and prepayments, and the cash flow waterfall with the transaction. The discount rate
used to present value the estimated cash flows is commensurate within the risk of the
residual interest. The fair value of the residual interest is $188.52 in this example.
Under FAS 140, an entity that contracts to service financial assets that it does not
own generally will be required to recognize either a servicing asset or a servicing li-
ability. A servicer of financial assets commonly receives the benefits of servicing—
revenues from contractually specified servicing fees, late charges, and other ancillary
income, including “float”—as compensation for performing the servicing activities
and incurring the related costs of servicing the assets. When the benefits of servicing
are more than adequate compensation for a servicer performing such servicing, the
contract results in a servicing asset. Adequate compensation is defined as the amount
of benefits of servicing that would fairly compensate a substitute servicer should one
be required, that includes the profit that would be demanded in the marketplace. A
servicing contract with adequate compensation would be able to be transferred to a
substitute servicer without a corresponding payment or receipt. If the benefits of serv-
icing are not expected to adequately compensate a servicer for performing the serv-
icing, the contract results in a servicing liability. In the case of a transfer of assets ac-
counted for as a sale, a servicing liability would serve to reduce the net proceeds of
the sale, thus decreasing the gain on the sale or increasing the loss. A servicing asset
would be treated as a retained interest in the securitized asset and, therefore, initially
would be carried at an amount based on its allocated book value. FAS 140 clarifies
that servicing assets and liabilities are not to be netted for financial reporting pur-
poses. Rather, they are to be treated separately as assets and liabilities. Since the 2%
contractual servicing fee in this example is more than adequate compensation, a $25
fair value resulted.
FAS 140 also requires that a transferor recognize any newly created assets ob-
tained and liabilities incurred in a transaction. These items usually would include put
or call options held or written, guarantee or recourse obligations, forward commit-
ments to deliver additional receivables (e.g., in connection with reinvestment provi-
sions of some credit card securitizations), swaps (e.g., provisions that convert inter-
est rates earned by the transferee from the fixed rate paid by the debtor to a variable
rate), and servicing liabilities, if applicable. These items would be initially measured
at fair value. Expenses such as accounting, legal and underwriting fees reduce the
gain.
(h) Subsequent Accounting. FAS 140, with certain notable exceptions concerning
servicing assets and liabilities and financial assets subject to prepayment as discussed
below, does not provide guidance about the subsequent accounting for items that are
recorded as a result of applying its provisions. Accordingly, assets and liabilities
recorded as a result of applying FAS 140 will be treated in accordance with existing
generally accepted accounting principles (GAAP) applicable to the item. Some of the
items emanating from transfers of financial assets may be debt securities that are ad-
dressed by FASB Statement No. 115, “Accounting for Certain Investments in Debt
and Equity Securities” (FAS 115) or derivative financial instruments that are ad-
dressed by FAS 133, “Accounting for Certain Derivative Instruments and Certain
Hedging Activities” (FAS 133).
FAS 140 provides that interest-only strips, loans, other receivables, retained inter-
ests in securitizations, or other financial assets that can contractually be prepaid or
21 • 16 ASSET SECURITIZATION