangible Asset
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
IRLC under ASC 815
ASC 815 ndash Commitments
ASC 815 ndash Hedge Accounting
Slide Number 41
Slide Number 42
Slide Number 43
Slide Number 44
Slide Number 45
Slide Number 46
Slide Number 47
Derivative Asset increases Capital
Slide Number 49
Slide Number 50
Slide Number 51
What is the Locked Pipeline
Slide Number 53
Slide Number 54
Slide Number 55
Slide Number 56
What about GAAP
Transformation Costs or Cost to Complete
IMB Transformational Costs ndash Best Practices
Slide Number 60
Slide Number 61
Slide Number 62
Slide Number 63
Derivative Asset Ooops
What is the Value of the IRLC - DA
Slide Number 66
AICPA Valuation Services
AICPA - Discounted Future Benefit
Hedging Data for DA Valuation
Percentage of Completion by Status
Net Cash Flow Valuation Data
IRLC-DA Grows in Value as Costs Incurred
Lock to LHFS DA Value Accretion
Revenue Potential vs Derivative Asset
GAAP Methods Only Right Once
Slide Number 76
IRLC Value is What You Negotiate
Slide Number 78
Slide Number 79
FASB Board Meeting ndash 32818
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
Slide Number 83
IRLC is Taxable when Recorded - BUT
Slide Number 85
Slide Number 86
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
PampL - with and without IRLC
IRLC Revenue is Confusing
Slide Number 91
Slide Number 92
Slide Number 93
Slide Number 94
Slide Number 95
Slide Number 96
Derivative Asset increases CapitalWe Create a Derivative Asset bybull DR Derivative Asset CR Income
bull What happens to IRLC Income ndash Becomes Capital
IMBs want more Capitalbull More IRLC means more Incomebull More Income means more Capitalbull More Capital means more Warehouse borrowingbull More Capital means qualifying for FHA amp Agencybull More IRLC means more Capital
Derivative Asset
Is Confusing to Business Ownersand leads to bad decisions
Capital Accounts with Derivative AssetThe Derivative Asset is not carried at Fair Value because the Derivative Asset cannot be sold for the carrying value
During 2018 several companies failed Capital = $2 million Derivative Asset = $2 million
The Owner did not understand why they were insolvent
Disclose the Impact of the Derivative Asset in Capital Accountsbull Common Stockbull Paid In Capitalbull Distributionsbull Retained Earnings (Move IRLC MTM impact from NI to Unrealized Gain)bull Unrealized Gain(Loss)
Thanks to Oystein Konsmo CFO at Nova Financial for implementing this practice
Derivative Asset Characteristics
What is the Locked Pipeline
bull IRLC is a lock commitments issued to borrowers bull They are ldquoApplications in Processrdquo bull IRLC are commitments ndash not Loans bull There is no active market for IRLCbull There is no Asset to basis adjust for MTM
bull Is a TBA-MBS tradeable in its current form YES
bull Is a IRLC tradeable in its current form NO
bull The IRLC must be Transformed into a loan then securitized to be valued as tradeable instrument
bull Transformational Costs are unavoidable and undeniable
bull IRLC is not pure derivative but is derivative under GAAP
bull Absorption Costing is a way to understand the basis for Transformational Costs = Work in Process but is it not perfect
bull I think MSR valuation of cash flow is a more accurate measure
Is an IRLC a Tradable Asset
How have CPAs Presented theDerivative Asset
INCONSISTANTLY
Derivative Asset vs Pipeline
Small Independent Large Public
Source ndash A Greer CPA
bull Warehouse Lenders Rely on CPA for GAAP Capitalbull Lenderrsquos Observe CPA Auditorshellip
ndash Overstate Capital with DAndash Under-apply Cost to Completendash Inconsistently apply Costs to Complete
bull Warehouse Lenders reduce Derivative Asset ndash Some arbitrarily reduce by 50ndash Some reduce based on Net Future Cash Flows
Warehouse Lenderrsquos Adjustment
What about GAAP
bull What does GAAP say about Transformation Costs
bull Direct Cost Deduction Method - direct costs only
bull Full Cost Absorption Method - direct and indirect costs
bull IRLC is a pure derivative - IRLC same as TBA-MBS
bull Net Future Cash Flow Valuation Method (discussed soon)
Transformation Costs or Cost to Completebull What is the value of the IRLC
bull Pull-thru adjusted MTM less Costs to Complete
bull What is the right amount of Transformation Costsbull Direct Cost Deduction Method - direct costs onlybull Full Cost Absorption Method - both direct and indirect costsbull IRLC is a pure derivative ndash no adjustment (IRLC = TBA-MBS)
bull Uncertainty Principalndash Exponential diminishing impact to closingndash You have it when you have it otherwise uncertainndash Day of Lock 99 uncertainty Day before closing 1 uncertainty
IMB Transformational Costs ndash Best PracticesDirect Expenses
bull LO commissions production commissionsbull Other Direct Production Costs
bull appraisals outsourcing courier credit reports other cosbull Other Direct Expenses
bull LO wages processors LOA bull underwriting funding disclosure and post closing
Indirect Expensesbull Allocated Production Rent Branch Rent Branch Overhead
Consequence of Ignoring Indirect Costs
Hawaii vs TexasHigh Balance vs Low Balance
Loan Size Matters
Loan Size Dynamics ndash One Loanbull ONE LOAN
bull High Balance low gainbull Low Balance high gain
bull Derivative Asset
bull Processing costs as of loan are different
bull Profit is same
Higher Gain
$50000000 Locked Pipeline
bull Texas lender is more than double Hawaii
bull Identical Cash Realization
bull Indirect Costs Matter
Direct Costs Only - Distort Results
Derivative Asset Value
View From Finance
Present Value of Net Future Cash Flow
Same as MSR
Derivative Asset OoopsMany CPAs firms have issued opinions on financial statements with derivative asset values I would challenge as not reasonable
Changing Presentation method now creates exposure to Opinion Risk
There is presently no consensus among CPA Auditors about how to apply GAAP
What is the Value of the IRLC - DA
Day of Lock Day Before Closing
High ProbabilityRevenue less Commission
Value is approaching Revenue
UnIncurred Costs Decrease as Percentage of Completion Increases
Low ProbabilityRevenue less all Costs
Value is approaching Zero
What is the value of an Intangible Asset
The Derivative Asset is an Intangible Asset
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
IRLC under ASC 815
ASC 815 ndash Commitments
ASC 815 ndash Hedge Accounting
Slide Number 41
Slide Number 42
Slide Number 43
Slide Number 44
Slide Number 45
Slide Number 46
Slide Number 47
Derivative Asset increases Capital
Slide Number 49
Slide Number 50
Slide Number 51
What is the Locked Pipeline
Slide Number 53
Slide Number 54
Slide Number 55
Slide Number 56
What about GAAP
Transformation Costs or Cost to Complete
IMB Transformational Costs ndash Best Practices
Slide Number 60
Slide Number 61
Slide Number 62
Slide Number 63
Derivative Asset Ooops
What is the Value of the IRLC - DA
Slide Number 66
AICPA Valuation Services
AICPA - Discounted Future Benefit
Hedging Data for DA Valuation
Percentage of Completion by Status
Net Cash Flow Valuation Data
IRLC-DA Grows in Value as Costs Incurred
Lock to LHFS DA Value Accretion
Revenue Potential vs Derivative Asset
GAAP Methods Only Right Once
Slide Number 76
IRLC Value is What You Negotiate
Slide Number 78
Slide Number 79
FASB Board Meeting ndash 32818
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
Slide Number 83
IRLC is Taxable when Recorded - BUT
Slide Number 85
Slide Number 86
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
PampL - with and without IRLC
IRLC Revenue is Confusing
Slide Number 91
Slide Number 92
Slide Number 93
Slide Number 94
Slide Number 95
Slide Number 96
Derivative Asset
Is Confusing to Business Ownersand leads to bad decisions
Capital Accounts with Derivative AssetThe Derivative Asset is not carried at Fair Value because the Derivative Asset cannot be sold for the carrying value
During 2018 several companies failed Capital = $2 million Derivative Asset = $2 million
The Owner did not understand why they were insolvent
Disclose the Impact of the Derivative Asset in Capital Accountsbull Common Stockbull Paid In Capitalbull Distributionsbull Retained Earnings (Move IRLC MTM impact from NI to Unrealized Gain)bull Unrealized Gain(Loss)
Thanks to Oystein Konsmo CFO at Nova Financial for implementing this practice
Derivative Asset Characteristics
What is the Locked Pipeline
bull IRLC is a lock commitments issued to borrowers bull They are ldquoApplications in Processrdquo bull IRLC are commitments ndash not Loans bull There is no active market for IRLCbull There is no Asset to basis adjust for MTM
bull Is a TBA-MBS tradeable in its current form YES
bull Is a IRLC tradeable in its current form NO
bull The IRLC must be Transformed into a loan then securitized to be valued as tradeable instrument
bull Transformational Costs are unavoidable and undeniable
bull IRLC is not pure derivative but is derivative under GAAP
bull Absorption Costing is a way to understand the basis for Transformational Costs = Work in Process but is it not perfect
bull I think MSR valuation of cash flow is a more accurate measure
Is an IRLC a Tradable Asset
How have CPAs Presented theDerivative Asset
INCONSISTANTLY
Derivative Asset vs Pipeline
Small Independent Large Public
Source ndash A Greer CPA
bull Warehouse Lenders Rely on CPA for GAAP Capitalbull Lenderrsquos Observe CPA Auditorshellip
ndash Overstate Capital with DAndash Under-apply Cost to Completendash Inconsistently apply Costs to Complete
bull Warehouse Lenders reduce Derivative Asset ndash Some arbitrarily reduce by 50ndash Some reduce based on Net Future Cash Flows
Warehouse Lenderrsquos Adjustment
What about GAAP
bull What does GAAP say about Transformation Costs
bull Direct Cost Deduction Method - direct costs only
bull Full Cost Absorption Method - direct and indirect costs
bull IRLC is a pure derivative - IRLC same as TBA-MBS
bull Net Future Cash Flow Valuation Method (discussed soon)
Transformation Costs or Cost to Completebull What is the value of the IRLC
bull Pull-thru adjusted MTM less Costs to Complete
bull What is the right amount of Transformation Costsbull Direct Cost Deduction Method - direct costs onlybull Full Cost Absorption Method - both direct and indirect costsbull IRLC is a pure derivative ndash no adjustment (IRLC = TBA-MBS)
bull Uncertainty Principalndash Exponential diminishing impact to closingndash You have it when you have it otherwise uncertainndash Day of Lock 99 uncertainty Day before closing 1 uncertainty
IMB Transformational Costs ndash Best PracticesDirect Expenses
bull LO commissions production commissionsbull Other Direct Production Costs
bull appraisals outsourcing courier credit reports other cosbull Other Direct Expenses
bull LO wages processors LOA bull underwriting funding disclosure and post closing
Indirect Expensesbull Allocated Production Rent Branch Rent Branch Overhead
Consequence of Ignoring Indirect Costs
Hawaii vs TexasHigh Balance vs Low Balance
Loan Size Matters
Loan Size Dynamics ndash One Loanbull ONE LOAN
bull High Balance low gainbull Low Balance high gain
bull Derivative Asset
bull Processing costs as of loan are different
bull Profit is same
Higher Gain
$50000000 Locked Pipeline
bull Texas lender is more than double Hawaii
bull Identical Cash Realization
bull Indirect Costs Matter
Direct Costs Only - Distort Results
Derivative Asset Value
View From Finance
Present Value of Net Future Cash Flow
Same as MSR
Derivative Asset OoopsMany CPAs firms have issued opinions on financial statements with derivative asset values I would challenge as not reasonable
Changing Presentation method now creates exposure to Opinion Risk
There is presently no consensus among CPA Auditors about how to apply GAAP
What is the Value of the IRLC - DA
Day of Lock Day Before Closing
High ProbabilityRevenue less Commission
Value is approaching Revenue
UnIncurred Costs Decrease as Percentage of Completion Increases
Low ProbabilityRevenue less all Costs
Value is approaching Zero
What is the value of an Intangible Asset
The Derivative Asset is an Intangible Asset
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
IRLC under ASC 815
ASC 815 ndash Commitments
ASC 815 ndash Hedge Accounting
Slide Number 41
Slide Number 42
Slide Number 43
Slide Number 44
Slide Number 45
Slide Number 46
Slide Number 47
Derivative Asset increases Capital
Slide Number 49
Slide Number 50
Slide Number 51
What is the Locked Pipeline
Slide Number 53
Slide Number 54
Slide Number 55
Slide Number 56
What about GAAP
Transformation Costs or Cost to Complete
IMB Transformational Costs ndash Best Practices
Slide Number 60
Slide Number 61
Slide Number 62
Slide Number 63
Derivative Asset Ooops
What is the Value of the IRLC - DA
Slide Number 66
AICPA Valuation Services
AICPA - Discounted Future Benefit
Hedging Data for DA Valuation
Percentage of Completion by Status
Net Cash Flow Valuation Data
IRLC-DA Grows in Value as Costs Incurred
Lock to LHFS DA Value Accretion
Revenue Potential vs Derivative Asset
GAAP Methods Only Right Once
Slide Number 76
IRLC Value is What You Negotiate
Slide Number 78
Slide Number 79
FASB Board Meeting ndash 32818
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
Slide Number 83
IRLC is Taxable when Recorded - BUT
Slide Number 85
Slide Number 86
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
PampL - with and without IRLC
IRLC Revenue is Confusing
Slide Number 91
Slide Number 92
Slide Number 93
Slide Number 94
Slide Number 95
Slide Number 96
Capital Accounts with Derivative AssetThe Derivative Asset is not carried at Fair Value because the Derivative Asset cannot be sold for the carrying value
