Basel III Approved by Fed - Watch Regulation Costs Rise; Fitch Addresses Nationstar Bonds; Apps Plummet

Okay, this week is dragging, many folks are off anyway, locks are bumping along the bottom, so I am going to switch things up a little, and put the joke first. In honor of tomorrow, and of South Carolina, here you go.

The F&M Bank & Trust Company is looking to hire a Team of Mortgage Professionals in the Central Region (Oklahoma City & Dallas).  F&M Bank has been in business for over 65 years strong and is a "locally owned" $2 billon bank founded in Tulsa, OK in 1946 (www.fmbankusa.com).  The bank itself has been primarily a commercial bank but its' growing mortgage operations has offices in both Oklahoma and Texas. F&M offers a very aggressive Jumbo pricing, conforming loan amounts up to $500,000, has a marketing structure to support referral sources, has access to a banking platform which generates additional referral leads and has a very competitive commission structure which also includes bonus for targeted production levels and has local underwriting and processing.  If you or anyone you know is looking for a new opportunity, please contact David Laughlin at dlaughlin@fmbankusa .com.

Yesterday the commentary mentioned the latest lawsuit settlement story about Citigroup paying Fannie Mae $968 million to resolve mortgage claims on 3.7 million loans. I received this note: "Rob, Sign me up for that Citi settlement deal. At $263 per loan, I will take that deal every day of the week in lieu of repurchase demands." It is a little more complicated than that, but it boils down to Citi wanting to keep its relationship with Fannie, and deciding to settle. And yes, smaller originators wanting to keep their relationship with an investor will also settle.

Yesterday the commentary also mentioned borrower-signed lock agreements. From a capital markets perspective, maybe that might improve pull through. But Connie C. wisely notes, "I can't say that signed lock-in agreements are a federal requirement. That said, they can be a critical document to validate other things that are federal requirements. RESPA requires that a GFE be provided once the borrower has locked in a rate, plus the value of the APOR for HPML testing is triggered by the lock-date as well as for HMDA Reporting. If one doesn't have a copy of a signed & dated lock agreement from the borrower, its darned hard to prove any of those things. As anyone who has gone through a compliance audit knows, if it isn't documented, it didn't happen."

Well, the Federal Reserve went and approved the Basel III regulations. (Here are a couple links for you to scan: Basel III Board Memo, Basel III Final Rule)

The final rules were released to U.S. banks. Remember that the Board's approval was the first step in the approval process, but the other Basel III regulators (the FDIC and the OCC) are expected to approve the rule shortly. The rules are phased in over five years starting January 1, 2014, but we will certainly see changes ahead of that. The Final Rule did not treat mortgage banking assets as severely as the proposed rule, however the Final Rule will have potentially significant implications going forward, especially for banks owning mortgage servicing assets (MSAs) and for FHA and VA loans as their risk weighting will increase. The Final Rule is effective on January 1, 2014, but many sections have separate phase-in rules.

The MBA reports that mortgage servicing assets were not given favorable treatment in the Final Rule. "The Rule requires that the following assets that individually exceed 10 percent of the common equity component of tier 1 capital be deducted from that component of tier 1 capital: Mortgage Servicing Assets defined as contractual rights owned by the bank to service for a fee mortgage loans owned by others, Deferred Tax Assets (DTAs) arising from temporary differences that the bank could not realize through net operating loss carrybacks, and significant investments in the capital of unconsolidated financial institutions in the form of common stock.

In addition, the aggregate of all assets in the above categories that exceed 15 percent of the common equity component of tier 1 capital must be deducted from that component of tier 1 capital. In addition, any MSAs not deducted from capital would be risk-weighted at 250 percent. The present risk-weight of MSA's is 100 percent."

