Pub. 10 2015-2016 Issue 1

May/June 2015 13 Extraordinary Service for Extraordinary Members. • The punitive capital treatment, on balance, reduces demand for MSAs, creating a less liquid market, which could result in lower prices for mortgages sold in the secondary market. By making it very expensive for banks to hold MSAs, a large disincentive exists for regional and community banks to service mortgage loans. Banks must either choose to sell their mortgage loans into the secondary market servicing-released (and potentially endanger their customer relationships) or cut their secondary market sales, thereby reducing their fee-based income. In the current low-interest-rate market, selling mortgage loans servicing-released is risky as MSAs historically increase in value as interest rates climb, largely because borrowers do not refinance and fewer loans are paid off. As such, banks typically useMSAs to offset lower origina- tion income when interest rates rise. When selling the servicing (as well as the loan), banks also lose the benefit of the borrower relationship (and borrowers lose the benefit of the bank relationship). As a result, a major unintended consequence of the new requirements under the Basel III rules is that mortgage servicing (and the borrower relationship) may move to third-party nonbank servicers largely outside the regulatory environment, 5 thus increasing the concentration of servicing held by less regulated, nonbank firms such as mortgage companies, hedge funds, and other private equity firms that are not subject to the new Basel III rules. Such companies likely are not the first choice of banks as a buyer of their MSAs. Moreover, this MSA disruption could disproportionately hurt rural lending. The rural economy depends on customized financial products and services that typically only community banks provide. Residential properties in rural communities are unique as they may sit on large parcels of land, be mixed- use in nature, or irregular in other ways. Such rural properties often lack adequate comparables and rarely fit the standard requirements of the secondary market. In addition, the bor- rowers may be farmers, cattlemen, or other small business owners whose debt-to-income ratios typically fall outside of secondary market parameters, despite such borrowers’ personal net worth and means to repay the loan. Community banks specialize in serving such borrowers. Anymajor disrup- tion in the ability of correspondent community banks to sell their MSAs to larger community or regional banks (or keep theirMSAs in-house) would adversely impact these rural bor- rowers as it is unlikely that large nonbank (or bank) servicers will understand the rural market and purchase suchMSAs. If banks are unable to keep or sell such rural-generated MSAs, rural lending in this area may disappear or severely decline. If banks decide to retain servicing, however, it is likely that servicing fees will increase, translating into higher loan rates for mortgage borrowers. Moreover, nonbank servicers could increase servicing fees to capitalize on the market flux, possibly creating a permanent change in mortgage pricing. Stop & Study In the rulemaking process, little or no consideration was given to the effect of the Basel III rules with respect to MSAs on the marketplace, especially on small banks. The American Bankers Association (ABA), along with other banking as- sociations (and individual banks), are educating and calling on Congress to fix the disruption caused by the MSA Basel III requirements. ABA supported H.R. 1408, which would defer implementation of the Basel III rules onMSAs until the impact of the new rules can be studied and alternatives explored. Spe- cifically, H.R. 1408woulddirect the federal banking agencies to jointly study MSAs, including their risk to insured depository institutions, their history, their valuation, and the potential effect of capital requirements on the mortgage servicing busi- ness. Within six months of enactment, the agencies would be required to report toCongress on their findings. The legislation also would suspend application of the Basel III rules to MSAs until three months after the report is issued for all banks that are not “global systemically important banks” as identified by the Financial Stability Oversight Council. 6 On April 9, 2015, the Congressional Budget Office (CBO) concluded that H.R. 1408 “would temporarily increase the regulatory capital of some banks by including additional MSAs as capital” and “could delay the corrective action or closure of a bank, potentially increasing the cost of resolution if such bank was to ultimately fail.” However, the CBO found that for a number of reasons—the brief duration of the delay, the low ratio of MSAs to total assets, the relatively lownumber of projected bank failures over the next year, and the phase-in of the current rules—the CBO expects that the probability and cost of future bank failures would not increase significantly under the bill. Accordingly, the CBO estimates the net effect on the federal budget in connection with the passage of H.R. 1408 would not be significant. As the Financial Stability Oversight Council has cited the growth of nonbank mortgage servicers as an emerging threat to the financial system 7 , passage of H.R. 1408 is a first step in understanding and correcting the MSA issue. However, any findings from a study remain to be seen. In the event that the conclusions of the study provide sufficient evidence of disruption, a regulatory carve-out for smaller banks on the MSA issue could be the next step on the path to relief. As of the date of this writing (May 1, 2015), H.R. 1408 is still in the United States House of Representatives.  Counselor’s Corner — continued on page 14 5 Although the Consumer Financial Protection Bureau and state regulators have some authority over these companies, many of them are not currently subject to prudential standards such as capital, liquidity, or risk management oversight. 6 Established under the Dodd-Frank Wall Street Reform and Consumer Protection Act, the Financial Stability Oversight Council provides comprehensive monitoring of the stability of the financial system. 7 See 2014 Annual Report of the Financial Stability Oversight Council.