During 2018 several companies failed Capital = $2 million Derivative Asset = $2 million
The Owner did not understand why they were insolvent
Disclose the Impact of the Derivative Asset in Capital Accountsbull Common Stockbull Paid In Capitalbull Distributionsbull Retained Earnings (Move IRLC MTM impact from NI to Unrealized Gain)bull Unrealized Gain(Loss)
Thanks to Oystein Konsmo CFO at Nova Financial for implementing this practice
Derivative Asset Characteristics
What is the Locked Pipeline
bull IRLC is a lock commitments issued to borrowers bull They are ldquoApplications in Processrdquo bull IRLC are commitments ndash not Loans bull There is no active market for IRLCbull There is no Asset to basis adjust for MTM
bull Is a TBA-MBS tradeable in its current form YES
bull Is a IRLC tradeable in its current form NO
bull The IRLC must be Transformed into a loan then securitized to be valued as tradeable instrument
bull Transformational Costs are unavoidable and undeniable
bull IRLC is not pure derivative but is derivative under GAAP
bull Absorption Costing is a way to understand the basis for Transformational Costs = Work in Process but is it not perfect
bull I think MSR valuation of cash flow is a more accurate measure
Is an IRLC a Tradable Asset
How have CPAs Presented theDerivative Asset
INCONSISTANTLY
Derivative Asset vs Pipeline
Small Independent Large Public
Source ndash A Greer CPA
bull Warehouse Lenders Rely on CPA for GAAP Capitalbull Lenderrsquos Observe CPA Auditorshellip
ndash Overstate Capital with DAndash Under-apply Cost to Completendash Inconsistently apply Costs to Complete
bull Warehouse Lenders reduce Derivative Asset ndash Some arbitrarily reduce by 50ndash Some reduce based on Net Future Cash Flows
Warehouse Lenderrsquos Adjustment
What about GAAP
bull What does GAAP say about Transformation Costs
bull Direct Cost Deduction Method - direct costs only
bull Full Cost Absorption Method - direct and indirect costs
bull IRLC is a pure derivative - IRLC same as TBA-MBS
bull Net Future Cash Flow Valuation Method (discussed soon)
Transformation Costs or Cost to Completebull What is the value of the IRLC
bull Pull-thru adjusted MTM less Costs to Complete
bull What is the right amount of Transformation Costsbull Direct Cost Deduction Method - direct costs onlybull Full Cost Absorption Method - both direct and indirect costsbull IRLC is a pure derivative ndash no adjustment (IRLC = TBA-MBS)
bull Uncertainty Principalndash Exponential diminishing impact to closingndash You have it when you have it otherwise uncertainndash Day of Lock 99 uncertainty Day before closing 1 uncertainty
IMB Transformational Costs ndash Best PracticesDirect Expenses
bull LO commissions production commissionsbull Other Direct Production Costs
bull appraisals outsourcing courier credit reports other cosbull Other Direct Expenses
bull LO wages processors LOA bull underwriting funding disclosure and post closing
Indirect Expensesbull Allocated Production Rent Branch Rent Branch Overhead
Consequence of Ignoring Indirect Costs
Hawaii vs TexasHigh Balance vs Low Balance
Loan Size Matters
Loan Size Dynamics ndash One Loanbull ONE LOAN
bull High Balance low gainbull Low Balance high gain
bull Derivative Asset
bull Processing costs as of loan are different
bull Profit is same
Higher Gain
$50000000 Locked Pipeline
bull Texas lender is more than double Hawaii
bull Identical Cash Realization
bull Indirect Costs Matter
Direct Costs Only - Distort Results
Derivative Asset Value
View From Finance
Present Value of Net Future Cash Flow
Same as MSR
Derivative Asset OoopsMany CPAs firms have issued opinions on financial statements with derivative asset values I would challenge as not reasonable
Changing Presentation method now creates exposure to Opinion Risk
There is presently no consensus among CPA Auditors about how to apply GAAP
What is the Value of the IRLC - DA
Day of Lock Day Before Closing
High ProbabilityRevenue less Commission
Value is approaching Revenue
UnIncurred Costs Decrease as Percentage of Completion Increases
Low ProbabilityRevenue less all Costs
Value is approaching Zero
What is the value of an Intangible Asset
The Derivative Asset is an Intangible Asset
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
IRLC under ASC 815
ASC 815 ndash Commitments
ASC 815 ndash Hedge Accounting
Slide Number 41
Slide Number 42
Slide Number 43
Slide Number 44
Slide Number 45
Slide Number 46
Slide Number 47
Derivative Asset increases Capital
Slide Number 49
Slide Number 50
Slide Number 51
What is the Locked Pipeline
Slide Number 53
Slide Number 54
Slide Number 55
Slide Number 56
What about GAAP
Transformation Costs or Cost to Complete
IMB Transformational Costs ndash Best Practices
Slide Number 60
Slide Number 61
Slide Number 62
Slide Number 63
Derivative Asset Ooops
What is the Value of the IRLC - DA
Slide Number 66
AICPA Valuation Services
AICPA - Discounted Future Benefit
Hedging Data for DA Valuation
Percentage of Completion by Status
Net Cash Flow Valuation Data
IRLC-DA Grows in Value as Costs Incurred
Lock to LHFS DA Value Accretion
Revenue Potential vs Derivative Asset
GAAP Methods Only Right Once
Slide Number 76
IRLC Value is What You Negotiate
Slide Number 78
Slide Number 79
FASB Board Meeting ndash 32818
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
Slide Number 83
IRLC is Taxable when Recorded - BUT
Slide Number 85
Slide Number 86
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
PampL - with and without IRLC
IRLC Revenue is Confusing
Slide Number 91
Slide Number 92
Slide Number 93
Slide Number 94
Slide Number 95
Slide Number 96
Derivative Asset Characteristics
What is the Locked Pipeline
bull IRLC is a lock commitments issued to borrowers bull They are ldquoApplications in Processrdquo bull IRLC are commitments ndash not Loans bull There is no active market for IRLCbull There is no Asset to basis adjust for MTM
bull Is a TBA-MBS tradeable in its current form YES
bull Is a IRLC tradeable in its current form NO
bull The IRLC must be Transformed into a loan then securitized to be valued as tradeable instrument
bull Transformational Costs are unavoidable and undeniable
bull IRLC is not pure derivative but is derivative under GAAP
bull Absorption Costing is a way to understand the basis for Transformational Costs = Work in Process but is it not perfect
bull I think MSR valuation of cash flow is a more accurate measure
Is an IRLC a Tradable Asset
How have CPAs Presented theDerivative Asset
INCONSISTANTLY
Derivative Asset vs Pipeline
Small Independent Large Public
Source ndash A Greer CPA
bull Warehouse Lenders Rely on CPA for GAAP Capitalbull Lenderrsquos Observe CPA Auditorshellip
ndash Overstate Capital with DAndash Under-apply Cost to Completendash Inconsistently apply Costs to Complete
bull Warehouse Lenders reduce Derivative Asset ndash Some arbitrarily reduce by 50ndash Some reduce based on Net Future Cash Flows
Warehouse Lenderrsquos Adjustment
What about GAAP
bull What does GAAP say about Transformation Costs
bull Direct Cost Deduction Method - direct costs only
bull Full Cost Absorption Method - direct and indirect costs
bull IRLC is a pure derivative - IRLC same as TBA-MBS
bull Net Future Cash Flow Valuation Method (discussed soon)
Transformation Costs or Cost to Completebull What is the value of the IRLC
bull Pull-thru adjusted MTM less Costs to Complete
bull What is the right amount of Transformation Costsbull Direct Cost Deduction Method - direct costs onlybull Full Cost Absorption Method - both direct and indirect costsbull IRLC is a pure derivative ndash no adjustment (IRLC = TBA-MBS)
bull Uncertainty Principalndash Exponential diminishing impact to closingndash You have it when you have it otherwise uncertainndash Day of Lock 99 uncertainty Day before closing 1 uncertainty
IMB Transformational Costs ndash Best PracticesDirect Expenses
bull LO commissions production commissionsbull Other Direct Production Costs
bull appraisals outsourcing courier credit reports other cosbull Other Direct Expenses
bull LO wages processors LOA bull underwriting funding disclosure and post closing
Indirect Expensesbull Allocated Production Rent Branch Rent Branch Overhead
Consequence of Ignoring Indirect Costs
Hawaii vs TexasHigh Balance vs Low Balance
Loan Size Matters
Loan Size Dynamics ndash One Loanbull ONE LOAN
bull High Balance low gainbull Low Balance high gain
bull Derivative Asset
bull Processing costs as of loan are different
bull Profit is same
Higher Gain
$50000000 Locked Pipeline
bull Texas lender is more than double Hawaii
bull Identical Cash Realization
bull Indirect Costs Matter
Direct Costs Only - Distort Results
Derivative Asset Value
View From Finance
Present Value of Net Future Cash Flow
Same as MSR
Derivative Asset OoopsMany CPAs firms have issued opinions on financial statements with derivative asset values I would challenge as not reasonable
Changing Presentation method now creates exposure to Opinion Risk
There is presently no consensus among CPA Auditors about how to apply GAAP
What is the Value of the IRLC - DA
Day of Lock Day Before Closing
High ProbabilityRevenue less Commission
Value is approaching Revenue
UnIncurred Costs Decrease as Percentage of Completion Increases
Low ProbabilityRevenue less all Costs
Value is approaching Zero
What is the value of an Intangible Asset
The Derivative Asset is an Intangible Asset
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
IRLC under ASC 815
ASC 815 ndash Commitments
ASC 815 ndash Hedge Accounting
Slide Number 41
Slide Number 42
Slide Number 43
Slide Number 44
Slide Number 45
Slide Number 46
Slide Number 47
Derivative Asset increases Capital
Slide Number 49
Slide Number 50
Slide Number 51
What is the Locked Pipeline
Slide Number 53
Slide Number 54
Slide Number 55
Slide Number 56
What about GAAP
Transformation Costs or Cost to Complete
IMB Transformational Costs ndash Best Practices
Slide Number 60
Slide Number 61
Slide Number 62
Slide Number 63
Derivative Asset Ooops
What is the Value of the IRLC - DA
Slide Number 66
AICPA Valuation Services
AICPA - Discounted Future Benefit
Hedging Data for DA Valuation
Percentage of Completion by Status
Net Cash Flow Valuation Data
IRLC-DA Grows in Value as Costs Incurred
Lock to LHFS DA Value Accretion
Revenue Potential vs Derivative Asset
GAAP Methods Only Right Once
Slide Number 76
IRLC Value is What You Negotiate
Slide Number 78
Slide Number 79
FASB Board Meeting ndash 32818
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
Slide Number 83
IRLC is Taxable when Recorded - BUT
Slide Number 85
Slide Number 86
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
PampL - with and without IRLC
IRLC Revenue is Confusing
Slide Number 91
Slide Number 92
Slide Number 93
Slide Number 94
Slide Number 95
Slide Number 96
What is the Locked Pipeline
bull IRLC is a lock commitments issued to borrowers bull They are ldquoApplications in Processrdquo bull IRLC are commitments ndash not Loans bull There is no active market for IRLCbull There is no Asset to basis adjust for MTM
bull Is a TBA-MBS tradeable in its current form YES
bull Is a IRLC tradeable in its current form NO
bull The IRLC must be Transformed into a loan then securitized to be valued as tradeable instrument
bull Transformational Costs are unavoidable and undeniable
bull IRLC is not pure derivative but is derivative under GAAP
bull Absorption Costing is a way to understand the basis for Transformational Costs = Work in Process but is it not perfect
bull I think MSR valuation of cash flow is a more accurate measure
Is an IRLC a Tradable Asset
How have CPAs Presented theDerivative Asset
INCONSISTANTLY
Derivative Asset vs Pipeline
Small Independent Large Public
Source ndash A Greer CPA
bull Warehouse Lenders Rely on CPA for GAAP Capitalbull Lenderrsquos Observe CPA Auditorshellip
ndash Overstate Capital with DAndash Under-apply Cost to Completendash Inconsistently apply Costs to Complete
bull Warehouse Lenders reduce Derivative Asset ndash Some arbitrarily reduce by 50ndash Some reduce based on Net Future Cash Flows
Warehouse Lenderrsquos Adjustment
What about GAAP
bull What does GAAP say about Transformation Costs
bull Direct Cost Deduction Method - direct costs only
bull Full Cost Absorption Method - direct and indirect costs
bull IRLC is a pure derivative - IRLC same as TBA-MBS
bull Net Future Cash Flow Valuation Method (discussed soon)
Transformation Costs or Cost to Completebull What is the value of the IRLC
bull Pull-thru adjusted MTM less Costs to Complete
bull What is the right amount of Transformation Costsbull Direct Cost Deduction Method - direct costs onlybull Full Cost Absorption Method - both direct and indirect costsbull IRLC is a pure derivative ndash no adjustment (IRLC = TBA-MBS)
bull Uncertainty Principalndash Exponential diminishing impact to closingndash You have it when you have it otherwise uncertainndash Day of Lock 99 uncertainty Day before closing 1 uncertainty
IMB Transformational Costs ndash Best PracticesDirect Expenses
bull LO commissions production commissionsbull Other Direct Production Costs
bull appraisals outsourcing courier credit reports other cosbull Other Direct Expenses
bull LO wages processors LOA bull underwriting funding disclosure and post closing
Indirect Expensesbull Allocated Production Rent Branch Rent Branch Overhead
Consequence of Ignoring Indirect Costs
Hawaii vs TexasHigh Balance vs Low Balance
Loan Size Matters
Loan Size Dynamics ndash One Loanbull ONE LOAN
bull High Balance low gainbull Low Balance high gain
bull Derivative Asset
bull Processing costs as of loan are different
