Friday, June 8, 2012

Basel III will change the Mortgage Landscape once again…….

Basel III will change the Mortgage Landscape once again…….

The mortgage industry has undergone many significant changes as a result of the financial crisis. 
One of the less known pending changes we have been monitoring for some time is about to take its final form.  Basel III in its current draft will increase consumer cost and reduce consumer’s choice of mortgage provider.  Banks, Large and Small, will have to make fundamental changes to maintain acceptable Tier 1 capital.  Capital available will potentially limit mortgage production and future growth of the product line.

For the past year we have been monitoring the evolution of Basel III and the U.S. Central Bank’s interpretation.  Basel III forces Banks to rely more on equity than debt to support their operations.  U.S. Banks have pushed the Central Bank to allow them to more heavily count mortgage servicing rights and the unrealized gains and losses of certain securities toward their capital requirements than allowed by Basel III international rule, but the U.S. Central Bank's drafted rule closely follows the international rule. 
The drafted proposal will impact large Banks and small community banks changing the Georgia Mortgage Provider landscape once again.  In the beginning, large banks were the main focus and were better positioned to raise capital; however, small community Banks are included in the current draft.  Increased capital requirements related to mortgage production could change many community Bank’s mortgage strategies including the size of the operation in relation to the Bank’s balance sheet and opportunity cost assessments.  While banks have enjoyed the benefits of their current exemption from State licensing requirements, Basel III will have a considerable impact on Bank’s overall mortgage product strategies going forward.

BASEL III is a global regulatory standard on bank capital adequacy, stress testing and market liquidity risk agreed upon by the members of the Basel Committee on Banking Supervision in 2010-11.  Basel III will require banks to hold 4.5% of common equity (up from 2% in Basel II) and 6% of Tier I capital (up from 4% in Basel II) of risk-weighted assets (RWA). Basel III also introduces additional capital buffers, (i) a mandatory capital conservation buffer of 2.5% and (ii) a discretionary countercyclical buffer, which allows national regulators to require up to another 2.5% of capital during periods of high credit growth. In addition, Basel III introduces a minimum 3% leverage ratio and two required liquidity ratios. The Liquidity Coverage Ratio requires a bank to hold sufficient high-quality liquid assets to cover its total net cash outflows over 30 days; the Net Stable Funding Ratio requires the available amount of stable funding to exceed the required amount of stable funding over a one-year period of extended stressSource:
-        Cal Haupt, Chief Executive Officer, Southeast Mortgage of Georgia, Inc.
Rob Chrisman recently wrote a good article on the topic.
Unfortunately for borrowers, and rate sheet pricing, the Fed voted "full speed ahead" for Basel III. "Mortgage servicing rights (MSR), for instance, are used far more by U.S. lenders than by their international competitors. Banks get paid fees for servicing a home loan, which means collecting payments and managing foreclosures, and because they can be sold in markets, their value has been allowed to count toward capital requirements. The Basel agreement limited to 10 percent how much MSR's could count toward the common equity component and the Fed decided to strictly follow that standard. In anticipation of the new rules, some banks have been selling off mortgage servicing rights, like earlier this week when BofA agreed to sell $10.4 billion in mortgage servicing rights to a unit of Nationstar Mortgage." 
In December 2010, the proposed Basel III Accord was finalized which, if adopted by U.S. banking regulators, will result in a new regulatory capital regime for MSR (mortgage servicing rights) assets. Under the Basel III Accord, the amount of MSRs that can be counted as Tier 1 capital is capped at 10%, effective January 1, 2013, with a phased implementation through 2018.  In addition, a bank must deduct the amount by which the aggregate of the following three items exceeds 15% of Tier 1 capital: (i) significant investments in unconsolidated financial institutions; (ii) MSRs; and (iii) deferred tax assets arising from temporary differences. The exclusions from the 10% and 15% thresholds will be phased in from 2013 to 2018.

What does this mean? Basel III as currently proposed (and fully phased in) will increase required capital for most entities but will significantly increase the effective capital requirements for entities with large MSR positions relative to their Tier 1 capital. This includes a few score of banks, including Wells Fargo. Under Basel III, for those institutions at or above the 10% of Tier 1 capital level, the marginal capital requirement is effectively 100%.  The net effect of Basel III is potentially a significant increase in capital requirements for the industry as a whole. Some of the largest originators, who are market leaders in setting mortgage rates, will need to either raise mortgage rates while reducing servicing released premiums paid in order to compensate for any incremental capital required, or accept lower returns. And you can bet that if Wells or Citi or Chase lowers their SRP's, the market will follow - and the borrower will bear the brunt of it.
But there are, alternatively, other solutions to manage the 10% capital limitation, including acquisition/merger, selling the MSR, and structuring and/or holding more loans on balance sheet (eliminating the recognition of a separate servicing asset). So it is no surprise to see the news yesterday that non-depository Nationstar Mortgage has signed a definitive agreement to acquire approximately $10.4 billion in residential mortgage servicing rights, as measured by unpaid principal balance, from Bank of America. The acquired servicing portfolio consists entirely of loans in government-sponsored enterprise (GSE) pools - expect the loans to transfer from Bank of America in July. Nationstar currently services more than 635,000 residential mortgages totaling nearly $103 billion in unpaid principal balance.

Source: Rob Chrisman, Mortgage News Daily – June 8, 2012

No comments: