Basel III Treatment of Mortgage Servicing Assets

The punitive treatment of mortgage servicing rights (MSRs) under the Basel III risk-based capital standards threatens to undermine the value of this important asset, with adverse implications for the entire mortgage finance chain.  Performance, capacity and service should be the primary drivers of who gets market share in servicing, not excessively high capital standards on one segment of the industry.

Overview:

  • The Basel III bank capital rule currently being phased-in increases the risk-weighting of MSRs held by banks from 100 percent to 250 percent.
  • It also decreases the cap on MSRs a bank may hold on its balance sheet to an unduly stringent 10 percent limit; MSR assets above the limit must be deducted dollar-for-dollar from regulatory capital.
  • In addition, MSRs, deferred tax assets and equity interests in unconsolidated financial entities are limited-in aggregate-to a 15 percent common equity component of tier one capital, above which they must be deducted from regulatory capital.
  • The unnecessarily punitive treatment of MSRs makes them one of the most costly asset classes in the entire Basel III framework, despite any actual evidence that the underlying risk warrants such punitive treatment.
  • MBA has consistently advocated for changing the MSR limits to avoid penalizing small and mid-size banks that value the consumer relationship provided through the MSR.  MBA also worked with the Treasury Department to ensure that this issues was included on its list of June 2017 of key reforms to reduce regulatory burden.
  • The banking regulators proposed a "pause" in Basel III implementation in August 2017. This would freeze Basel III implementation regarding MSRs for banks with less than $250 billion in assets as regulators considered proposals to "simplify" the treatment of MSRs under Basel.  The simplification proposal was released in late September 2017 and comments are due in November 2017.
  • The November 2017 proposal suggest raising the cap to a 25 percent limit while retaining the 250 percent risk weighting.   

Impact:

  • In significant part due to the new Basel rules, many banks shed their MSR assets, moving them to banks with smaller MSR exposures and to non-bank servicers.
  • Some of these transfers are driven by Basel-related issues, not necessarily by the core competencies of the parties involved. As a result, many banks that are strong servicers and want to remain in the business are forced to dramatically increase capital levels or sell the asset.
  • With the transfer of servicing out of a bank, the bank is losing one of its two primary relationships with retail customers (deposit and mortgage loan relationship), a safe and sound earning asset and a natural hedge to the loan production side of the business.
  • The punitive capital treatment, on balance, reduces aggregate demand for MSRs, creating a less liquid market that could result in lower prices for mortgages sold in the secondary market and higher rates for consumers.   

MBA's Position/Next Steps:

  • MBA has engaged with the Trump administration to increase their awareness of the issues created by Basel III and its disproportionate impact on an asset that is unique to the American mortgage system. MBA has urged the administration to revise the treatment of MSRs as part of its ongoing regulatory review under the Executive Order on Core Principles for Financial Regulation and appreciates the attention to this issue in the Treasury's recent report on reducing regulatory burden. 
  • MBA appreciates both the implementation pause and focus on changing the Basel III MSR treatment.  MBA submitted comments in favor of the implementation pause and will be commenting on the proposed simplification. 

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