bull Profit is same
Higher Gain
$50000000 Locked Pipeline
bull Texas lender is more than double Hawaii
bull Identical Cash Realization
bull Indirect Costs Matter
Direct Costs Only - Distort Results
Derivative Asset Value
View From Finance
Present Value of Net Future Cash Flow
Same as MSR
Derivative Asset OoopsMany CPAs firms have issued opinions on financial statements with derivative asset values I would challenge as not reasonable
Changing Presentation method now creates exposure to Opinion Risk
There is presently no consensus among CPA Auditors about how to apply GAAP
What is the Value of the IRLC - DA
Day of Lock Day Before Closing
High ProbabilityRevenue less Commission
Value is approaching Revenue
UnIncurred Costs Decrease as Percentage of Completion Increases
Low ProbabilityRevenue less all Costs
Value is approaching Zero
What is the value of an Intangible Asset
The Derivative Asset is an Intangible Asset
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
IRLC under ASC 815
ASC 815 ndash Commitments
ASC 815 ndash Hedge Accounting
Slide Number 41
Slide Number 42
Slide Number 43
Slide Number 44
Slide Number 45
Slide Number 46
Slide Number 47
Derivative Asset increases Capital
Slide Number 49
Slide Number 50
Slide Number 51
What is the Locked Pipeline
Slide Number 53
Slide Number 54
Slide Number 55
Slide Number 56
What about GAAP
Transformation Costs or Cost to Complete
IMB Transformational Costs ndash Best Practices
Slide Number 60
Slide Number 61
Slide Number 62
Slide Number 63
Derivative Asset Ooops
What is the Value of the IRLC - DA
Slide Number 66
AICPA Valuation Services
AICPA - Discounted Future Benefit
Hedging Data for DA Valuation
Percentage of Completion by Status
Net Cash Flow Valuation Data
IRLC-DA Grows in Value as Costs Incurred
Lock to LHFS DA Value Accretion
Revenue Potential vs Derivative Asset
GAAP Methods Only Right Once
Slide Number 76
IRLC Value is What You Negotiate
Slide Number 78
Slide Number 79
FASB Board Meeting ndash 32818
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
Slide Number 83
IRLC is Taxable when Recorded - BUT
Slide Number 85
Slide Number 86
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
PampL - with and without IRLC
IRLC Revenue is Confusing
Slide Number 91
Slide Number 92
Slide Number 93
Slide Number 94
Slide Number 95
Slide Number 96
bull Is a TBA-MBS tradeable in its current form YES
bull Is a IRLC tradeable in its current form NO
bull The IRLC must be Transformed into a loan then securitized to be valued as tradeable instrument
bull Transformational Costs are unavoidable and undeniable
bull IRLC is not pure derivative but is derivative under GAAP
bull Absorption Costing is a way to understand the basis for Transformational Costs = Work in Process but is it not perfect
bull I think MSR valuation of cash flow is a more accurate measure
Is an IRLC a Tradable Asset
How have CPAs Presented theDerivative Asset
INCONSISTANTLY
Derivative Asset vs Pipeline
Small Independent Large Public
Source ndash A Greer CPA
bull Warehouse Lenders Rely on CPA for GAAP Capitalbull Lenderrsquos Observe CPA Auditorshellip
ndash Overstate Capital with DAndash Under-apply Cost to Completendash Inconsistently apply Costs to Complete
bull Warehouse Lenders reduce Derivative Asset ndash Some arbitrarily reduce by 50ndash Some reduce based on Net Future Cash Flows
Warehouse Lenderrsquos Adjustment
What about GAAP
bull What does GAAP say about Transformation Costs
bull Direct Cost Deduction Method - direct costs only
bull Full Cost Absorption Method - direct and indirect costs
bull IRLC is a pure derivative - IRLC same as TBA-MBS
bull Net Future Cash Flow Valuation Method (discussed soon)
Transformation Costs or Cost to Completebull What is the value of the IRLC
bull Pull-thru adjusted MTM less Costs to Complete
bull What is the right amount of Transformation Costsbull Direct Cost Deduction Method - direct costs onlybull Full Cost Absorption Method - both direct and indirect costsbull IRLC is a pure derivative ndash no adjustment (IRLC = TBA-MBS)
bull Uncertainty Principalndash Exponential diminishing impact to closingndash You have it when you have it otherwise uncertainndash Day of Lock 99 uncertainty Day before closing 1 uncertainty
IMB Transformational Costs ndash Best PracticesDirect Expenses
bull LO commissions production commissionsbull Other Direct Production Costs
bull appraisals outsourcing courier credit reports other cosbull Other Direct Expenses
bull LO wages processors LOA bull underwriting funding disclosure and post closing
Indirect Expensesbull Allocated Production Rent Branch Rent Branch Overhead
Consequence of Ignoring Indirect Costs
Hawaii vs TexasHigh Balance vs Low Balance
Loan Size Matters
Loan Size Dynamics ndash One Loanbull ONE LOAN
bull High Balance low gainbull Low Balance high gain
bull Derivative Asset
bull Processing costs as of loan are different
bull Profit is same
Higher Gain
$50000000 Locked Pipeline
bull Texas lender is more than double Hawaii
bull Identical Cash Realization
bull Indirect Costs Matter
Direct Costs Only - Distort Results
Derivative Asset Value
View From Finance
Present Value of Net Future Cash Flow
Same as MSR
Derivative Asset OoopsMany CPAs firms have issued opinions on financial statements with derivative asset values I would challenge as not reasonable
Changing Presentation method now creates exposure to Opinion Risk
There is presently no consensus among CPA Auditors about how to apply GAAP
What is the Value of the IRLC - DA
Day of Lock Day Before Closing
High ProbabilityRevenue less Commission
Value is approaching Revenue
UnIncurred Costs Decrease as Percentage of Completion Increases
Low ProbabilityRevenue less all Costs
Value is approaching Zero
What is the value of an Intangible Asset
The Derivative Asset is an Intangible Asset
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
IRLC under ASC 815
ASC 815 ndash Commitments
ASC 815 ndash Hedge Accounting
Slide Number 41
Slide Number 42
Slide Number 43
Slide Number 44
Slide Number 45
Slide Number 46
Slide Number 47
Derivative Asset increases Capital
Slide Number 49
Slide Number 50
Slide Number 51
What is the Locked Pipeline
Slide Number 53
Slide Number 54
Slide Number 55
Slide Number 56
What about GAAP
Transformation Costs or Cost to Complete
IMB Transformational Costs ndash Best Practices
Slide Number 60
Slide Number 61
Slide Number 62
Slide Number 63
Derivative Asset Ooops
What is the Value of the IRLC - DA
Slide Number 66
AICPA Valuation Services
AICPA - Discounted Future Benefit
Hedging Data for DA Valuation
Percentage of Completion by Status
Net Cash Flow Valuation Data
IRLC-DA Grows in Value as Costs Incurred
Lock to LHFS DA Value Accretion
Revenue Potential vs Derivative Asset
GAAP Methods Only Right Once
Slide Number 76
IRLC Value is What You Negotiate
Slide Number 78
Slide Number 79
FASB Board Meeting ndash 32818
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
Slide Number 83
IRLC is Taxable when Recorded - BUT
Slide Number 85
Slide Number 86
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
PampL - with and without IRLC
IRLC Revenue is Confusing
Slide Number 91
Slide Number 92
Slide Number 93
Slide Number 94
Slide Number 95
Slide Number 96
How have CPAs Presented theDerivative Asset
INCONSISTANTLY
Derivative Asset vs Pipeline
Small Independent Large Public
Source ndash A Greer CPA
bull Warehouse Lenders Rely on CPA for GAAP Capitalbull Lenderrsquos Observe CPA Auditorshellip
ndash Overstate Capital with DAndash Under-apply Cost to Completendash Inconsistently apply Costs to Complete
bull Warehouse Lenders reduce Derivative Asset ndash Some arbitrarily reduce by 50ndash Some reduce based on Net Future Cash Flows
Warehouse Lenderrsquos Adjustment
What about GAAP
bull What does GAAP say about Transformation Costs
bull Direct Cost Deduction Method - direct costs only
bull Full Cost Absorption Method - direct and indirect costs
bull IRLC is a pure derivative - IRLC same as TBA-MBS
bull Net Future Cash Flow Valuation Method (discussed soon)
Transformation Costs or Cost to Completebull What is the value of the IRLC
bull Pull-thru adjusted MTM less Costs to Complete
bull What is the right amount of Transformation Costsbull Direct Cost Deduction Method - direct costs onlybull Full Cost Absorption Method - both direct and indirect costsbull IRLC is a pure derivative ndash no adjustment (IRLC = TBA-MBS)
bull Uncertainty Principalndash Exponential diminishing impact to closingndash You have it when you have it otherwise uncertainndash Day of Lock 99 uncertainty Day before closing 1 uncertainty
IMB Transformational Costs ndash Best PracticesDirect Expenses
bull LO commissions production commissionsbull Other Direct Production Costs
bull appraisals outsourcing courier credit reports other cosbull Other Direct Expenses
bull LO wages processors LOA bull underwriting funding disclosure and post closing
Indirect Expensesbull Allocated Production Rent Branch Rent Branch Overhead
Consequence of Ignoring Indirect Costs
Hawaii vs TexasHigh Balance vs Low Balance
Loan Size Matters
Loan Size Dynamics ndash One Loanbull ONE LOAN
bull High Balance low gainbull Low Balance high gain
bull Derivative Asset
bull Processing costs as of loan are different
bull Profit is same
Higher Gain
$50000000 Locked Pipeline
bull Texas lender is more than double Hawaii
bull Identical Cash Realization
bull Indirect Costs Matter
Direct Costs Only - Distort Results
Derivative Asset Value
View From Finance
Present Value of Net Future Cash Flow
Same as MSR
Derivative Asset OoopsMany CPAs firms have issued opinions on financial statements with derivative asset values I would challenge as not reasonable
Changing Presentation method now creates exposure to Opinion Risk
There is presently no consensus among CPA Auditors about how to apply GAAP
What is the Value of the IRLC - DA
Day of Lock Day Before Closing
High ProbabilityRevenue less Commission
Value is approaching Revenue
UnIncurred Costs Decrease as Percentage of Completion Increases
Low ProbabilityRevenue less all Costs
Value is approaching Zero
What is the value of an Intangible Asset
The Derivative Asset is an Intangible Asset
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
IRLC under ASC 815
ASC 815 ndash Commitments
ASC 815 ndash Hedge Accounting
Slide Number 41
Slide Number 42
Slide Number 43
Slide Number 44
Slide Number 45
Slide Number 46
Slide Number 47
Derivative Asset increases Capital
Slide Number 49
Slide Number 50
Slide Number 51
What is the Locked Pipeline
Slide Number 53
Slide Number 54
Slide Number 55
Slide Number 56
What about GAAP
Transformation Costs or Cost to Complete
IMB Transformational Costs ndash Best Practices
Slide Number 60
Slide Number 61
Slide Number 62
Slide Number 63
Derivative Asset Ooops
What is the Value of the IRLC - DA
Slide Number 66
AICPA Valuation Services
AICPA - Discounted Future Benefit
Hedging Data for DA Valuation
Percentage of Completion by Status
Net Cash Flow Valuation Data
IRLC-DA Grows in Value as Costs Incurred
Lock to LHFS DA Value Accretion
Revenue Potential vs Derivative Asset
GAAP Methods Only Right Once
Slide Number 76
IRLC Value is What You Negotiate
Slide Number 78
Slide Number 79
FASB Board Meeting ndash 32818
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
Slide Number 83
IRLC is Taxable when Recorded - BUT
Slide Number 85
Slide Number 86
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
PampL - with and without IRLC
IRLC Revenue is Confusing
Slide Number 91
Slide Number 92
Slide Number 93
Slide Number 94
Slide Number 95
Slide Number 96
Derivative Asset vs Pipeline
Small Independent Large Public
Source ndash A Greer CPA
bull Warehouse Lenders Rely on CPA for GAAP Capitalbull Lenderrsquos Observe CPA Auditorshellip
ndash Overstate Capital with DAndash Under-apply Cost to Completendash Inconsistently apply Costs to Complete
bull Warehouse Lenders reduce Derivative Asset ndash Some arbitrarily reduce by 50ndash Some reduce based on Net Future Cash Flows
Warehouse Lenderrsquos Adjustment
What about GAAP
bull What does GAAP say about Transformation Costs
bull Direct Cost Deduction Method - direct costs only
bull Full Cost Absorption Method - direct and indirect costs
bull IRLC is a pure derivative - IRLC same as TBA-MBS
bull Net Future Cash Flow Valuation Method (discussed soon)
Transformation Costs or Cost to Completebull What is the value of the IRLC
bull Pull-thru adjusted MTM less Costs to Complete
bull What is the right amount of Transformation Costsbull Direct Cost Deduction Method - direct costs onlybull Full Cost Absorption Method - both direct and indirect costsbull IRLC is a pure derivative ndash no adjustment (IRLC = TBA-MBS)
bull Uncertainty Principalndash Exponential diminishing impact to closingndash You have it when you have it otherwise uncertainndash Day of Lock 99 uncertainty Day before closing 1 uncertainty
IMB Transformational Costs ndash Best PracticesDirect Expenses
bull LO commissions production commissionsbull Other Direct Production Costs
bull appraisals outsourcing courier credit reports other cosbull Other Direct Expenses
bull LO wages processors LOA bull underwriting funding disclosure and post closing
Indirect Expensesbull Allocated Production Rent Branch Rent Branch Overhead
Consequence of Ignoring Indirect Costs
Hawaii vs TexasHigh Balance vs Low Balance
Loan Size Matters
Loan Size Dynamics ndash One Loanbull ONE LOAN
bull High Balance low gainbull Low Balance high gain
bull Derivative Asset
bull Processing costs as of loan are different
bull Profit is same
Higher Gain
$50000000 Locked Pipeline
