Are Regulators Driving Banks Out of Mortgage Servicing?

Financial institutions are raising concerns anew about a set of regulations that they say are forcing banks out of the servicing business as they sell their rights to nonbanks.

Regulators finalized Basel III rules last summer that put significant restrictions on banks' ability to hold mortgage servicing rights, particularly for smaller institutions. As a result, the regulations are hastening banks' exit from servicing and stoking fears that the agencies went too far. 

"We are calling on regulators to revisit this, because you want banks to service the loans they make to customers and you don’t want to drive servicing out of banks," said Robert Davis, an executive vice president at the American Bankers Association. "You create a significant capital advantage for nonbank servicers…and you’re creating an environment that makes it harder for banks to hold servicing assets."

At issue is a provision in the Basel package of rules that would limit mortgage servicing assets to 10% of a bank’s Tier 1 common equity, with additional holdings deducted from the Tier 1 capital account. Assets under the 10% cap would also eventually be risk-weighted at 250%. In addition, combined holdings of mortgage servicing and several other assets are limited to 15%.

"The Basel rules treat mortgage servicing assets quite harshly," said Pete Mills, senior vice president of residential policy and member services at the Mortgage Bankers Association. "It’s very expensive to hold on the balance sheet because of the capital treatment."

A number of trade groups have raised concerns with the servicing measure since the rules were initially proposed, but regulators did not make big changes in favor of the industry when they signed the final Basel III package last year. The ABA, for example, continues to advocate for the banking agencies to consider raising the 10% threshold to 25% and eliminating the aggregated 15% cap altogether.

Lawmakers have also jumped into the fray, though the odds of tangible legislative action on the issue remain very slim at the moment. Rep. Blaine Luetkemeyer, R-Mo., introduced a bill last month with several other House Republicans that would delay the requirements from going into effect for smaller institutions while the banking agencies complete a study on the impact of the new provision on the mortgage servicing market.

"It’s a proposed gift to community banks in an election year," said Isaac Boltansky, a policy analyst at Compass Point Research and Trading.

Critics argue that the Basel III provision is further accelerating the transfer of mortgage servicing business from banks to nonbanks—a move that is already under way due to a number of market forces.

"In the last couple of years, the nonbank servicers have exponentially grown, and are now controlling about half of the market," said Karen Shaw Petrou, managing partner at Federal Financial Analytics.

Banks also face a squeeze from another direction. Several large institutions were hit hard with enforcement actions over their servicing practices for dealing with delinquent loans after the financial crisis and servicers now face tough new rules from the Consumer Financial Protection Bureau—providing more rationale for banks to consider moving away from the business, which can be risky and expensive when loans sour.

At the same time, policymakers are raising fresh questions about the drive to transfer servicing to specialty nonbank providers that arguably face less regulatory oversight with respect to capital levels—an issue that the Federal Housing Finance Agency and others are said to be looking into as well.

"You’re creating incentives to move mortgage servicing assets out of the banking system. And now you have on the other side all of this elevated concern about that very thing happening," the MBA's Mills said. "There’s a lack of coordination on the issue."

The New York State Department of Financial Services recently halted a large servicing transfer from Wells Fargo to Ocwen, a major nonbank servicer, citing concerns with the company’s portfolio growth. Rep. Maxine Waters also raised questions about servicing transfers to nonbanks in a letter last month to the Office of the Comptroller of the Currency and Joseph A. Smith Jr., the national mortgage settlement monitor.

"I write to you to request that you carefully scrutinize the sale of mortgage servicing rights from banks to nonbank servicers to ensure that nonbank servicers have the capacity to handle the increased volume in loans, and that borrowers are not suffering from deterioration in the protections afforded to them because of such transfers," Waters wrote.

The CFPB said in a strikingly forceful speech that it will begin to crack down on servicers not in compliance with its new consumer rules. How far the agency will take its authority over servicing issues is yet unclear, particularly as more of the business moves into the nonbanking realm.

Edward Mills, a policy analyst at FBR Capital Markets, said, "At a point when you don’t know what exactly your regulator is going to do, it raises more concern when the regulator appears to take a very aggressive stance—all but threatening enforcement actions and fines and penalties."

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