Feeling the Impact of Basel III on Private Securitization Activity

It’s been a few months since the final Basel III Framework was endorsed by the G-20, complete with its revised “phase-in schedule” of changes to new capital ratios for both Common Equity Capital and Tier 1 Capital for banks. 

Many securitization industry followers may recall that back in July and August of 2010, there was much discussion about the provision in Basel III which would signficantly reduce the “credit” that banks would receive when applying Mortgage Servicing Rights (“MSR’s”) towards their Tier 1 Capital requirements.

Banks have traditionally been able to apply 100% of the value of MSR’s to their Tier 1 ratios.  Under Basel III, banks may only be able to apply a portion of their MSR’s to their Tier 1 requirements.  Under the new rules, MSR’s and other related classes of assets may only make up 15% of a bank’s Tier 1 capital requirement.  This has led many industry professionals to predict a significant contraction in the size of the private mortgage-backed business, even after the recovery of the markets from the recent credit crisis.

Most of the logic lies in the fact that many banks, both large and small, that have run active mortgage businesses and especially those that have run private RMBS programs, will now view the overall economics of the mortgage business in a very different light.  The Tier 1 credit that MSR’s have traditionally generated for these institutions has been one more ancillary benefit to those organizations; certainly one that “doing without” may discourage banks from being as committed to the mortgage business.

Some have gone further and stated that the reduced MSR benefit may drive pricing up for borrowers, as there will be fewer banks competing for these loans.  We’re not prepared to jump on that wagon, just yet, but it does sound like the argument may have some merit.

It will be interesting to see how the banks react to these new requirements, this year and next.  Basel III does provide the banks with a “phased-in” approach to this reduction in benefits for MSR’s, beginning with a 20% reduction in 2014, 40% in 2015, 60% in 2016, 80% in 2017 and, finally the full reduction to a 15% credit towards Tier 1 in 2018. 

If some of these predictions are correct, then we would believe that the banks would already be starting to make  some adjustments in their mortgage businesses.  Certainly, from a reporting perspective, 2013 will be here faster than you think.

There is another school of thought that suggests that private market securitization activity will not be reduced, as a result of the Basel III MSR rule.  Rather, it has been suggested that the there will be a significant expansion of the REIT industry and the buying and selling of MSR’s in the private market, as banks calibrate and re-calibrate their balance sheets each quarter.  In other words, perhaps the banks will get comfortable with the notion that they may not be able to retain all the benefits that “retained servicing” has provided over the years but that they can keep a significant slice of it in the form attractive re-sale values in a more fluid secondary market.

Next week, the securitization industry will be gathering in Orlando, FL for the American Securitization Forum’s Annual Conference.  The agenda is stockpiled with panels discussing a variety of new regulatory changes and polices.  Perhaps the impact of Basel III on the private mortgage-backed industry will get some air time.

About markferraris
Managing Principal Orchard Street Partners LLC

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