bull Texas lender is more than double Hawaii
bull Identical Cash Realization
bull Indirect Costs Matter
Direct Costs Only - Distort Results
Derivative Asset Value
View From Finance
Present Value of Net Future Cash Flow
Same as MSR
Derivative Asset OoopsMany CPAs firms have issued opinions on financial statements with derivative asset values I would challenge as not reasonable
Changing Presentation method now creates exposure to Opinion Risk
There is presently no consensus among CPA Auditors about how to apply GAAP
What is the Value of the IRLC - DA
Day of Lock Day Before Closing
High ProbabilityRevenue less Commission
Value is approaching Revenue
UnIncurred Costs Decrease as Percentage of Completion Increases
Low ProbabilityRevenue less all Costs
Value is approaching Zero
What is the value of an Intangible Asset
The Derivative Asset is an Intangible Asset
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
IRLC under ASC 815
ASC 815 ndash Commitments
ASC 815 ndash Hedge Accounting
Slide Number 41
Slide Number 42
Slide Number 43
Slide Number 44
Slide Number 45
Slide Number 46
Slide Number 47
Derivative Asset increases Capital
Slide Number 49
Slide Number 50
Slide Number 51
What is the Locked Pipeline
Slide Number 53
Slide Number 54
Slide Number 55
Slide Number 56
What about GAAP
Transformation Costs or Cost to Complete
IMB Transformational Costs ndash Best Practices
Slide Number 60
Slide Number 61
Slide Number 62
Slide Number 63
Derivative Asset Ooops
What is the Value of the IRLC - DA
Slide Number 66
AICPA Valuation Services
AICPA - Discounted Future Benefit
Hedging Data for DA Valuation
Percentage of Completion by Status
Net Cash Flow Valuation Data
IRLC-DA Grows in Value as Costs Incurred
Lock to LHFS DA Value Accretion
Revenue Potential vs Derivative Asset
GAAP Methods Only Right Once
Slide Number 76
IRLC Value is What You Negotiate
Slide Number 78
Slide Number 79
FASB Board Meeting ndash 32818
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
Slide Number 83
IRLC is Taxable when Recorded - BUT
Slide Number 85
Slide Number 86
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
PampL - with and without IRLC
IRLC Revenue is Confusing
Slide Number 91
Slide Number 92
Slide Number 93
Slide Number 94
Slide Number 95
Slide Number 96
bull Warehouse Lenders Rely on CPA for GAAP Capitalbull Lenderrsquos Observe CPA Auditorshellip
ndash Overstate Capital with DAndash Under-apply Cost to Completendash Inconsistently apply Costs to Complete
bull Warehouse Lenders reduce Derivative Asset ndash Some arbitrarily reduce by 50ndash Some reduce based on Net Future Cash Flows
Warehouse Lenderrsquos Adjustment
What about GAAP
bull What does GAAP say about Transformation Costs
bull Direct Cost Deduction Method - direct costs only
bull Full Cost Absorption Method - direct and indirect costs
bull IRLC is a pure derivative - IRLC same as TBA-MBS
bull Net Future Cash Flow Valuation Method (discussed soon)
Transformation Costs or Cost to Completebull What is the value of the IRLC
bull Pull-thru adjusted MTM less Costs to Complete
bull What is the right amount of Transformation Costsbull Direct Cost Deduction Method - direct costs onlybull Full Cost Absorption Method - both direct and indirect costsbull IRLC is a pure derivative ndash no adjustment (IRLC = TBA-MBS)
bull Uncertainty Principalndash Exponential diminishing impact to closingndash You have it when you have it otherwise uncertainndash Day of Lock 99 uncertainty Day before closing 1 uncertainty
IMB Transformational Costs ndash Best PracticesDirect Expenses
bull LO commissions production commissionsbull Other Direct Production Costs
bull appraisals outsourcing courier credit reports other cosbull Other Direct Expenses
bull LO wages processors LOA bull underwriting funding disclosure and post closing
Indirect Expensesbull Allocated Production Rent Branch Rent Branch Overhead
Consequence of Ignoring Indirect Costs
Hawaii vs TexasHigh Balance vs Low Balance
Loan Size Matters
Loan Size Dynamics ndash One Loanbull ONE LOAN
bull High Balance low gainbull Low Balance high gain
bull Derivative Asset
bull Processing costs as of loan are different
bull Profit is same
Higher Gain
$50000000 Locked Pipeline
bull Texas lender is more than double Hawaii
bull Identical Cash Realization
bull Indirect Costs Matter
Direct Costs Only - Distort Results
Derivative Asset Value
View From Finance
Present Value of Net Future Cash Flow
Same as MSR
Derivative Asset OoopsMany CPAs firms have issued opinions on financial statements with derivative asset values I would challenge as not reasonable
Changing Presentation method now creates exposure to Opinion Risk
There is presently no consensus among CPA Auditors about how to apply GAAP
What is the Value of the IRLC - DA
Day of Lock Day Before Closing
High ProbabilityRevenue less Commission
Value is approaching Revenue
UnIncurred Costs Decrease as Percentage of Completion Increases
Low ProbabilityRevenue less all Costs
Value is approaching Zero
What is the value of an Intangible Asset
The Derivative Asset is an Intangible Asset
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
IRLC under ASC 815
ASC 815 ndash Commitments
ASC 815 ndash Hedge Accounting
Slide Number 41
Slide Number 42
Slide Number 43
Slide Number 44
Slide Number 45
Slide Number 46
Slide Number 47
Derivative Asset increases Capital
Slide Number 49
Slide Number 50
Slide Number 51
What is the Locked Pipeline
Slide Number 53
Slide Number 54
Slide Number 55
Slide Number 56
What about GAAP
Transformation Costs or Cost to Complete
IMB Transformational Costs ndash Best Practices
Slide Number 60
Slide Number 61
Slide Number 62
Slide Number 63
Derivative Asset Ooops
What is the Value of the IRLC - DA
Slide Number 66
AICPA Valuation Services
AICPA - Discounted Future Benefit
Hedging Data for DA Valuation
Percentage of Completion by Status
Net Cash Flow Valuation Data
IRLC-DA Grows in Value as Costs Incurred
Lock to LHFS DA Value Accretion
Revenue Potential vs Derivative Asset
GAAP Methods Only Right Once
Slide Number 76
IRLC Value is What You Negotiate
Slide Number 78
Slide Number 79
FASB Board Meeting ndash 32818
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
Slide Number 83
IRLC is Taxable when Recorded - BUT
Slide Number 85
Slide Number 86
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
PampL - with and without IRLC
IRLC Revenue is Confusing
Slide Number 91
Slide Number 92
Slide Number 93
Slide Number 94
Slide Number 95
Slide Number 96
What about GAAP
bull What does GAAP say about Transformation Costs
bull Direct Cost Deduction Method - direct costs only
bull Full Cost Absorption Method - direct and indirect costs
bull IRLC is a pure derivative - IRLC same as TBA-MBS
bull Net Future Cash Flow Valuation Method (discussed soon)
Transformation Costs or Cost to Completebull What is the value of the IRLC
bull Pull-thru adjusted MTM less Costs to Complete
bull What is the right amount of Transformation Costsbull Direct Cost Deduction Method - direct costs onlybull Full Cost Absorption Method - both direct and indirect costsbull IRLC is a pure derivative ndash no adjustment (IRLC = TBA-MBS)
bull Uncertainty Principalndash Exponential diminishing impact to closingndash You have it when you have it otherwise uncertainndash Day of Lock 99 uncertainty Day before closing 1 uncertainty
IMB Transformational Costs ndash Best PracticesDirect Expenses
bull LO commissions production commissionsbull Other Direct Production Costs
bull appraisals outsourcing courier credit reports other cosbull Other Direct Expenses
bull LO wages processors LOA bull underwriting funding disclosure and post closing
Indirect Expensesbull Allocated Production Rent Branch Rent Branch Overhead
Consequence of Ignoring Indirect Costs
Hawaii vs TexasHigh Balance vs Low Balance
Loan Size Matters
Loan Size Dynamics ndash One Loanbull ONE LOAN
bull High Balance low gainbull Low Balance high gain
bull Derivative Asset
bull Processing costs as of loan are different
bull Profit is same
Higher Gain
$50000000 Locked Pipeline
bull Texas lender is more than double Hawaii
bull Identical Cash Realization
bull Indirect Costs Matter
Direct Costs Only - Distort Results
Derivative Asset Value
View From Finance
Present Value of Net Future Cash Flow
Same as MSR
Derivative Asset OoopsMany CPAs firms have issued opinions on financial statements with derivative asset values I would challenge as not reasonable
Changing Presentation method now creates exposure to Opinion Risk
There is presently no consensus among CPA Auditors about how to apply GAAP
What is the Value of the IRLC - DA
Day of Lock Day Before Closing
High ProbabilityRevenue less Commission
Value is approaching Revenue
UnIncurred Costs Decrease as Percentage of Completion Increases
Low ProbabilityRevenue less all Costs
Value is approaching Zero
What is the value of an Intangible Asset
The Derivative Asset is an Intangible Asset
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
IRLC under ASC 815
ASC 815 ndash Commitments
ASC 815 ndash Hedge Accounting
Slide Number 41
Slide Number 42
Slide Number 43
Slide Number 44
Slide Number 45
Slide Number 46
Slide Number 47
Derivative Asset increases Capital
Slide Number 49
Slide Number 50
Slide Number 51
What is the Locked Pipeline
Slide Number 53
Slide Number 54
Slide Number 55
Slide Number 56
What about GAAP
Transformation Costs or Cost to Complete
IMB Transformational Costs ndash Best Practices
Slide Number 60
Slide Number 61
Slide Number 62
Slide Number 63
Derivative Asset Ooops
What is the Value of the IRLC - DA
Slide Number 66
AICPA Valuation Services
AICPA - Discounted Future Benefit
Hedging Data for DA Valuation
Percentage of Completion by Status
Net Cash Flow Valuation Data
IRLC-DA Grows in Value as Costs Incurred
Lock to LHFS DA Value Accretion
Revenue Potential vs Derivative Asset
GAAP Methods Only Right Once
Slide Number 76
IRLC Value is What You Negotiate
Slide Number 78
Slide Number 79
FASB Board Meeting ndash 32818
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
Slide Number 83
IRLC is Taxable when Recorded - BUT
Slide Number 85
Slide Number 86
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
PampL - with and without IRLC
IRLC Revenue is Confusing
Slide Number 91
Slide Number 92
Slide Number 93
Slide Number 94
Slide Number 95
Slide Number 96
Transformation Costs or Cost to Completebull What is the value of the IRLC
bull Pull-thru adjusted MTM less Costs to Complete
bull What is the right amount of Transformation Costsbull Direct Cost Deduction Method - direct costs onlybull Full Cost Absorption Method - both direct and indirect costsbull IRLC is a pure derivative ndash no adjustment (IRLC = TBA-MBS)
bull Uncertainty Principalndash Exponential diminishing impact to closingndash You have it when you have it otherwise uncertainndash Day of Lock 99 uncertainty Day before closing 1 uncertainty
IMB Transformational Costs ndash Best PracticesDirect Expenses
bull LO commissions production commissionsbull Other Direct Production Costs
bull appraisals outsourcing courier credit reports other cosbull Other Direct Expenses
bull LO wages processors LOA bull underwriting funding disclosure and post closing
Indirect Expensesbull Allocated Production Rent Branch Rent Branch Overhead
Consequence of Ignoring Indirect Costs
Hawaii vs TexasHigh Balance vs Low Balance
Loan Size Matters
Loan Size Dynamics ndash One Loanbull ONE LOAN
bull High Balance low gainbull Low Balance high gain
bull Derivative Asset
bull Processing costs as of loan are different
bull Profit is same
Higher Gain
$50000000 Locked Pipeline
bull Texas lender is more than double Hawaii
bull Identical Cash Realization
bull Indirect Costs Matter
Direct Costs Only - Distort Results
Derivative Asset Value
View From Finance
Present Value of Net Future Cash Flow
Same as MSR
Derivative Asset OoopsMany CPAs firms have issued opinions on financial statements with derivative asset values I would challenge as not reasonable
Changing Presentation method now creates exposure to Opinion Risk
There is presently no consensus among CPA Auditors about how to apply GAAP
What is the Value of the IRLC - DA
Day of Lock Day Before Closing
High ProbabilityRevenue less Commission
Value is approaching Revenue
UnIncurred Costs Decrease as Percentage of Completion Increases
Low ProbabilityRevenue less all Costs
Value is approaching Zero
What is the value of an Intangible Asset
The Derivative Asset is an Intangible Asset
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
IRLC under ASC 815
ASC 815 ndash Commitments
ASC 815 ndash Hedge Accounting
Slide Number 41
Slide Number 42
Slide Number 43
Slide Number 44
Slide Number 45
Slide Number 46
Slide Number 47
Derivative Asset increases Capital
Slide Number 49
Slide Number 50
Slide Number 51
What is the Locked Pipeline
Slide Number 53
Slide Number 54
Slide Number 55
Slide Number 56
What about GAAP
Transformation Costs or Cost to Complete
IMB Transformational Costs ndash Best Practices
Slide Number 60
Slide Number 61
Slide Number 62
Slide Number 63
Derivative Asset Ooops
What is the Value of the IRLC - DA
Slide Number 66
AICPA Valuation Services
AICPA - Discounted Future Benefit
Hedging Data for DA Valuation
Percentage of Completion by Status
Net Cash Flow Valuation Data
IRLC-DA Grows in Value as Costs Incurred
Lock to LHFS DA Value Accretion
Revenue Potential vs Derivative Asset
GAAP Methods Only Right Once
Slide Number 76
IRLC Value is What You Negotiate
Slide Number 78
Slide Number 79
FASB Board Meeting ndash 32818
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
Slide Number 83
IRLC is Taxable when Recorded - BUT
Slide Number 85
