Lenders were blessed and burned last week when the Financial Accounting Standards Board addressed implementation issues for its new standard to account for derivatives that affect their ability to hedge risks.

One issue followed shortly after a letter received from the Mortgage Bankers Association that expressed the trade group’s concern about a tentative decision by the Derivatives Implementation Group (DIG), an independent group that analyzes issues stemming from the new proposal and suggests solutions for FASB’s approval. That issue concerned accounting for combinations of options to hedge market risk, especially from mortgage servicing rights in the case of mortgage lenders.

The DIG decided that a combination of options can only be designated a net-purchase option, and so receive the desired hedge accounting if it meets four criteria. The MBA said in its letter that most mortgage lenders using such an instrument to hedge mortgage servicing rights would, due to the nature of the business, be unable to meet the criteria, and so would have to account for it as a net-written option. Such designations can only be accounted for as hedges under very specific and limited circumstances.

Jim Edwards, vice president of capital markets for Homeside Lending and a member of the MBA’s Hedge Accounting Task Force, said that while task force participants did not believe accounting for hedging instruments drove the mortgage lending business, the new accounting would have ramifications.

"Members acknowledged that there will be additional documentation and analytical work required to demonstrate an expectation of hedge’s effectiveness," he said. "The MBA was concerned that the conditions in DIG’s response may limit the use of certain combination option strategies being used or contemplated by some mortgage bankers," Edwards said. Edwards added, however, that such strategies are only a small part of hedging choices.

While FASB did not give mortgage lenders reprieve last week on the combination of options issue, it did ease up on the timing restriction the DIG initially required to receive hedge accounting and defer the gains or losses of a cash flow hedge of a forecasted transaction, if it appears the forecasted transaction will occur after originally specified. The DIG said that in order to receive hedge accounting, the transaction must occur within an addition period that is no more than 10% of the originally specified time period, or 60 days. The mortgage industry, according to Tim Lucas, technical director at FASB, noted that the 10% limit was excessively strict for many mortgage cash flow hedges, so the board "blew the 10% away."