The Office Federal Housing Enterprise Oversight (OFHEO) Director James Lockhart announced that the OFHEO has sent to the Federal Register a final rule for loss severity calculations under OFHEO’s Risk-Based Capital (RBC) regulation. The new regulation applies to the GSEs.

According to a press release from the OFHEO, the final rule corrects certain deficiencies in the formulas used to calculate risk-based capital.

The risk-based capital requirement is defined as the amount of total capital, core capital plus a general allowance for loan losses less specific reserves, that an agency must hold to absorb projected losses resulting from future adverse interest-rate and credit-risk conditions specified by the statute, plus 30% mandated by statute to cover “management and operations risk.”

With this action, the OFHEO implements two changes to the existing rule. The first one is being implemented because certain loss severity equations result in the agencies recording profits instead of losses on foreclosed mortgages during the calculation of the risk-based capital requirement. Unchanged, the loss severity equations overestimate these agencies' recoveries for defaulted government-guaranteed and low LTV mortgages.

Those results are not consistent with the Risk-Based Capital regulation and result in significant reductions to the risk-based capital requirements of the GSEs. The second change is being done due to the prior treatment of Federal Housing Administration insurance associated with single-family mortgages with an LTV below 78% is inconsistent with current law.

The changes announced today correct these deficiencies, according to the OFHEO.

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