Slide Number 86
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
PampL - with and without IRLC
IRLC Revenue is Confusing
Slide Number 91
Slide Number 92
Slide Number 93
Slide Number 94
Slide Number 95
Slide Number 96
IMB Transformational Costs ndash Best PracticesDirect Expenses
bull LO commissions production commissionsbull Other Direct Production Costs
bull appraisals outsourcing courier credit reports other cosbull Other Direct Expenses
bull LO wages processors LOA bull underwriting funding disclosure and post closing
Indirect Expensesbull Allocated Production Rent Branch Rent Branch Overhead
Consequence of Ignoring Indirect Costs
Hawaii vs TexasHigh Balance vs Low Balance
Loan Size Matters
Loan Size Dynamics ndash One Loanbull ONE LOAN
bull High Balance low gainbull Low Balance high gain
bull Derivative Asset
bull Processing costs as of loan are different
bull Profit is same
Higher Gain
$50000000 Locked Pipeline
bull Texas lender is more than double Hawaii
bull Identical Cash Realization
bull Indirect Costs Matter
Direct Costs Only - Distort Results
Derivative Asset Value
View From Finance
Present Value of Net Future Cash Flow
Same as MSR
Derivative Asset OoopsMany CPAs firms have issued opinions on financial statements with derivative asset values I would challenge as not reasonable
Changing Presentation method now creates exposure to Opinion Risk
There is presently no consensus among CPA Auditors about how to apply GAAP
What is the Value of the IRLC - DA
Day of Lock Day Before Closing
High ProbabilityRevenue less Commission
Value is approaching Revenue
UnIncurred Costs Decrease as Percentage of Completion Increases
Low ProbabilityRevenue less all Costs
Value is approaching Zero
What is the value of an Intangible Asset
The Derivative Asset is an Intangible Asset
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
IRLC under ASC 815
ASC 815 ndash Commitments
ASC 815 ndash Hedge Accounting
Slide Number 41
Slide Number 42
Slide Number 43
Slide Number 44
Slide Number 45
Slide Number 46
Slide Number 47
Derivative Asset increases Capital
Slide Number 49
Slide Number 50
Slide Number 51
What is the Locked Pipeline
Slide Number 53
Slide Number 54
Slide Number 55
Slide Number 56
What about GAAP
Transformation Costs or Cost to Complete
IMB Transformational Costs ndash Best Practices
Slide Number 60
Slide Number 61
Slide Number 62
Slide Number 63
Derivative Asset Ooops
What is the Value of the IRLC - DA
Slide Number 66
AICPA Valuation Services
AICPA - Discounted Future Benefit
Hedging Data for DA Valuation
Percentage of Completion by Status
Net Cash Flow Valuation Data
IRLC-DA Grows in Value as Costs Incurred
Lock to LHFS DA Value Accretion
Revenue Potential vs Derivative Asset
GAAP Methods Only Right Once
Slide Number 76
IRLC Value is What You Negotiate
Slide Number 78
Slide Number 79
FASB Board Meeting ndash 32818
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
Slide Number 83
IRLC is Taxable when Recorded - BUT
Slide Number 85
Slide Number 86
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
PampL - with and without IRLC
IRLC Revenue is Confusing
Slide Number 91
Slide Number 92
Slide Number 93
Slide Number 94
Slide Number 95
Slide Number 96
Consequence of Ignoring Indirect Costs
Hawaii vs TexasHigh Balance vs Low Balance
Loan Size Matters
Loan Size Dynamics ndash One Loanbull ONE LOAN
bull High Balance low gainbull Low Balance high gain
bull Derivative Asset
bull Processing costs as of loan are different
bull Profit is same
Higher Gain
$50000000 Locked Pipeline
bull Texas lender is more than double Hawaii
bull Identical Cash Realization
bull Indirect Costs Matter
Direct Costs Only - Distort Results
Derivative Asset Value
View From Finance
Present Value of Net Future Cash Flow
Same as MSR
Derivative Asset OoopsMany CPAs firms have issued opinions on financial statements with derivative asset values I would challenge as not reasonable
Changing Presentation method now creates exposure to Opinion Risk
There is presently no consensus among CPA Auditors about how to apply GAAP
What is the Value of the IRLC - DA
Day of Lock Day Before Closing
High ProbabilityRevenue less Commission
Value is approaching Revenue
UnIncurred Costs Decrease as Percentage of Completion Increases
Low ProbabilityRevenue less all Costs
Value is approaching Zero
What is the value of an Intangible Asset
The Derivative Asset is an Intangible Asset
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
IRLC under ASC 815
ASC 815 ndash Commitments
ASC 815 ndash Hedge Accounting
Slide Number 41
Slide Number 42
Slide Number 43
Slide Number 44
Slide Number 45
Slide Number 46
Slide Number 47
Derivative Asset increases Capital
Slide Number 49
Slide Number 50
Slide Number 51
What is the Locked Pipeline
Slide Number 53
Slide Number 54
Slide Number 55
Slide Number 56
What about GAAP
Transformation Costs or Cost to Complete
IMB Transformational Costs ndash Best Practices
Slide Number 60
Slide Number 61
Slide Number 62
Slide Number 63
Derivative Asset Ooops
What is the Value of the IRLC - DA
Slide Number 66
AICPA Valuation Services
AICPA - Discounted Future Benefit
Hedging Data for DA Valuation
Percentage of Completion by Status
Net Cash Flow Valuation Data
IRLC-DA Grows in Value as Costs Incurred
Lock to LHFS DA Value Accretion
Revenue Potential vs Derivative Asset
GAAP Methods Only Right Once
Slide Number 76
IRLC Value is What You Negotiate
Slide Number 78
Slide Number 79
FASB Board Meeting ndash 32818
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
Slide Number 83
IRLC is Taxable when Recorded - BUT
Slide Number 85
Slide Number 86
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
PampL - with and without IRLC
IRLC Revenue is Confusing
Slide Number 91
Slide Number 92
Slide Number 93
Slide Number 94
Slide Number 95
Slide Number 96
Loan Size Dynamics ndash One Loanbull ONE LOAN
bull High Balance low gainbull Low Balance high gain
bull Derivative Asset
bull Processing costs as of loan are different
bull Profit is same
Higher Gain
$50000000 Locked Pipeline
bull Texas lender is more than double Hawaii
bull Identical Cash Realization
bull Indirect Costs Matter
Direct Costs Only - Distort Results
Derivative Asset Value
View From Finance
Present Value of Net Future Cash Flow
Same as MSR
Derivative Asset OoopsMany CPAs firms have issued opinions on financial statements with derivative asset values I would challenge as not reasonable
Changing Presentation method now creates exposure to Opinion Risk
There is presently no consensus among CPA Auditors about how to apply GAAP
What is the Value of the IRLC - DA
Day of Lock Day Before Closing
High ProbabilityRevenue less Commission
Value is approaching Revenue
UnIncurred Costs Decrease as Percentage of Completion Increases
Low ProbabilityRevenue less all Costs
Value is approaching Zero
What is the value of an Intangible Asset
The Derivative Asset is an Intangible Asset
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
IRLC under ASC 815
ASC 815 ndash Commitments
ASC 815 ndash Hedge Accounting
Slide Number 41
Slide Number 42
Slide Number 43
Slide Number 44
Slide Number 45
Slide Number 46
Slide Number 47
Derivative Asset increases Capital
Slide Number 49
Slide Number 50
Slide Number 51
What is the Locked Pipeline
Slide Number 53
Slide Number 54
Slide Number 55
Slide Number 56
What about GAAP
Transformation Costs or Cost to Complete
IMB Transformational Costs ndash Best Practices
Slide Number 60
Slide Number 61
Slide Number 62
Slide Number 63
Derivative Asset Ooops
What is the Value of the IRLC - DA
Slide Number 66
AICPA Valuation Services
AICPA - Discounted Future Benefit
Hedging Data for DA Valuation
Percentage of Completion by Status
Net Cash Flow Valuation Data
IRLC-DA Grows in Value as Costs Incurred
Lock to LHFS DA Value Accretion
Revenue Potential vs Derivative Asset
GAAP Methods Only Right Once
Slide Number 76
IRLC Value is What You Negotiate
Slide Number 78
Slide Number 79
FASB Board Meeting ndash 32818
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
Slide Number 83
IRLC is Taxable when Recorded - BUT
Slide Number 85
Slide Number 86
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
PampL - with and without IRLC
IRLC Revenue is Confusing
Slide Number 91
Slide Number 92
Slide Number 93
Slide Number 94
Slide Number 95
Slide Number 96
$50000000 Locked Pipeline
bull Texas lender is more than double Hawaii
bull Identical Cash Realization
bull Indirect Costs Matter
Direct Costs Only - Distort Results
Derivative Asset Value
View From Finance
Present Value of Net Future Cash Flow
Same as MSR
Derivative Asset OoopsMany CPAs firms have issued opinions on financial statements with derivative asset values I would challenge as not reasonable
Changing Presentation method now creates exposure to Opinion Risk
There is presently no consensus among CPA Auditors about how to apply GAAP
What is the Value of the IRLC - DA
Day of Lock Day Before Closing
High ProbabilityRevenue less Commission
Value is approaching Revenue
UnIncurred Costs Decrease as Percentage of Completion Increases
Low ProbabilityRevenue less all Costs
Value is approaching Zero
What is the value of an Intangible Asset
The Derivative Asset is an Intangible Asset
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
IRLC under ASC 815
ASC 815 ndash Commitments
ASC 815 ndash Hedge Accounting
Slide Number 41
Slide Number 42
Slide Number 43
Slide Number 44
Slide Number 45
Slide Number 46
Slide Number 47
Derivative Asset increases Capital
Slide Number 49
Slide Number 50
Slide Number 51
What is the Locked Pipeline
Slide Number 53
Slide Number 54
Slide Number 55
Slide Number 56
What about GAAP
Transformation Costs or Cost to Complete
IMB Transformational Costs ndash Best Practices
Slide Number 60
Slide Number 61
Slide Number 62
Slide Number 63
Derivative Asset Ooops
What is the Value of the IRLC - DA
Slide Number 66
AICPA Valuation Services
AICPA - Discounted Future Benefit
Hedging Data for DA Valuation
Percentage of Completion by Status
Net Cash Flow Valuation Data
IRLC-DA Grows in Value as Costs Incurred
Lock to LHFS DA Value Accretion
Revenue Potential vs Derivative Asset
GAAP Methods Only Right Once
Slide Number 76
IRLC Value is What You Negotiate
Slide Number 78
Slide Number 79
FASB Board Meeting ndash 32818
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
Slide Number 83
IRLC is Taxable when Recorded - BUT
Slide Number 85
Slide Number 86
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
PampL - with and without IRLC
IRLC Revenue is Confusing
Slide Number 91
Slide Number 92
Slide Number 93
Slide Number 94
Slide Number 95
Slide Number 96
Derivative Asset Value
View From Finance
Present Value of Net Future Cash Flow
Same as MSR
Derivative Asset OoopsMany CPAs firms have issued opinions on financial statements with derivative asset values I would challenge as not reasonable
Changing Presentation method now creates exposure to Opinion Risk
There is presently no consensus among CPA Auditors about how to apply GAAP
What is the Value of the IRLC - DA
Day of Lock Day Before Closing
High ProbabilityRevenue less Commission
Value is approaching Revenue
UnIncurred Costs Decrease as Percentage of Completion Increases
Low ProbabilityRevenue less all Costs
Value is approaching Zero
What is the value of an Intangible Asset
The Derivative Asset is an Intangible Asset
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
IRLC under ASC 815
ASC 815 ndash Commitments
ASC 815 ndash Hedge Accounting
Slide Number 41
Slide Number 42
Slide Number 43
Slide Number 44
Slide Number 45
Slide Number 46
Slide Number 47
Derivative Asset increases Capital
Slide Number 49
Slide Number 50
Slide Number 51
What is the Locked Pipeline
Slide Number 53
Slide Number 54
Slide Number 55
Slide Number 56
What about GAAP
Transformation Costs or Cost to Complete
IMB Transformational Costs ndash Best Practices
Slide Number 60
Slide Number 61
Slide Number 62
Slide Number 63
Derivative Asset Ooops
What is the Value of the IRLC - DA
Slide Number 66
AICPA Valuation Services
AICPA - Discounted Future Benefit
Hedging Data for DA Valuation
Percentage of Completion by Status
Net Cash Flow Valuation Data
IRLC-DA Grows in Value as Costs Incurred
Lock to LHFS DA Value Accretion
Revenue Potential vs Derivative Asset
GAAP Methods Only Right Once
Slide Number 76
IRLC Value is What You Negotiate
Slide Number 78
Slide Number 79
FASB Board Meeting ndash 32818
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
Slide Number 83
IRLC is Taxable when Recorded - BUT
Slide Number 85
Slide Number 86
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
PampL - with and without IRLC
IRLC Revenue is Confusing
Slide Number 91
Slide Number 92
Slide Number 93
Slide Number 94
Slide Number 95
Slide Number 96
Derivative Asset OoopsMany CPAs firms have issued opinions on financial statements with derivative asset values I would challenge as not reasonable
Changing Presentation method now creates exposure to Opinion Risk
There is presently no consensus among CPA Auditors about how to apply GAAP
What is the Value of the IRLC - DA
Day of Lock Day Before Closing
High ProbabilityRevenue less Commission
Value is approaching Revenue
UnIncurred Costs Decrease as Percentage of Completion Increases
Low ProbabilityRevenue less all Costs
Value is approaching Zero
What is the value of an Intangible Asset
The Derivative Asset is an Intangible Asset
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
IRLC under ASC 815
ASC 815 ndash Commitments
ASC 815 ndash Hedge Accounting
Slide Number 41
Slide Number 42
Slide Number 43
Slide Number 44
Slide Number 45
Slide Number 46
Slide Number 47
