MSR Market is Building: Signs of Basel III Impact Have Begun

It looks like we may have been right on the money about the “motivations” of traditional mortgage originators to sell mortgage servicing rights (“MSR’s”) in the “Basel III” regulatory environment.

Some of our readers may recall that back in February of 2011, we wrote a piece related to the negative impact of Basel III regulations on the value of holding MSR’s by large US banks, particularly those engaged in the RMBS markets (both through the GSE’s and for their own private conduits).  No longer would these banks be able to utilize the value of these MSR’s as an offset to their regulatory capital requirements, a distinct benefit under the existing rules.

First, here is a reprint of our earlier article.

Feeling the Impact of Basel III on Private Securitization Activity

February 4, 2011 by

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.

END

 Back in February, we predicted that the big mortgage lenders would begin to develop strategies aimed at offloading at least a percentage of their MSR’s as a result of this reduced benefit to their Tier 1 capital ratios.  Little did we know that the biggest cow in the yard would get started so soon and in such a big way.
 
Last week, there was news in the markets that Bank of America was close to completing the sale of $50Billion in Freddie Mac MSR’s to an undisclosed buyer.  This is on top of another $70Billion that BoA sold in a hush-hush trade apparently completed in August 2011.
 
Now, granted both trades apparently involve legacy Countrywide Mortgage portfolios and who wouldn’t want to create as much space between your company and the old Countrywide, if you were current BoA management.  Nevertheless, just 3 or 4 years ago, these MSR’s would likely have been touted as a windfall benefit for BoA in the Countrywide transaction.
 
BoA is almost universally viewed as in an “asset sale mode” and clearly, if they can get a good price for their MSR’s this is a good way to raise capital to address a portion of their short-term needs.  However, over the longer term, we do not see this as a positive trend and if we are correct, the loss of the “regulatory capital benefit” associated with MSR’s cannot  be good news for the recovery of the RMBS markets in the US.
 

About markferraris
Managing Principal Orchard Street Partners LLC

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