However, the regulators agreed with MBA's comment letters in three MSR-related areas. The first is that the existing 10 percent haircut of MSA's from capital under section 475 (b) of FIDICIA will be removed. Under the proposed rule, any non-cash gain on sale recorded for securitization interests (multi-tranche securities) would have to be reversed. Under the final rule, the gain on sale associated with the set-up of an MSA on securitization would not have to be reversed. And deferred tax liabilities associated with the MSA tax safe harbor can be used to offset MSA's used in the 10 percent and 15 percent limits above.

The final rule rejected the proposed Category 1/Category 2 approach for residential mortgages and proposed risk-weight which ranged from 35 percent to 200 percent based upon LTV. Instead, the rule retains "the treatment for residential mortgage exposures that is currently set forth in the general risk-based capital rules." Exposures secured by a first lien on a single-family home that are prudently underwritten and performing receive a 50 percent risk-weight; all other loans receive a 100 percent risk-weight. "Prudently underwritten" is not synched with QM, though could plausibly be interpreted more broadly. This is positive for the industry. But the risk-weight for FHA and VA loans would increase from zero percent to 20 percent, which is the same for MBS issued by Fannie Mae and Freddie Mac.

Residential mortgages are excluded from the definition of financial collateral in the Final Rule since they were not thought to be appropriate because they exhibit increased variation and credit risk, and are relatively more speculative than the recognized forms of financial collateral under the proposal. Per the MBA, the present definition of financial collateral for banks filing under the advanced approach includes residential mortgages in the financial collateral definition, generally allowing warehouse lines of credit to be risk-weighted at 50 percent (the risk-weight of the underlying collateral). Under the new rule, all banks would have to treat warehouse lines as commercial loans with a risk-weight of 100 percent.

Here is the MBA's complete take on it.

What does it all mean? Are servicing values going to plunge? Hopefully not, although any bank that values it's servicing at more than 10% of tier 1 capital will be reading the fine print, and perhaps adjusting its portfolio. There are certainly non-bank servicers willing to buy more. Remember that small and medium-sized US banks not subject to the advanced approaches rules (those that hold less than $250 billion in consolidated assets and less than $10 billion of on-balance-sheet foreign exposures) are required to apply either the SSFA methodology or the gross-up approach to determine risk weights on their securitization exposures, including RMBS, CMBS, and ABS. One can find more details here.

What is the "SSFA methodology"? The SSFA approach is a recently introduced methodology that avoids the usage of credit ratings in determining capital requirements for securitizations. Instead, the SSFA approach relies on the 90+ delinquency percentage and the risk weights of the underlying exposures in the securitization, as well as the attachment and detachment points of the bond, to calculate capital requirements. Relative to Basel II rules, the formula generally results in lower capital requirements on below-IG-rated, legacy senior securitizations, and higher capital requirements on IG-rated mezzanine exposures (e.g., new-issue AAs or As). For those out there who love the nitty gritty, Barclays reports that, "The final rule did make some clarifications/changes with respect to the SSFA approach: Re-remics holding only a single securitization exposure that has been re-tranched are not considered re-securitizations and, importantly, are not penalized with the higher 1.5 value. The parameter has been clarified to be floored at zero. This issue was somewhat unclear in the original SSFA proposal released for comment in June 2012 but has been resolved in the final version of the rules. The 'W' parameter used to define the 90+ delinquency rate on the securitization explicitly excludes the deferral of principal and interest payments on loans where the deferral is unrelated to the performance of the loan or the borrower. Specifically, student loans - with their varying repayment statuses (i.e., in-school, deferment, forbearance) during which principal and interest were not required to be paid by the borrower - and retail credit cards - with promotional offers of no interest/no payments for 12 months - that are in their deferral periods will not be included in the calculation of 'W'."

"Banks not subject to the advanced approaches rules also have the option to apply the gross-up approach to determine capital requirements on all of their securitized assets. For senior securitization exposures, the gross-up approach effectively results in the same risk weight as the risk weight of the underlying loans; however, the methodology heavily penalizes mezzanine securities, even if they are IG rated. If a bank chooses to apply the gross-up approach, it must apply the gross-up approach to all of its securitization positions and cannot selectively apply the SSFA approach to some assets and the gross-up approach to others" per a Barclays report.