Derivative Asset increases Capital
Slide Number 49
Slide Number 50
Slide Number 51
What is the Locked Pipeline
Slide Number 53
Slide Number 54
Slide Number 55
Slide Number 56
What about GAAP
Transformation Costs or Cost to Complete
IMB Transformational Costs ndash Best Practices
Slide Number 60
Slide Number 61
Slide Number 62
Slide Number 63
Derivative Asset Ooops
What is the Value of the IRLC - DA
Slide Number 66
AICPA Valuation Services
AICPA - Discounted Future Benefit
Hedging Data for DA Valuation
Percentage of Completion by Status
Net Cash Flow Valuation Data
IRLC-DA Grows in Value as Costs Incurred
Lock to LHFS DA Value Accretion
Revenue Potential vs Derivative Asset
GAAP Methods Only Right Once
Slide Number 76
IRLC Value is What You Negotiate
Slide Number 78
Slide Number 79
FASB Board Meeting ndash 32818
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
Slide Number 83
IRLC is Taxable when Recorded - BUT
Slide Number 85
Slide Number 86
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
PampL - with and without IRLC
IRLC Revenue is Confusing
Slide Number 91
Slide Number 92
Slide Number 93
Slide Number 94
Slide Number 95
Slide Number 96
What is the Value of the IRLC - DA
Day of Lock Day Before Closing
High ProbabilityRevenue less Commission
Value is approaching Revenue
UnIncurred Costs Decrease as Percentage of Completion Increases
Low ProbabilityRevenue less all Costs
Value is approaching Zero
What is the value of an Intangible Asset
The Derivative Asset is an Intangible Asset
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
IRLC under ASC 815
ASC 815 ndash Commitments
ASC 815 ndash Hedge Accounting
Slide Number 41
Slide Number 42
Slide Number 43
Slide Number 44
Slide Number 45
Slide Number 46
Slide Number 47
Derivative Asset increases Capital
Slide Number 49
Slide Number 50
Slide Number 51
What is the Locked Pipeline
Slide Number 53
Slide Number 54
Slide Number 55
Slide Number 56
What about GAAP
Transformation Costs or Cost to Complete
IMB Transformational Costs ndash Best Practices
Slide Number 60
Slide Number 61
Slide Number 62
Slide Number 63
Derivative Asset Ooops
What is the Value of the IRLC - DA
Slide Number 66
AICPA Valuation Services
AICPA - Discounted Future Benefit
Hedging Data for DA Valuation
Percentage of Completion by Status
Net Cash Flow Valuation Data
IRLC-DA Grows in Value as Costs Incurred
Lock to LHFS DA Value Accretion
Revenue Potential vs Derivative Asset
GAAP Methods Only Right Once
Slide Number 76
IRLC Value is What You Negotiate
Slide Number 78
Slide Number 79
FASB Board Meeting ndash 32818
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
Slide Number 83
IRLC is Taxable when Recorded - BUT
Slide Number 85
Slide Number 86
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
PampL - with and without IRLC
IRLC Revenue is Confusing
Slide Number 91
Slide Number 92
Slide Number 93
Slide Number 94
Slide Number 95
Slide Number 96
What is the value of an Intangible Asset
The Derivative Asset is an Intangible Asset
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
IRLC under ASC 815
ASC 815 ndash Commitments
ASC 815 ndash Hedge Accounting
Slide Number 41
Slide Number 42
Slide Number 43
Slide Number 44
Slide Number 45
Slide Number 46
Slide Number 47
Derivative Asset increases Capital
Slide Number 49
Slide Number 50
Slide Number 51
What is the Locked Pipeline
Slide Number 53
Slide Number 54
Slide Number 55
Slide Number 56
What about GAAP
Transformation Costs or Cost to Complete
IMB Transformational Costs ndash Best Practices
Slide Number 60
Slide Number 61
Slide Number 62
Slide Number 63
Derivative Asset Ooops
What is the Value of the IRLC - DA
Slide Number 66
AICPA Valuation Services
AICPA - Discounted Future Benefit
Hedging Data for DA Valuation
Percentage of Completion by Status
Net Cash Flow Valuation Data
IRLC-DA Grows in Value as Costs Incurred
Lock to LHFS DA Value Accretion
Revenue Potential vs Derivative Asset
GAAP Methods Only Right Once
Slide Number 76
IRLC Value is What You Negotiate
Slide Number 78
Slide Number 79
FASB Board Meeting ndash 32818
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
Slide Number 83
IRLC is Taxable when Recorded - BUT
Slide Number 85
Slide Number 86
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
PampL - with and without IRLC
IRLC Revenue is Confusing
Slide Number 91
Slide Number 92
Slide Number 93
Slide Number 94
Slide Number 95
Slide Number 96
AICPA Valuation Servicesbull The AICPA Statement on Standards for Valuation Services supports
Valuation of an Intangible Asset using the Income Market or Cost approach for valuation conclusions
bull The IRLC-DA has no Market ndash (you canrsquot sell an IRLC)bull The Income Approach aka Discounted Future Benefit technique is
approximated in this webinar when applied to the IRLC-DAbull Similar to Present Value of Net Future Cash Flow used for MSR
bull Fundamentally in Valuation ndash DOES THE VALUE MAKE SENCE
bull Email me for a copy of the standard or go to httpswwwaicpaorgcontentdamaicpainterestareasforensicandvaluationresourcesstandardsdownloadabledocumentsssvs-full-versionpdf
bull The AICPA offers credentials in Forensics and Valuationbull I hold Certification in Financial Forensics
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
IRLC under ASC 815
ASC 815 ndash Commitments
ASC 815 ndash Hedge Accounting
Slide Number 41
Slide Number 42
Slide Number 43
Slide Number 44
Slide Number 45
Slide Number 46
Slide Number 47
Derivative Asset increases Capital
Slide Number 49
Slide Number 50
Slide Number 51
What is the Locked Pipeline
Slide Number 53
Slide Number 54
Slide Number 55
Slide Number 56
What about GAAP
Transformation Costs or Cost to Complete
IMB Transformational Costs ndash Best Practices
Slide Number 60
Slide Number 61
Slide Number 62
Slide Number 63
Derivative Asset Ooops
What is the Value of the IRLC - DA
Slide Number 66
AICPA Valuation Services
AICPA - Discounted Future Benefit
Hedging Data for DA Valuation
Percentage of Completion by Status
Net Cash Flow Valuation Data
IRLC-DA Grows in Value as Costs Incurred
Lock to LHFS DA Value Accretion
Revenue Potential vs Derivative Asset
GAAP Methods Only Right Once
Slide Number 76
IRLC Value is What You Negotiate
Slide Number 78
Slide Number 79
FASB Board Meeting ndash 32818
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
Slide Number 83
IRLC is Taxable when Recorded - BUT
Slide Number 85
Slide Number 86
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
PampL - with and without IRLC
IRLC Revenue is Confusing
Slide Number 91
Slide Number 92
Slide Number 93
Slide Number 94
Slide Number 95
Slide Number 96
Net Future Cash Flow Methodbull Evaluate Hedging Data by Status Codebull Probability Weighted By Segmentbull Calculate Percentage Of Completionbull Allocate Total Cost Per Loanbull Estimated Value of Intangible Asset
Disclaimer Not GAAP Auditor Judgment
AICPA - Discounted Future Benefit
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
IRLC under ASC 815
ASC 815 ndash Commitments
ASC 815 ndash Hedge Accounting
Slide Number 41
Slide Number 42
Slide Number 43
Slide Number 44
Slide Number 45
Slide Number 46
Slide Number 47
Derivative Asset increases Capital
Slide Number 49
Slide Number 50
Slide Number 51
What is the Locked Pipeline
Slide Number 53
Slide Number 54
Slide Number 55
Slide Number 56
What about GAAP
Transformation Costs or Cost to Complete
IMB Transformational Costs ndash Best Practices
Slide Number 60
Slide Number 61
Slide Number 62
Slide Number 63
Derivative Asset Ooops
What is the Value of the IRLC - DA
Slide Number 66
AICPA Valuation Services
AICPA - Discounted Future Benefit
Hedging Data for DA Valuation
Percentage of Completion by Status
Net Cash Flow Valuation Data
IRLC-DA Grows in Value as Costs Incurred
Lock to LHFS DA Value Accretion
Revenue Potential vs Derivative Asset
GAAP Methods Only Right Once
Slide Number 76
IRLC Value is What You Negotiate
Slide Number 78
Slide Number 79
FASB Board Meeting ndash 32818
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
Slide Number 83
IRLC is Taxable when Recorded - BUT
Slide Number 85
Slide Number 86
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
PampL - with and without IRLC
IRLC Revenue is Confusing
Slide Number 91
Slide Number 92
Slide Number 93
Slide Number 94
Slide Number 95
Slide Number 96
Hedging Data for DA Valuationbull Hedging Measures Pull-Thru by Status Code
bull Status Codes define Position in Locked Pipeline for Pull-thrubull Status Codes = Lock Start Proc End Proc Approved CTCbull Pull-thru Probability example = 50 65 80 90 98
bull Pull-thru by Status Code varies widely (40 to 99)bull Pull-thru changes depending upon Product LO Branch Purpose
bull Pipeline by Status Codes provides reasonable basis to apply net future cash flow valuation methods
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
IRLC under ASC 815
ASC 815 ndash Commitments
ASC 815 ndash Hedge Accounting
Slide Number 41
Slide Number 42
Slide Number 43
Slide Number 44
Slide Number 45
Slide Number 46
Slide Number 47
Derivative Asset increases Capital
Slide Number 49
Slide Number 50
Slide Number 51
What is the Locked Pipeline
Slide Number 53
Slide Number 54
Slide Number 55
Slide Number 56
What about GAAP
Transformation Costs or Cost to Complete
IMB Transformational Costs ndash Best Practices
Slide Number 60
Slide Number 61
Slide Number 62
Slide Number 63
Derivative Asset Ooops
What is the Value of the IRLC - DA
Slide Number 66
AICPA Valuation Services
AICPA - Discounted Future Benefit
Hedging Data for DA Valuation
Percentage of Completion by Status
Net Cash Flow Valuation Data
IRLC-DA Grows in Value as Costs Incurred
Lock to LHFS DA Value Accretion
Revenue Potential vs Derivative Asset
GAAP Methods Only Right Once
Slide Number 76
IRLC Value is What You Negotiate
Slide Number 78
Slide Number 79
FASB Board Meeting ndash 32818
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
Slide Number 83
IRLC is Taxable when Recorded - BUT
Slide Number 85
Slide Number 86
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
PampL - with and without IRLC
IRLC Revenue is Confusing
Slide Number 91
Slide Number 92
Slide Number 93
Slide Number 94
Slide Number 95
Slide Number 96
Percentage of Completion by StatusAssign Percentage of Completion by Status CodeLock 5 Start Proc - 15 End Proc - 30 Approved - 40 CTC 46
Allocate Total Cost Per Loan by status code based on percentage completion
Never allocate 100 of cost because commission and sales costs are not incurred until the application becomes a loan
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
IRLC under ASC 815
ASC 815 ndash Commitments
ASC 815 ndash Hedge Accounting
Slide Number 41
Slide Number 42
Slide Number 43
Slide Number 44
Slide Number 45
Slide Number 46
Slide Number 47
Derivative Asset increases Capital
Slide Number 49
Slide Number 50
Slide Number 51
What is the Locked Pipeline
Slide Number 53
Slide Number 54
Slide Number 55
Slide Number 56
What about GAAP
Transformation Costs or Cost to Complete
IMB Transformational Costs ndash Best Practices
Slide Number 60
Slide Number 61
Slide Number 62
Slide Number 63
Derivative Asset Ooops
What is the Value of the IRLC - DA
Slide Number 66
AICPA Valuation Services
AICPA - Discounted Future Benefit
Hedging Data for DA Valuation
Percentage of Completion by Status
Net Cash Flow Valuation Data
IRLC-DA Grows in Value as Costs Incurred
Lock to LHFS DA Value Accretion
Revenue Potential vs Derivative Asset
GAAP Methods Only Right Once
Slide Number 76
IRLC Value is What You Negotiate
Slide Number 78
Slide Number 79
FASB Board Meeting ndash 32818
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
Slide Number 83
IRLC is Taxable when Recorded - BUT
Slide Number 85
Slide Number 86
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
PampL - with and without IRLC
IRLC Revenue is Confusing
Slide Number 91
Slide Number 92
Slide Number 93
Slide Number 94
Slide Number 95
Slide Number 96
Net Cash Flow Valuation Data
MTM Value1
MTM
1) MTM Value = Purchase Commitment less Buyer Imposed Transaction Costs (sales costs from PA)
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
IRLC under ASC 815
ASC 815 ndash Commitments
ASC 815 ndash Hedge Accounting
Slide Number 41
Slide Number 42
Slide Number 43
Slide Number 44
Slide Number 45
Slide Number 46
Slide Number 47
Derivative Asset increases Capital
Slide Number 49
Slide Number 50
Slide Number 51
What is the Locked Pipeline
Slide Number 53
Slide Number 54
Slide Number 55
Slide Number 56
What about GAAP
Transformation Costs or Cost to Complete
IMB Transformational Costs ndash Best Practices
Slide Number 60
Slide Number 61
Slide Number 62
Slide Number 63
Derivative Asset Ooops
What is the Value of the IRLC - DA
Slide Number 66
AICPA Valuation Services
AICPA - Discounted Future Benefit
Hedging Data for DA Valuation
Percentage of Completion by Status
Net Cash Flow Valuation Data
IRLC-DA Grows in Value as Costs Incurred
Lock to LHFS DA Value Accretion
Revenue Potential vs Derivative Asset
GAAP Methods Only Right Once
Slide Number 76
IRLC Value is What You Negotiate
Slide Number 78
Slide Number 79
FASB Board Meeting ndash 32818
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
Slide Number 83
IRLC is Taxable when Recorded - BUT
Slide Number 85
Slide Number 86
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
PampL - with and without IRLC
IRLC Revenue is Confusing
Slide Number 91
Slide Number 92
Slide Number 93
Slide Number 94
Slide Number 95
Slide Number 96
IRLC-DA Grows in Value as Costs Incurred
Day of LockDA worth Little95 Costs UnincurredAbsorption Method
Day Before CloseDA worth Most54 Costs Are UnincurredDirect Cost Method
