Persistent punitive mortgage capital requirements emerged as a top concern in banks' "endgame" comment letters, despite regulators' efforts to revitalize banks' mortgage activity.
US banks are calling on federal regulators to revise the proposed Basel III "endgame" capital framework in the final rules. In comment letters submitted ahead of the June 18 deadline, financial institutions argued the capital rules overhaul would still penalize mortgage activities and ultimately constrain credit.
Objecting loan-to-value reliance
Under the proposals, residential mortgage risk weights would be tailored to each loan depending on its loan-to-value (LTV) ratio, as opposed to current uniform risk weights. However, banks do not think the changes go far enough to tailor mortgage risk weights and should include more factors.
"While LTV can be a useful measure of risk, it is not, and should not be, on its own, the sole predictor of credit performance," BayCoast Bank Chief Risk Officer and General Counsel Casey Brouthers wrote in a June 18 letter to regulators.
The overreliance on LTVs could be particularly harmful for private, community banks with less access to capital than larger, public competitors with access to external capital, he added. That dynamic "could have an unintended impact on limiting credit availability within our local communities (such as first-time homebuyers and low-to-moderate income communities who are more likely to utilize higher-LTV loans with PMI)," the executive wrote, noting that BayCoast has even fewer external capital options given its mutual holding company structure.
Ephrata National Bank's Chief Risk Officer Nick Klein expressed a similar opinion in a June 8 letter. The executive stated that "while LTV is an important indicator of loss severity, it is not the primary determinant of credit risk in real-world underwriting," pointing to factors like debt-to-income and credit history that are central to community bank lending decisions.
Without changes in the final rule, the bank's ability to comply with the Community Reinvestment Act (CRA) could be harmed, Klein added.
"We originate many higher-LTV mortgages for first-time homebuyers and lower-income households. Under the proposal, these loans may receive higher risk weights, increasing the cost of capital associated with these exposures," he wrote. "These loans are central to fulfilling the CRA and expanding access to homeownership."
The executive suggested regulators include borrower-based metrics like debt-to-income ratios and credit scores into risk weights, as well as consideration for CRA-related loans.
Several banks, such as Fifth Third Bancorp, Valley National Bancorp, Axos Financial Inc., Gateway First Bank and BayCoast Bank, requested that regulators include private mortgage insurance (PMI) in mortgage risk weights. Banks argued that it is a proven credit risk mitigant and ignoring it overstates risk, particularly for loans to first-time homebuyers.
"Excluding PMI from the LTV calculation understates the risk mitigation already present in many mortgage portfolios and may discourage banks from requiring PMI on higher-LTV originations, which is a counterproductive outcome from a safety and soundness perspective," John Tolla, Axos chief risk officer, wrote in an April 15 letter.
Varying approaches to mortgage servicing
One of the most widespread points of contention among banks' comment letters was the 250% risk weight for mortgage servicing assets (MSAs), even while eliminating the current deduction threshold. Banks agreed that the 250% risk weight fails to recognize risk management and the benefits of hedging, but they differed on how regulators should amend the final rule.
BOK Financial Corp. suggested that regulators implement a tiered approach in which hedged mortgage servicing rights (MSRs) receive risk weightings of 100% to 125%, while unhedged MSRs receive a 250% risk weight.
"This tiered approach would reward sound risk management practice, create a meaningful economic incentive for banks to hold and prudently hedge MSRs, and more accurately reflect the residual risk profile of well-managed MSR portfolios. It would also align capital treatment more closely with the actual risk contribution of these assets to a bank's overall risk profile," two BOK executives wrote in an April 28 letter.
Many others, such as Western Alliance, BayCoast Bank, Fifth Third and West Gate Bank, suggested a flat reduction to a 100% risk weight for hedged MSAs.
"Without reducing the 250% risk weighting to 100%, it disincentivizes financial institutions from engaging in mortgage servicing activities, which in turn negatively impacts the communities we set out to support," BayCoast's Brouthers wrote.
Banks have increasingly moved away from mortgage servicing over the last two decades due to the high capital requirements. Very few banks would benefit under the proposals, as only nine banks exceed current threshold limits, a recent analysis by S&P Global Market Intelligence found.