On the other hand, banks subject to the advanced approaches rules are required to apply the supervisory formula approach (SFA) to determine capital requirements on securitizations, if all of the data needed in the formula are available. Otherwise, the bank is permitted to apply the SSFA methodology.

But there are changes to the risk-weighting methodology for mortgage whole loans. Whereas the proposed rules stipulated that mortgage loans would be assigned a risk weight of 35-200%, depending on the LTV of the loan and its collateral characteristics, the final rules allow banks to continue to utilize their general risk-weighting framework to determine mortgage loan risk weights. Specifically, mortgage loans are assigned either a 50% or a 100% risk weight, depending on their loan characteristics. Loans meeting these criteria will be assigned a 50% risk weight: loans secured by a 1-4 family residential property and is either owner occupied or rented, loan is in a first-lien position, the loan is not 90+ days delinquent or in non-accrual status, the loan must meet prudential underwriting standards, including an LTV requirement that has been set internally by the bank (historically 90%), the loan has not been restructured or modified, although loans that have been modified under HAMP are not considered restructured/modified.

Mortgages that do not meet the above criteria, including second liens, seriously delinquent loans, and loans underwritten with extremely high LTVs, are assigned a 100% risk weight.

The effect of the change in the mortgage risk-weighting methodology is generally positive for non-agencies, as many loans originated prior to 2008 would have received a higher risk weight under the proposed methodology.

Under the existing capital regime, such unrealized losses and gains are excluded from the calculation of Tier 1 capital ratio. Thus, changes in the value of agency MBS securities due to rate fluctuations have no effect on Tier 1 capital under the current regime. However, this will not be the case in the future, and including certain numbers into the capital ratio calculation will have the effect of increasing the volatility of capital ratios. Although banks could potentially reduce this effect by reclassifying these securities under their HTM or trading books and adopting more active hedging strategies, these come at the cost of lower liquidity and/or higher income volatility. As a result, it is likely that banks will reduce their duration exposure to decrease the interest rate risk on their agency MBS holdings. This could have an effect on agency MBS as banks shorten the duration window of their agency MBS purchases for their portfolio. Additionally, banks are likely to refrain from adding significant agency MBS to their portfolios, given the risks of a potential selloff of the sort seen over the past two months. This could temporarily reduce the demand for agency MBS from the banking sector.

Banks not subject to the advanced approaches rules are required to adopt the new securitization risk-weighting methodology starting on January 1, 2015. As noted above, however, advanced approaches banks must start to comply with the revised advanced approaches rules (i.e., required to apply the SFA methodology or the SSFA if it is not feasible to apply the SFA) on January 1, 2014.

Finishing up with the servicing discussion, Fitch has come out saying that bonds being serviced by Nationstar will see some losses.

This morning we learned what lock desks everywhere already knew: locks fell steeply last week. The MBA reported that applications fell 12% from the prior week, with refis falling 16% and purchases falling 3%. Applications to refinance are now down to 64% of the total, the lowest level since May 2011. And as we'd expect, the ARM percentage increased to 8% of total applications, the highest level since July 2008.

The market was pretty quiet yesterday, with low volumes and not much change to rates. But we've had the ADP numbers this morning, stronger than expected. Companies in the U.S. boosted employment by 188,000 workers in June, figures from the Roseland, New Jersey-based ADP Research Institute showed today. The median forecast of 38 economists surveyed by Bloomberg called for an advance of 160,000. This may bump up expectations for Friday's jobs numbers. At the start of the day (remember the bond market closes early today, so don't look for rate sheets to improve - who wants to take a bunch of locks ahead of Friday's jobs data?) the 10-yr is roughly unchanged at 2.48% as are MBS prices.