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
IRLC under ASC 815
ASC 815 ndash Commitments
ASC 815 ndash Hedge Accounting
Slide Number 41
Slide Number 42
Slide Number 43
Slide Number 44
Slide Number 45
Slide Number 46
Slide Number 47
Derivative Asset increases Capital
Slide Number 49
Slide Number 50
Slide Number 51
What is the Locked Pipeline
Slide Number 53
Slide Number 54
Slide Number 55
Slide Number 56
What about GAAP
Transformation Costs or Cost to Complete
IMB Transformational Costs ndash Best Practices
Slide Number 60
Slide Number 61
Slide Number 62
Slide Number 63
Derivative Asset Ooops
What is the Value of the IRLC - DA
Slide Number 66
AICPA Valuation Services
AICPA - Discounted Future Benefit
Hedging Data for DA Valuation
Percentage of Completion by Status
Net Cash Flow Valuation Data
IRLC-DA Grows in Value as Costs Incurred
Lock to LHFS DA Value Accretion
Revenue Potential vs Derivative Asset
GAAP Methods Only Right Once
Slide Number 76
IRLC Value is What You Negotiate
Slide Number 78
Slide Number 79
FASB Board Meeting ndash 32818
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
Slide Number 83
IRLC is Taxable when Recorded - BUT
Slide Number 85
Slide Number 86
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
PampL - with and without IRLC
IRLC Revenue is Confusing
Slide Number 91
Slide Number 92
Slide Number 93
Slide Number 94
Slide Number 95
Slide Number 96
Lock to LHFS DA Value Accretion
IRLC-DA conversion to LHFS triggers commission as incurred cost
LHFS MTM = Revenue less sales costs only
Derivative Asset Value ClimbsAs UnIncurred Costs Decline
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
IRLC under ASC 815
ASC 815 ndash Commitments
ASC 815 ndash Hedge Accounting
Slide Number 41
Slide Number 42
Slide Number 43
Slide Number 44
Slide Number 45
Slide Number 46
Slide Number 47
Derivative Asset increases Capital
Slide Number 49
Slide Number 50
Slide Number 51
What is the Locked Pipeline
Slide Number 53
Slide Number 54
Slide Number 55
Slide Number 56
What about GAAP
Transformation Costs or Cost to Complete
IMB Transformational Costs ndash Best Practices
Slide Number 60
Slide Number 61
Slide Number 62
Slide Number 63
Derivative Asset Ooops
What is the Value of the IRLC - DA
Slide Number 66
AICPA Valuation Services
AICPA - Discounted Future Benefit
Hedging Data for DA Valuation
Percentage of Completion by Status
Net Cash Flow Valuation Data
IRLC-DA Grows in Value as Costs Incurred
Lock to LHFS DA Value Accretion
Revenue Potential vs Derivative Asset
GAAP Methods Only Right Once
Slide Number 76
IRLC Value is What You Negotiate
Slide Number 78
Slide Number 79
FASB Board Meeting ndash 32818
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
Slide Number 83
IRLC is Taxable when Recorded - BUT
Slide Number 85
Slide Number 86
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
PampL - with and without IRLC
IRLC Revenue is Confusing
Slide Number 91
Slide Number 92
Slide Number 93
Slide Number 94
Slide Number 95
Slide Number 96
Revenue Potential vs Derivative Asset
Total MTM and Revenue is $8250
LHFS MTM = Revenue less sales costs only
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
IRLC under ASC 815
ASC 815 ndash Commitments
ASC 815 ndash Hedge Accounting
Slide Number 41
Slide Number 42
Slide Number 43
Slide Number 44
Slide Number 45
Slide Number 46
Slide Number 47
Derivative Asset increases Capital
Slide Number 49
Slide Number 50
Slide Number 51
What is the Locked Pipeline
Slide Number 53
Slide Number 54
Slide Number 55
Slide Number 56
What about GAAP
Transformation Costs or Cost to Complete
IMB Transformational Costs ndash Best Practices
Slide Number 60
Slide Number 61
Slide Number 62
Slide Number 63
Derivative Asset Ooops
What is the Value of the IRLC - DA
Slide Number 66
AICPA Valuation Services
AICPA - Discounted Future Benefit
Hedging Data for DA Valuation
Percentage of Completion by Status
Net Cash Flow Valuation Data
IRLC-DA Grows in Value as Costs Incurred
Lock to LHFS DA Value Accretion
Revenue Potential vs Derivative Asset
GAAP Methods Only Right Once
Slide Number 76
IRLC Value is What You Negotiate
Slide Number 78
Slide Number 79
FASB Board Meeting ndash 32818
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
Slide Number 83
IRLC is Taxable when Recorded - BUT
Slide Number 85
Slide Number 86
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
PampL - with and without IRLC
IRLC Revenue is Confusing
Slide Number 91
Slide Number 92
Slide Number 93
Slide Number 94
Slide Number 95
Slide Number 96
GAAP Methods Only Right Once
Full MTM
Direct Cost
Absorption
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
IRLC under ASC 815
ASC 815 ndash Commitments
ASC 815 ndash Hedge Accounting
Slide Number 41
Slide Number 42
Slide Number 43
Slide Number 44
Slide Number 45
Slide Number 46
Slide Number 47
Derivative Asset increases Capital
Slide Number 49
Slide Number 50
Slide Number 51
What is the Locked Pipeline
Slide Number 53
Slide Number 54
Slide Number 55
Slide Number 56
What about GAAP
Transformation Costs or Cost to Complete
IMB Transformational Costs ndash Best Practices
Slide Number 60
Slide Number 61
Slide Number 62
Slide Number 63
Derivative Asset Ooops
What is the Value of the IRLC - DA
Slide Number 66
AICPA Valuation Services
AICPA - Discounted Future Benefit
Hedging Data for DA Valuation
Percentage of Completion by Status
Net Cash Flow Valuation Data
IRLC-DA Grows in Value as Costs Incurred
Lock to LHFS DA Value Accretion
Revenue Potential vs Derivative Asset
GAAP Methods Only Right Once
Slide Number 76
IRLC Value is What You Negotiate
Slide Number 78
Slide Number 79
FASB Board Meeting ndash 32818
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
Slide Number 83
IRLC is Taxable when Recorded - BUT
Slide Number 85
Slide Number 86
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
PampL - with and without IRLC
IRLC Revenue is Confusing
Slide Number 91
Slide Number 92
Slide Number 93
Slide Number 94
Slide Number 95
Slide Number 96
IRLCWhere the Rubber
Meets the Road
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
IRLC under ASC 815
ASC 815 ndash Commitments
ASC 815 ndash Hedge Accounting
Slide Number 41
Slide Number 42
Slide Number 43
Slide Number 44
Slide Number 45
Slide Number 46
Slide Number 47
Derivative Asset increases Capital
Slide Number 49
Slide Number 50
Slide Number 51
What is the Locked Pipeline
Slide Number 53
Slide Number 54
Slide Number 55
Slide Number 56
What about GAAP
Transformation Costs or Cost to Complete
IMB Transformational Costs ndash Best Practices
Slide Number 60
Slide Number 61
Slide Number 62
Slide Number 63
Derivative Asset Ooops
What is the Value of the IRLC - DA
Slide Number 66
AICPA Valuation Services
AICPA - Discounted Future Benefit
Hedging Data for DA Valuation
Percentage of Completion by Status
Net Cash Flow Valuation Data
IRLC-DA Grows in Value as Costs Incurred
Lock to LHFS DA Value Accretion
Revenue Potential vs Derivative Asset
GAAP Methods Only Right Once
Slide Number 76
IRLC Value is What You Negotiate
Slide Number 78
Slide Number 79
FASB Board Meeting ndash 32818
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
Slide Number 83
IRLC is Taxable when Recorded - BUT
Slide Number 85
Slide Number 86
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
PampL - with and without IRLC
IRLC Revenue is Confusing
Slide Number 91
Slide Number 92
Slide Number 93
Slide Number 94
Slide Number 95
Slide Number 96
IRLC Value is What You Negotiatebull Margin Compression ndash Companies Are Failingbull CFOs Must Have More Capitalbull There is no IRLC consensus among CPA Auditorsbull Focus is Keep CFO Happy amp Pass Pier Reviewbull Direct Cost Method gives high value amp common practicebull Document the Basis for IRLC Valuebull Must Include Level 3 Disclosure 820-10-50-2(bbb)bull Use AICPA SSVS to support Opinion of Valuebull Make sure DA impact on Insolvency is presented
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
bull Existing principles-based guidance in ASC 820 is adequate
bull Follow disclosure requirement in 820-10-50-2(bbb)
bull Recommendation that MBA write a white paper As of 111518The group has not reached a consensus possibly because the CPA auditors have Opinion Risk if they change and the CFOs want the DA to be high because they have Capital Risk
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
IRLC under ASC 815
ASC 815 ndash Commitments
ASC 815 ndash Hedge Accounting
Slide Number 41
Slide Number 42
Slide Number 43
Slide Number 44
Slide Number 45
Slide Number 46
Slide Number 47
Derivative Asset increases Capital
Slide Number 49
Slide Number 50
Slide Number 51
What is the Locked Pipeline
Slide Number 53
Slide Number 54
Slide Number 55
Slide Number 56
What about GAAP
Transformation Costs or Cost to Complete
IMB Transformational Costs ndash Best Practices
Slide Number 60
Slide Number 61
Slide Number 62
Slide Number 63
Derivative Asset Ooops
What is the Value of the IRLC - DA
Slide Number 66
AICPA Valuation Services
AICPA - Discounted Future Benefit
Hedging Data for DA Valuation
Percentage of Completion by Status
Net Cash Flow Valuation Data
IRLC-DA Grows in Value as Costs Incurred
Lock to LHFS DA Value Accretion
Revenue Potential vs Derivative Asset
GAAP Methods Only Right Once
Slide Number 76
IRLC Value is What You Negotiate
Slide Number 78
Slide Number 79
FASB Board Meeting ndash 32818
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
Slide Number 83
IRLC is Taxable when Recorded - BUT
Slide Number 85
Slide Number 86
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
PampL - with and without IRLC
IRLC Revenue is Confusing
Slide Number 91
Slide Number 92
Slide Number 93
Slide Number 94
Slide Number 95
Slide Number 96
The FASB stated on March 28 that the asset is subject to Level 3 inputs because of the unobservable cost and pull-through components
The MBArsquos white paper states that it is Level 3
For IRLC to meet Level 2 criteria the inputs to the model must be observable either directly or indirectly for substantially the full term of the asset No user could see pull-through for the full life of the lock much less the costs and revenues involved
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
IRLC under ASC 815
ASC 815 ndash Commitments
ASC 815 ndash Hedge Accounting
Slide Number 41
Slide Number 42
Slide Number 43
Slide Number 44
Slide Number 45
Slide Number 46
Slide Number 47
Derivative Asset increases Capital
Slide Number 49
Slide Number 50
Slide Number 51
What is the Locked Pipeline
Slide Number 53
Slide Number 54
Slide Number 55
Slide Number 56
What about GAAP
Transformation Costs or Cost to Complete
IMB Transformational Costs ndash Best Practices
Slide Number 60
Slide Number 61
Slide Number 62
Slide Number 63
Derivative Asset Ooops
What is the Value of the IRLC - DA
Slide Number 66
AICPA Valuation Services
AICPA - Discounted Future Benefit
Hedging Data for DA Valuation
Percentage of Completion by Status
Net Cash Flow Valuation Data
IRLC-DA Grows in Value as Costs Incurred
Lock to LHFS DA Value Accretion
Revenue Potential vs Derivative Asset
GAAP Methods Only Right Once
Slide Number 76
IRLC Value is What You Negotiate
Slide Number 78
Slide Number 79
FASB Board Meeting ndash 32818
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
Slide Number 83
IRLC is Taxable when Recorded - BUT
Slide Number 85
Slide Number 86
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
PampL - with and without IRLC
IRLC Revenue is Confusing
Slide Number 91
Slide Number 92
Slide Number 93
Slide Number 94
Slide Number 95
Slide Number 96
Existing Disclosures Requirement
ldquoFor recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy a description of the valuation technique(s) and the inputs used in the fair value measurement [ ]
For fair value measurements categorized within Level 3 of the fair value hierarchy a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement
Did your 2017 audit reports follow the 820-10-50-2(bbb) requirement
820-10-50-2(bbb)
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
IRLC under ASC 815
ASC 815 ndash Commitments
ASC 815 ndash Hedge Accounting
Slide Number 41
Slide Number 42
Slide Number 43
Slide Number 44
Slide Number 45
Slide Number 46
Slide Number 47
Derivative Asset increases Capital
Slide Number 49
Slide Number 50
Slide Number 51
What is the Locked Pipeline
Slide Number 53
Slide Number 54
Slide Number 55
Slide Number 56
What about GAAP
Transformation Costs or Cost to Complete
IMB Transformational Costs ndash Best Practices
Slide Number 60
Slide Number 61
Slide Number 62
Slide Number 63
Derivative Asset Ooops
What is the Value of the IRLC - DA
Slide Number 66
AICPA Valuation Services
AICPA - Discounted Future Benefit
Hedging Data for DA Valuation
Percentage of Completion by Status
Net Cash Flow Valuation Data
IRLC-DA Grows in Value as Costs Incurred
Lock to LHFS DA Value Accretion
Revenue Potential vs Derivative Asset
GAAP Methods Only Right Once
Slide Number 76
IRLC Value is What You Negotiate
Slide Number 78
Slide Number 79
FASB Board Meeting ndash 32818
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
Slide Number 83
IRLC is Taxable when Recorded - BUT
Slide Number 85
Slide Number 86
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
PampL - with and without IRLC
IRLC Revenue is Confusing
Slide Number 91
Slide Number 92
Slide Number 93
Slide Number 94
Slide Number 95
Slide Number 96
Tax Implication From MTM of IRLC amp Hedge
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
IRLC under ASC 815
ASC 815 ndash Commitments
ASC 815 ndash Hedge Accounting
Slide Number 41
Slide Number 42
Slide Number 43
