- Key takeaway: The current Basel III capital proposal does not explicitly include mortgage insurance as a factor in determining a loan's risk weight, but seeks industry input on the potential benefits and drawbacks of doing so, leaving the door open to possible changes.
- Expert quote: "There are like 50 reasons why banks don't want to do mortgage. All of these things help, but it's not as if banks will be like, 'Oh, PMI is recognized,' and all of a sudden every bank is going to open up a mortgage operation." — Matt Bisanz, partner at Mayer Brown.
- What's at stake: The Federal Reserve is asking for input on the potential benefits and drawbacks of incorporating PMI into risk-weight calculations, signaling the issue remains under consideration as part of the broader Basel framework review.
WASHINGTON — A push by bank prudential regulators to coax banks back into the mortgage market by revising risk weights as part of the Basel III endgame proposal still leaves key hurdles unresolved, including how private mortgage insurance is treated.
One sticking point is the exclusion of PMI from risk-weight calculations for single-family mortgages held on banks' balance sheets — at least for now.
Under the current proposal — as in the existing risk-based capital framework — prudently underwritten high loan-to-value mortgages with insurance receive risk weights below 100%, though the insurance itself is not explicitly recognized as credit risk mitigation. Mortgage stakeholders argue those weights should be reduced even further because mortgage insurance effectively reduces the credit risk associated with higher LTV loans.
James Sias, mortgage executive at Fifth Third Bank, said the proposal in general is a step forward, but that regulators should account for the risk-reducing effect of insurance.
"The true economic risk to the bank of holding a loan with PMI is materially different from an uninsured exposure at the same balance," Sias said. "Think about two loans at 95% LTV — one with mortgage insurance and one without. If both default, our loss experience will be different.
"If the objective of risk-sensitive capital is to ensure that requirements reflect actual risk, it's worth asking whether identical treatment for insured and uninsured loans at the same LTV fully captures the economics," he added.
Conventional loans, which make up the majority of U.S. mortgages, typically require PMI when borrowers put down less than 20% upon purchase. That added insurance is meant to protect lenders in the event of borrower default. Most of these loans are sold to Fannie Mae or Freddie Mac.
The Federal Reserve said
Still, the Fed has asked for industry input on the potential benefits and drawbacks of incorporating PMI specifically into its new LTV-based risk weight system, signaling the issue remains under consideration as part of the broader Basel framework review. Comments are due June 18.
Matt Bisanz, a partner at Mayer Brown, said the request for feedback is a positive signal, even if regulatory changes remain uncertain.
"There is this historical reluctance among the regulators to recognize PMI because it's provided by insurance companies, and some of those failed in 2008 and regulators have never forgiven them for the fail," he said. "I'm not sure how they would include it, but it's better than saying no."
The exclusion of PMI from capital calculations could influence lending behavior, particularly for borrowers with limited down payments.
"The higher capital makes those loans more capital intensive and perhaps less attractive," said Pete Mills, senior vice president of residential policy at the Mortgage Bankers Association. "Mortgage insurance would allow you to get the benefit of a lower risk rating by recognizing the fact that it lowers the effect of LTV."
Despite the uncertainty around PMI, there are changes in the proposed Basel framework that address other long-standing concerns for banks.
According to Mills, the latest iteration of Basel proposes to remove a cap on mortgage servicing assets, which banks had viewed as overly stringent.
"They have removed that cap on the extent to which your servicing rights can contribute towards your tier one capital," said Mills. "There was a hard cap above which … you basically had dollar-for-dollar capital. That's extremely punitive and that has been removed."
Mills said the Basel proposal also includes a request for comment on the appropriate risk weighting MSAs, which currently would carry a 250% risk weight, potentially signaling future recalibration.
"If they do both those things, we think that will be a significant change," he said. "It will encourage many banks to either grow their existing mortgage business and possibly some banks to get back into the mortgage business, if they've left it all together."
Attention to the topic of getting banks back into the mortgage space was highlighted by Fed Chair for Supervision Michelle Bowman in
"[The] overcalibration of the capital treatment for these activities [has resulted] in requirements that are both disproportionate to risk and that make mortgage activities too costly for banks to engage," Bowman said, speaking at an American Bankers Association event. "I see a path forward that incorporates both renewed bank participation in the mortgage market and a safe and sound banking system."
But even with the proposed changes, Bisanz said
"We would of course be more appreciative if PMI was recognized, but you know there's like 50 reasons why banks don't want to do mortgage," said Bisanz. "This includes [Consumer Financial Protection Bureau]
