Pub. 10 2015-2016 Issue 1

www.nebankers.org 12 Extraordinary Service for Extraordinary Members. A CRITICAL COMPONENT OF THE mortgage banking business model is the value of the mort- gage servicing asset (MSA) 1 created at the time of loan origination. During the origination process, banks have the choice of either retaining the servicing function or selling the servic- ing to a third party. Many banks prefer retaining servicing to maintain the relationship with the borrower and to be positioned to control any workout in the event a collateral or borrower issue causes a delinquency. A servicing- retained strategy maintains valuable connections with customers, while managing interest rate risk by selling long-term credit assets. Implementation of Basel III 2 , howev- er, is disrupting the market for MSAs by imposing punitive capital requirements forcing many banks to sell these assets, usually to nonbank mortgage servicing firms that have little connection with the original borrowers. Recognizing this disruption, Reps. Ed Permutter (D- CO) and Blaine Luetkemeyer (R-MO) introduced a bill that requires a delay in the implementation of the Basel III rules impacting MSAs until the effect of the new rules can be studied and better alternatives explored. 3 The American Bankers Association (ABA), as well as other banking trade associations, sup- port such “stop and study” bills and “are calling on regulators to revisit this, because you want banks to service the loans they make to customers and you don’t want to drive servicing out of banks.” 4 Basel III MSA Rules At issue is a provision in the Basel III rules that limit MSAs to 10 percent of a bank’s Tier 1 common equity (CET1), with additional holdings deducted from the Tier 1 capital account. MSAs under the 10 percent cap also would eventually be risk-weighted at 250 percent (begin- ning in 2018). In addition, combined holdings of MSAs and several other assets are limited to 15 percent. Ex- pressed in terms of capital ratios, MSAs COUNSELOR’S CORNER Are the Basel III Mortgage Servicing Assets Requirements Endangering Certain Relationship Lending? Jeff Makovicka and the Hon. David Karnes , Kutak Rock LLP will shrink the numerator (when they exceed the 10 percent threshold) and inflate the denominator, resulting in a lower regulatory capital ratio. This is a significant change from the previ- ous capital regime, in which there was no limitation on the amount of MSAs included in Tier 1 capital and carried a risk weighting of 100 percent. The vital concern for most of the banking industry is not that they hold MSAs in excess of 10 percent of CET1 but that the capital requirements of MSAs below a 10 percent threshold have increased significantly. Issues & Impact • Servicing loans is a specialty of many banks, including many regional and community banks, and MSAs often- times will exceed 10 percent. • The deduction of MSAs that exceed 10 percent of a bank’s CET1 capital combined with the high (and in 2018 punitive) risk weight could severely impact some regional and community banks, possibly even lowering their capital levels below well-capitalized status. • Based on the capital treatment, some banks may choose to exit the mort- gage servicing business impacting long-standing customer relationships and reducing fee-based income. This choice would not be based on the core competencies of the parties but rather on Basel III issues. As a result, many banks that are good at servicing and desire to remain in the business will be forced to increase capital levels or shed the asset. • With the transfer of servicing out of banks, banks are losing one of their primary relationships with retail customers, a safe and sound earning asset, and a natural hedge to the loan production side of the business. • Consumers experience higher prices as banks attempt to price to attain a benchmark earnings rate on a higher required capital level. 1 MSAs are contractual rights to service (for a fee) the mortgage loans owned by others. 2 “Basel III” means the Global Regulatory Framework for More Resilient Banks and Banking Systems issued by the Basel Committee on Banking Supervision on Dec. 16, 2010, as revised on June 1, 2011. The term “Basel III rules” means the U.S. implementation of Basel III through the Board of Governors of the Federal Reserve System, the Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corporation’s rules entitled “Regulatory Capital Rules: Regulatory Capital, Implementation of Basel III, Capital Adequacy, Transition Provisions, Prompt Corrective Action, Standardized Approach for Risk-Weighted Assets, Market Discipline and Disclosure Requirements, Advanced Approaches Risk-Based Capital Rule, and Market Risk Capital Rule.” 3 Mortgage Servicing Asset Capital Requirements Act of 2015, H.R. 1408. 4 Robert Davis, ABA Executive Vice President.