Slide Number 44
Slide Number 45
Slide Number 46
Slide Number 47
Derivative Asset increases Capital
Slide Number 49
Slide Number 50
Slide Number 51
What is the Locked Pipeline
Slide Number 53
Slide Number 54
Slide Number 55
Slide Number 56
What about GAAP
Transformation Costs or Cost to Complete
IMB Transformational Costs ndash Best Practices
Slide Number 60
Slide Number 61
Slide Number 62
Slide Number 63
Derivative Asset Ooops
What is the Value of the IRLC - DA
Slide Number 66
AICPA Valuation Services
AICPA - Discounted Future Benefit
Hedging Data for DA Valuation
Percentage of Completion by Status
Net Cash Flow Valuation Data
IRLC-DA Grows in Value as Costs Incurred
Lock to LHFS DA Value Accretion
Revenue Potential vs Derivative Asset
GAAP Methods Only Right Once
Slide Number 76
IRLC Value is What You Negotiate
Slide Number 78
Slide Number 79
FASB Board Meeting ndash 32818
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
Slide Number 83
IRLC is Taxable when Recorded - BUT
Slide Number 85
Slide Number 86
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
PampL - with and without IRLC
IRLC Revenue is Confusing
Slide Number 91
Slide Number 92
Slide Number 93
Slide Number 94
Slide Number 95
Slide Number 96
IRLC is Taxable when Recorded - BUTbull If count as book income then counted as tax income bull MSR not taxes until cash collect (no change)
bull Under the Tax Cuts and Jobs Act accrual method taxpayers recognize taxable income no later than the tax year in which the item is recognized as book revenue
bull There is a 4 year deferral election
bull There is a continuing debate about the taxability of the IRLC but without IRS revenue ruling the TCJA is clear
bull Increasing Cost to Complete will reduce taxable income
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
IRLC under ASC 815
ASC 815 ndash Commitments
ASC 815 ndash Hedge Accounting
Slide Number 41
Slide Number 42
Slide Number 43
Slide Number 44
Slide Number 45
Slide Number 46
Slide Number 47
Derivative Asset increases Capital
Slide Number 49
Slide Number 50
Slide Number 51
What is the Locked Pipeline
Slide Number 53
Slide Number 54
Slide Number 55
Slide Number 56
What about GAAP
Transformation Costs or Cost to Complete
IMB Transformational Costs ndash Best Practices
Slide Number 60
Slide Number 61
Slide Number 62
Slide Number 63
Derivative Asset Ooops
What is the Value of the IRLC - DA
Slide Number 66
AICPA Valuation Services
AICPA - Discounted Future Benefit
Hedging Data for DA Valuation
Percentage of Completion by Status
Net Cash Flow Valuation Data
IRLC-DA Grows in Value as Costs Incurred
Lock to LHFS DA Value Accretion
Revenue Potential vs Derivative Asset
GAAP Methods Only Right Once
Slide Number 76
IRLC Value is What You Negotiate
Slide Number 78
Slide Number 79
FASB Board Meeting ndash 32818
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
Slide Number 83
IRLC is Taxable when Recorded - BUT
Slide Number 85
Slide Number 86
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
PampL - with and without IRLC
IRLC Revenue is Confusing
Slide Number 91
Slide Number 92
Slide Number 93
Slide Number 94
Slide Number 95
Slide Number 96
GAAP Revenue RecognitionRevenue at Lock
Expense at ClosingCash at Sale and PO Settlement
Volume Variability Drives Impact
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
IRLC under ASC 815
ASC 815 ndash Commitments
ASC 815 ndash Hedge Accounting
Slide Number 41
Slide Number 42
Slide Number 43
Slide Number 44
Slide Number 45
Slide Number 46
Slide Number 47
Derivative Asset increases Capital
Slide Number 49
Slide Number 50
Slide Number 51
What is the Locked Pipeline
Slide Number 53
Slide Number 54
Slide Number 55
Slide Number 56
What about GAAP
Transformation Costs or Cost to Complete
IMB Transformational Costs ndash Best Practices
Slide Number 60
Slide Number 61
Slide Number 62
Slide Number 63
Derivative Asset Ooops
What is the Value of the IRLC - DA
Slide Number 66
AICPA Valuation Services
AICPA - Discounted Future Benefit
Hedging Data for DA Valuation
Percentage of Completion by Status
Net Cash Flow Valuation Data
IRLC-DA Grows in Value as Costs Incurred
Lock to LHFS DA Value Accretion
Revenue Potential vs Derivative Asset
GAAP Methods Only Right Once
Slide Number 76
IRLC Value is What You Negotiate
Slide Number 78
Slide Number 79
FASB Board Meeting ndash 32818
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
Slide Number 83
IRLC is Taxable when Recorded - BUT
Slide Number 85
Slide Number 86
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
PampL - with and without IRLC
IRLC Revenue is Confusing
Slide Number 91
Slide Number 92
Slide Number 93
Slide Number 94
Slide Number 95
Slide Number 96
Example of GAAP Revenue Recognition
Impact on Monthly PampL of Mortgage Lender
the following schedule is just for reference
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
IRLC under ASC 815
ASC 815 ndash Commitments
ASC 815 ndash Hedge Accounting
Slide Number 41
Slide Number 42
Slide Number 43
Slide Number 44
Slide Number 45
Slide Number 46
Slide Number 47
Derivative Asset increases Capital
Slide Number 49
Slide Number 50
Slide Number 51
What is the Locked Pipeline
Slide Number 53
Slide Number 54
Slide Number 55
Slide Number 56
What about GAAP
Transformation Costs or Cost to Complete
IMB Transformational Costs ndash Best Practices
Slide Number 60
Slide Number 61
Slide Number 62
Slide Number 63
Derivative Asset Ooops
What is the Value of the IRLC - DA
Slide Number 66
AICPA Valuation Services
AICPA - Discounted Future Benefit
Hedging Data for DA Valuation
Percentage of Completion by Status
Net Cash Flow Valuation Data
IRLC-DA Grows in Value as Costs Incurred
Lock to LHFS DA Value Accretion
Revenue Potential vs Derivative Asset
GAAP Methods Only Right Once
Slide Number 76
IRLC Value is What You Negotiate
Slide Number 78
Slide Number 79
FASB Board Meeting ndash 32818
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
Slide Number 83
IRLC is Taxable when Recorded - BUT
Slide Number 85
Slide Number 86
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
PampL - with and without IRLC
IRLC Revenue is Confusing
Slide Number 91
Slide Number 92
Slide Number 93
Slide Number 94
Slide Number 95
Slide Number 96
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
IRLC under ASC 815
ASC 815 ndash Commitments
ASC 815 ndash Hedge Accounting
Slide Number 41
Slide Number 42
Slide Number 43
Slide Number 44
Slide Number 45
Slide Number 46
Slide Number 47
Derivative Asset increases Capital
Slide Number 49
Slide Number 50
Slide Number 51
What is the Locked Pipeline
Slide Number 53
Slide Number 54
Slide Number 55
Slide Number 56
What about GAAP
Transformation Costs or Cost to Complete
IMB Transformational Costs ndash Best Practices
Slide Number 60
Slide Number 61
Slide Number 62
Slide Number 63
Derivative Asset Ooops
What is the Value of the IRLC - DA
Slide Number 66
AICPA Valuation Services
AICPA - Discounted Future Benefit
Hedging Data for DA Valuation
Percentage of Completion by Status
Net Cash Flow Valuation Data
IRLC-DA Grows in Value as Costs Incurred
Lock to LHFS DA Value Accretion
Revenue Potential vs Derivative Asset
GAAP Methods Only Right Once
Slide Number 76
IRLC Value is What You Negotiate
Slide Number 78
Slide Number 79
FASB Board Meeting ndash 32818
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
Slide Number 83
IRLC is Taxable when Recorded - BUT
Slide Number 85
Slide Number 86
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
PampL - with and without IRLC
IRLC Revenue is Confusing
Slide Number 91
Slide Number 92
Slide Number 93
Slide Number 94
Slide Number 95
Slide Number 96
Volume and PampL LHFS only (Exclude IRLC)
Revenue and Expense at Closing Cash at Sale
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
IRLC under ASC 815
ASC 815 ndash Commitments
ASC 815 ndash Hedge Accounting
Slide Number 41
Slide Number 42
Slide Number 43
Slide Number 44
Slide Number 45
Slide Number 46
Slide Number 47
Derivative Asset increases Capital
Slide Number 49
Slide Number 50
Slide Number 51
What is the Locked Pipeline
Slide Number 53
Slide Number 54
Slide Number 55
Slide Number 56
What about GAAP
Transformation Costs or Cost to Complete
IMB Transformational Costs ndash Best Practices
Slide Number 60
Slide Number 61
Slide Number 62
Slide Number 63
Derivative Asset Ooops
What is the Value of the IRLC - DA
Slide Number 66
AICPA Valuation Services
AICPA - Discounted Future Benefit
Hedging Data for DA Valuation
Percentage of Completion by Status
Net Cash Flow Valuation Data
IRLC-DA Grows in Value as Costs Incurred
Lock to LHFS DA Value Accretion
Revenue Potential vs Derivative Asset
GAAP Methods Only Right Once
Slide Number 76
IRLC Value is What You Negotiate
Slide Number 78
Slide Number 79
FASB Board Meeting ndash 32818
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
Slide Number 83
IRLC is Taxable when Recorded - BUT
Slide Number 85
Slide Number 86
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
PampL - with and without IRLC
IRLC Revenue is Confusing
Slide Number 91
Slide Number 92
Slide Number 93
Slide Number 94
Slide Number 95
Slide Number 96
PampL - with and without IRLC
78000000
105300000
GAAP is OrangeManagement is Gray
50544000
Revenue at Lock Expense at Closing Cash at Sale
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
SFAS 140 ASC 860-50-25-1 MSRMortgage Servicing Rights
IRLC under ASC 815
ASC 815 ndash Commitments
ASC 815 ndash Hedge Accounting
Slide Number 41
Slide Number 42
Slide Number 43
Slide Number 44
Slide Number 45
Slide Number 46
Slide Number 47
Derivative Asset increases Capital
Slide Number 49
Slide Number 50
Slide Number 51
What is the Locked Pipeline
Slide Number 53
Slide Number 54
Slide Number 55
Slide Number 56
What about GAAP
Transformation Costs or Cost to Complete
IMB Transformational Costs ndash Best Practices
Slide Number 60
Slide Number 61
Slide Number 62
Slide Number 63
Derivative Asset Ooops
What is the Value of the IRLC - DA
Slide Number 66
AICPA Valuation Services
AICPA - Discounted Future Benefit
Hedging Data for DA Valuation
Percentage of Completion by Status
Net Cash Flow Valuation Data
IRLC-DA Grows in Value as Costs Incurred
Lock to LHFS DA Value Accretion
Revenue Potential vs Derivative Asset
GAAP Methods Only Right Once
Slide Number 76
IRLC Value is What You Negotiate
Slide Number 78
Slide Number 79
FASB Board Meeting ndash 32818
IRLC is Level 3 Fair Value ndash FIX BOOK
Existing Disclosures Requirement
Slide Number 83
IRLC is Taxable when Recorded - BUT
Slide Number 85
Slide Number 86
Loans Closed over 6 months
Volume and PampL LHFS only (Exclude IRLC)
PampL - with and without IRLC
IRLC Revenue is Confusing
Slide Number 91
Slide Number 92
Slide Number 93
Slide Number 94
Slide Number 95
Slide Number 96
IRLC Revenue is Confusingbull Explaining the IRLC Revenue Recognition is difficultbull Recognize Revenue at Lock and Expense at Closing
bull Even though CTC is applied to reduce the IRLC the Recognition of IRLC Revenue at Lock given changing volume levels distorts PampL If monthly volume never changed distortion is abated
bull IRLC is very difficult for Management to Understandbull We use charts and graphs to highlight the IRLC impact
bull It is essential to prepare Management the PampL Impact when volume drops and GAAP shows a loss
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
1 The Mortgage Road Application thru Servicing2 Confirm Loan Accounting Details amp Loan Level Profitability3 Revenue Recognition Unintended Consequence of GAAP4 Cash flow prediction and management5 Warehouse Line Management6 Operational Performance Metrics7 Technology infrastructure How much Is enough8 Regulatory Basics ndash ECOA TILA TRID RESPA HMDA BCFP9 Organizational Design Interrelatedness amp Complexity10 Origination Functional Overview 11 Details of each origination related function12 Leadership Tactics for Sales Management13 Who is the Customer14 What about the Customer Journey15 LO Comp and branch cost management
16 The MSA basis for regulatory compliance17 Loan Program Profitability ndash Who so many bond programs18 When to move from BE to Short-TBA19 Hedging TBA-MBS Co-Issue Pair-off Mandatory amp DVP20 Details of Hedge Accounting amp MTM ndash21 Hedging ldquoblackboxrdquo amp the Monti Carlo Sim Pull-Thru Pull-Thru 22 Servicing Details ndash functions (Investor accounting thru Loss Mit)23 Subservicer details ndash oversight TPM requirements value assessment24 MSR valuation PSACPR Cost Basis amp the IRR25 When to bring Servicing in-house26 Strategy for growth Who are we amp Vision Mission Values Culture27 Multi-Channel alternatives Retail Wholesale Direct Reverse28 How to Fund Growth29 MampA in mortgage lending ndash buy a branch or a company30 Identifying Targets for Acquisition
CFO Mortgage Lending Bootcamp
Helping CPAs amp CFOs Develop a Comprehensive Understanding of Mortgage Lending
Slide Number 1
Slide Number 2
Slide Number 3
Presentation Outline
Slide Number 5
Simple and Easy
Slide Number 7
Hedging For Accountants
Purpose of Hedging
The BE Road
Slide Number 11
Multi-Variant Correlation
Hedging Off-Set
Slide Number 14
Hedge Rate Shock Report
Optionality of Lock Commitment
Slide Number 17
Slide Number 18
The Hedging Road
Slide Number 20
Slide Number 21
Slide Number 22
Slide Number 23
Slide Number 24
Slide Number 25
Slide Number 26
Slide Number 27
Slide Number 28
Slide Number 29
Current Coupon Price Structure
MBS Security Price Change
Impact of Price Change
Dec to Jan ndash Big Price Change
Mortgage Hedge AccountingASC 815 ndash Derivatives ASC 820 ndash Fair Value MeasurementASC 825 ndash Fair Value OptionASC 860 ndash MSR
