The Basel Committee on Banking Supervision, under the auspices of the Bank for International Settlements (BIS), offered proposals last week to revamp current international bank capital requirements, including a significant reduction in the risk weighting for high-quality corporate paper.
The BIS's 62-page report seemed to offer both good and bad news for the mortgage market. The good news was, contrary to market-wide rumors early last week, the BIS did not recommend that current 0% risk weightings for Ginnie Mae bonds be increased to become more like those for Fannie Mae and Freddie Mac bonds, which currently have a risk weighting of 20%.
However, what could prove to be bad news was the BIS's proposal that risk weightings for all high-quality corporates be reduced from 100% to 20%, which would mean such bonds, at least from a risk weighting perspective, would be more attractive relative to mortgage product and agency debt than they are today.
In addition to the highly rated corporates, asset-backed securities with triple-A ratings would also receive the 20% risk weighting under the BIS plan. However, the proposal would not change risk weightings for residential MBS, currently at 50%, or commercial MBS, at 100%.
"It really could realign demand among banks for these securities," said Linda Lowell, an MBS researcher at Credit Suisse First Boston. "It is going to take a long time to see how much banks are going to shift. But it certainly might take a bite out of the MBS appetite."
The Basel Committee said banks would have until March 31, 2000, to comment on the plan, which is designed to provide a guideline for banking supervision in industrialized countries. The proposal was set forth to replace the previous Capital Accord of 1988, which described how much capital must be set aside by internationally active banks against their loans.
"One must remember that this won't happen for a very long time, considering the proposal had a comment period of 10 months," said Art Frank, an MBS researcher at Nomura Securities. "However, if they do move in this direction, it will likely induce some bank portfolios to invest in high-quality corporate bonds, which traditionally had not played much of a role, and banks might dispense of some of their mortgage paper and debentures."
Meanwhile, risk weightings for lower-rated tranches of securitizations would actually increase under the plan. Those rated below double-B plus would receive a 150% risk weighting, and those rated single-B plus or below would be deducted from capital. Tranches rated triple-B plus to triple-B minus receive a 100% risk weighting.
This could affect banks' ability to hold residuals in their securitizations, said an attorney who is expert in securitization. That would have some impact on home-equity deals.
Still Some Optimism
To be sure, no one in the MBS market expects demand for agency paper to dry up. While Lowell believes that banks will eventually shift some of their CMO holdings to ABS, which may offer more attractive yields, she noted that the narrower spreads associated with high-quality corporate paper might not make that product as attractive as it sounds.
"I'm not sure the change in risk weightings would enhance bank demand for corporates," Lowell added. "We could expect some fine tuning in demand for the MBS market, but then again, the market is always distracted by a heavy ABS calendar."
In terms of the BIS plan, even though it wouldn't change risk weightings for MBS or CMBS product, some market players took heart in the fact that ABS would enjoy a lower risk weighting, postulating that the move could galvanize U.S. bank regulators to finally proceed with a longstanding proposal to give a 20% risk-weighting to triple-A rated asset-backed bonds, as well as residential and commercial MBS.
This proposal surfaced in late 1997, and the comment period ended in February 1998. Since then, it has languished without any further action.
"With this Basel announcement, it would appear the international community is coming into closer accord with the risk-based treatment that has been in operation for some time by the Office of Thrift Supervision and resulted in no negative impact," said George Green, a senior economist at the National Association of Realtors.
"Hopefully," he said, "the Basel announcement will spur American bank regulatory agencies to renew their consideration of triple-A-rated and double-A-rated securities for the 20% risk weight."
Added George Miller, deputy general counsel at the Bond Market Association: "At first blush, the 20% risk weightings for triple-A- to double-A minus [ABS] is consistent with our view of a more appropriate capital treatment for mortgage-backed and asset-backed securities."
The Basel proposal had been delayed by a dispute over German commercial mortgages. Sources said the Germans were not allowed to set aside less capital for commercial mortgages as they wished.
Bank regulators in most developed nations establish their regulatory framework within the parameters set by the Basel Committee.
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