Capital rules may radically shift the mortgage industry. Here's how

December 11, 2023 4:00 AM

Depositories are reviewing one set of proposed capital regulations and there are separate rules in development that will pertain to nonbanks. Should both sets of new standards for ensuring liquidity go into effect, the combined impact could radically reconfigure the composition of the mortgage industry.

Not only do the Basel III endgame bank rules have some implications for nondepositories in the business, but some institutions in both categories will be contending with the effects of new capital regulations at the government-sponsored enterprises and Ginnie Mae. The changes for those major players in the secondary market could have a domino effect.

While the depository regulations had yet to be finalized at the time of this writing, it seemed likely at deadline that the combined effect of all of these would lead to changes in what types of players take on different roles in home lending as some drop out and others step up.

"I think you're going to see a market reshifting or rebalancing in the next few years as certain players have to abide by these rules," said Andy Duane, attorney at mortgage law firm Polunsky Beitel Green.

Lending implications

To some degree, there is a common ground between depository and nonbank mortgage firms when it comes to the proposed rules for the former. That's because stricter capital regulations could constrain interest in providing funding lines that banks provide to nondepositories.

But as executives at nonbank Pennymac recently noted in an earnings call, tighter mortgage capital rules also could have some upsides for some nonbanks in that they could reduce competition for loans. Banks below the asset size cutoff for depository rules also may benefit.

"You might see a little bit of reshuffling down into the nonbanks and the community banks. You could see maybe some of them merge. Larger banks, if they're unable to keep up with all these capital rules, might just not be as attracted to mortgage lending," Duane said.

Lenders who sell to aggregators might end up rethinking their strategies due to investors changing their involvement or pricing. There could be more sales directly to the enterprises as a result, depending on how what they're willing to pay for loans compares.

That could change pricing in third-party originations, which can be subject to relatively less favorable pricing than other loans the enterprises buy.

The enterprise regulatory capital framework changes recently finalized did not incorporate a Mortgage Bankers Association suggestion to end inconsistent pricing for TPO loans. However, the Federal Housing Finance Agency has said further ECRF changes are possible.

There's also some concern about the intersection of the proposed bank rules, which could start implementation as early as July 2025, and a Ginnie Mae nonbank risk-based capital rule set for year-end 2024. (Implementation of the depository rules, however, will take years to complete.)

The proposed bank rule would apply relatively higher risk weightings to lower down payment products, which overlap with the profile of Federal Housing Administration-insured mortgages that Ginnie securitizes. These are often loans for first-time buyers with affordability hurdles.

Depository involvement in the FHA market is already limited, and there also are questions about whether pending capital requirements for nonbanks that are Ginnie issuers might combine with the bank rules to further thin the field in this market.

Two rules target servicing

The new Ginnie risk-based capital requirements for nonbanks are the last part of a broader set of updated counterparty standards for mortgage companies and they, like proposed regulations at depositories, make it tougher to hold mortgage servicing rights.

Ginnie drew up its overall counterparty updates in coordination with the FHFA, but the risk-based capital rule is unique to the former's issuers, so its impact would be contained to that market.

There have been a lot of mixed reactions to the Ginnie rule and debate about whether companies are done repositioning for it or not.

So with pending bank regulation potentially making it tougher for depositories to hold mortgage servicing rights around the same time that the Ginnie rules could be doing the same, there could be pullback from the government market on both sides.

"While many nonbank mortgage firms have publicly announced they're ready to implement the amended capital and liquidity requirements, there is talk about the impact of having the appetite to originate and price demand for MSRs, not to mention future advance rate and covenants required by bank warehouse lenders," said JB Long, president of the newly rebranded Incenter Capital Advisors. "I think that's where that component and the Basel component kind of intersect."

There will likely be limits to the impact on servicing in general though, given the nonbank capital restriction doesn't extend to the large GSE market, he said.

Also even with stricter capital rules in place, MSRs can have attractions related to customer acquisition, so although some nonbanks have said they may switch to subservicing to avoid the impact, others have said they'll stay in the game and benefit from it. Banks likely will too.

Customer value can keep servicing attractive even if currently high interest rates that support it were to fall, diminishing its financial appeal and increasing origination opportunities. (Servicing and originations naturally hedge each other from rate moves.)

"There are those that may want to hang on to it because they have recapture platforms," Long said.

And it would be primarily depositories above a certain threshold that would shed MSRs, or just let their business go into runoff, if the bank rules were to be finalized as proposed, he added.

Still, there's anticipation the intersection of the two rules could hit the government market disproportionately and create additional complications for reverse mortgages, which are equity withdrawal loans for seniors that the FHA insures and Ginnie securitizes.

The intersection of rate volatility and policies related to loan pooling that require Ginnie issuers to hold loans on financing lines for prolonged periods have pressured this sector's liquidity.

"That's a narrow space. There have been a couple of failures over the last year in that market and seizing of certain assets," Long said.

It's a concern government officials are aware of and have been working to remedy via policy. Private capital markets players also could potentially play a role.

A net positive for private securitization

A small niche with the private capital markets has developed structured finance vehicles for servicing and related financing that could help with some of the liquidity needs that could result from stricter capital rules.

While these are likely to remain esoteric rather than mainstream structures, there could be activity in this space next year, Kroll Bond Rating Agency analysts said at a recent press briefing on the 2024 outlook.

A more mainstream, private structured finance market that mortgage capital rules may give more of a boost to is the one for securitized single-family loans.

To be sure, so long as rates remain relatively high, volume in this market is likely to be lacking. But with banks potentially wanting to get more mortgages off their balance sheets and more correspondent sellers possibly seeking new outlets, it may have some new sources of supply.

"Regulatory capital changes and the banking crisis that happened earlier this year are making the nonbank space a little bit more attractive, and the nonbank space typically uses private-label securitization more frequently," said Jack Kahan, senior managing director and head of residential mortgage-backed securities at KBRA. "So that can lead to some additional collateral issuance going into next year."

The proposed capital rules for banks could put a little bit of a damper on depository demand for RMBS as well. However, depositories are less significant investors in the PL RMBS market than they are for agency securitizations. So the capital rules are potentially a net positive for it.

With banking regulators possibly unaware of all these nuances in the mortgage market and their proposed capital rules in an extended comment period, Duane considers it a good time to send input along these lines to them and also share any potential broader impacts on borrowers.

"We talk about this as big bank regulation, but at the same time, where does that cost the compliance kind of trickle down to?" he said.