Remember all those prognostications from industry experts how the Dodd-Frank bill would destroy the nonbank segment of the mortgage industry, resulting in a total takeover of residential finance by depositories?
You can put your worry beads away. Thanks to international banking regulators and their views on the economic value of mortgage servicing rights, it appears that the bank takeover of mortgage banking may never happen.
Buried in the details of the Basel III accord on international bank capital standards is language that caps MSRs at 10% of equity compared to the current cap of 100%. The MSR language has received little or no coverage in the trade press, but servicing advisors and mortgage analysts are beginning to take note, trying to figure out what it all means for both MSRs and the mortgage industry as a whole.
And here's the really interesting news: International banking regulators wanted to ban MSRs counting from capital entirely, something Federal Deposit Insurance Corp. chairman Sheila Bair mentioned (in passing) during her recent Congressional testimony on implementing the Dodd-Frank bill.
Bair believes — as do many mortgage professionals — that MSRs "clearly have value" and applauded the U.S. bank regulator delegation for proving their case to the Basel committee. But what she didn't say is how much of a haircut MSRs took in the final international regulation: going from 100% to 10%.
But the obvious question is this: Just how many banks are going to be hurt by this capital haircut on MSRs? A new report from Sandler O'Neill said it knows of roughly 60 banks with $1.5 trillion in assets where MSRs account for 10% or more of capital. In a new report, Sandler analyst Thomas Killian noted, "For these banks, and others with higher levels of MSRs or deferred tax assets, the deduction of these assets from the amount of common equity could significantly reduce their calculated capital ratios."
In an interview with National Mortgage News, Killian noted that Sandler knows the identity of the 60 institutions, although it did not publish their names in the report. (He said anyone who has time and access to public earnings reports can figure it out.)
The good news for the 60—as Killian told me—is that they have time to adjust their business models. The Basel III accord provides a multi-year phase in on MSR caps.
But Killian was clear on what it all means for the big picture: these banks will have to retain less residential servicing and sell more, which plays into the hands of a new theory forming out there that nonbanks, REITs and hedge funds could move into the mortgage industry and fill the void.
After all, nonbanks and hedge funds don't have to face Basel III or banking regulators because they operate in what Killian and others refer to as the Shadow Banking Community.
Tom Piercy, managing partner for Interactive Mortgage Advisors (IMA) in Denver, said he is hearing talk from "major banks" that change is on the way, but he's not yet convinced on how dramatic it might be. Although Basel III caps bank capital at 10% for MSRs, no one believes it will force any of the “Big Three” (Bank of America, Wells Fargo and JPMorgan Chase) to change—in any significant way—how they operate in residential finance, at least not right away.
According to calculations done by National Mortgage News, BofA, Wells and JPM value their MSRs (as an asset) at $15 billion, $13.3 billion and $11.9 billion, respectively.
Piercy thinks the Basel III cap on MSRs will lead to a "greater need" for midsized nonbank players to "back fill" voids that will be created when certain bank players reassess their role in residential finance/servicing.
"I’m not sure yet if this is a paradigm shift," the IMA executive said. "I think it will create a greater need for midsized [nonbank] players, but I also believe that the mortgagor is still a coveted customer for most banks."
A key point in this debate of bank vs. nonbank is the capital requirements for seller/servicers that conduct business with Fannie Mae, Freddie Mac and GNMA. Lenders must now have a minimum $2.5 million in capital before they can get their "government eagle," but few think the requirement will keep anyone who knows what they're doing out of the business.
One West Coast mortgage banker I talked to told me he's seen this change coming for a year now and plans to raise cash to start a “hard money” lending operation. (He did not want to be identified.) His target is $100 million.
But what about MSRs? If banks can only count 10% of their value toward capital does that mean MSRs will be considered a less valuable asset in the secondary market? Some servicing advisors told me that the days of selling new MSRs for six- and seven-times the serving fee in the secondary market are over. But that doesn't mean — at all — that MSRs have no value.
"Hedge funds or REITs might become huge buyers of MSRs," Killian said. "But don't expect banks to fire sale these assets."