MSRs in focus as Fed rethinks Basel III rules

Federal Reserve discussions about relaxing Basel III capital treatment of mortgage servicing assets could make MSRs more attractive for banks, but early analysis points to limited near-term market impact.

Comments from Federal Reserve Vice Chair for Supervision Michelle Bowman on Monday indicated the Fed was discussing removing the requirement to deduct mortgage servicing assets from regulatory capital as required under the Basel III framework, but that it would keep the 250% risk-weighting in place for now, a flash note from Keefe, Bruyette & Woods analysts, led by Christopher McGratty, said.  The Fed plans to seek comment from the banking industry on what the appropriate risk weight should be.

The difficulty in measuring what a revision will accomplish

If the change was made, the immediate impact on the mortgage market is likely limited, but growth in the nonbank sector could slow over time, the analysts, which also include Bose George, commented.

"We believe that there are few large banks that are limiting their participation specifically due the capital treatment of mortgages or MSRs," KBW wrote, pointing to data which finds the largest bank originators in 2025 were Chase at No. 5 and Western Alliance Bancorp, below at sixth.

The suggestion from Bowman that not all banks are cut out to own MSRs makes it difficult to say how much impact this could have on the servicing market, said Tom Piercy, president of Rocktop Capital Advisors.

"There have been no specifics. You'll hear in the discussions, 150[% risk weight] seems to be the number that's been bandied about but again, there's nothing concrete," Piercy said.

Making it less expensive for banks to allocate capital against mortgage asset classes like servicing rights will not necessarily raise MSR values, he said.

"It would be beneficial for the valuation of the MSR asset by these regulated institutions, but would we necessarily see MSR values increase? Most likely not," said Piercy.

Bowman's capital proposal is more likely to improve pricing for new originations through channels such as retail and correspondent, rather than increasing their bids on bulk portfolios, although it could mean they become selectively more competitive when it comes to the latter," he continued.

If the shift were to happen, it would have more of an effect on the conforming servicing sales market, one servicer noted.

"Where banks have been a lot more active is in the GSE space. I think you'll see a more immediate impact to that. You may see more appetite for bulk MSRs in that space," David Sheeler, executive vice president at Freedom Mortgage, said at the Mortgage Bankers Association's Servicing Solutions Conference in Dallas.

Banks' appetite for MSRs also will depend on the shape of the yield curve formed between long- and short-term interest rates, Sheeler continued.

How mortgage stocks are affected by Bowman's remarks

On Tuesday, the first trading day following the Bowman statements, among mortgage and housing stocks tracked by National Mortgage News, Rocket had the largest percentage loss, at 1.66% after being down by 3.4% at midday. Pennymac Mortgage Trust was 1.03% lower, while UWM Holdings, the nation's largest originator, was 1.02% down on the day.

But other nonbanks closed higher, including Figure, up 4.59%%; Finance of America, 3.95%; and Pennymac Financial Services, up 2.03%.

Chase gained 1.51%, compared with a 0.83% increase at midday while Western Alliance was 1.53% higher. Wells Fargo, which used to have a significant presence in mortgage, was up 0.48%, while Bank of America was 0.36% over its prior close.

"More favorable capital treatment should make it easier for more banks to hold MSRs," KBW said. "Banks can generate better returns on equity on MSRs than non-banks, assuming a similar cost to service, as banks benefit from their ability to utilize escrow deposits, and non-banks have more limited ability to use leverage."

A long-standing concern over bank mortgage activities

Former Ginnie Mae President Ted Tozer was concerned during his term about the shift in the agency's securitization issuers from primarily banks to the nonbanks, in large part because of the Basel III rules. The logic was when mortgages in a securitization default, banks have more capabilities of handling the advance requirements than nonbanks do.

But this wasn't the only reason; many banks had dropped out of the Federal Housing Administration program after the Obama Administration made wide use of the False Claims Act in order to recoup losses related to mortgage defaults.

Mortgage Bankers Association President and CEO Bob Broeksmit said in his opening remarks delivered to a Feb. 11 House Financial Services Subcommittee on Housing and Insurance hearing on the future of the secondary market, that the bank portfolio market share of residential origination dollar volumes averaged roughly 25% as compared to 50% going to the government-sponsored enterprises, 20% to Ginnie Mae and 5% or so for private label securitizations.

The committee chair, Rep. Mike Flood, R-Neb. addressed Broeksmit with his comments declaring he was worried about banks and community banks losing their connection to homeowners when all of the mortgages go to Fannie Mae and Freddie Mac because of the servicing rights capital rules.

The risk weighting from Basel III is 250%, it should be no more than 100%, Broeksmit said in response, and the MBA has been working with regulators to change it.

"It would help banks get back into the servicing business," Broeksmit continued. "They've effectively been driven out of it because of these onerous capital requirements."

The impact on origination volume

In a prepared statement specifically on the Bowman comments put out prior to the MBA's Servicing Solutions Conference, the group welcomed her "outlining a path toward revitalizing bank participation in mortgage lending," Broeksmit said. "Her recognition that aspects of the current capital framework have discouraged banks from competing for mortgage origination and servicing activity is an important step forward."

During a panel discussion at the conference, Broeksmit added that "these are potentially monumental changes."

KBW is also of the view that originations from banks will increase because of the change, and it wouldn't just be for portfolio purposes.

"By holding more servicing, banks should be able to originate more to sell into the secondary market," the flash note said. "Also, the potential capital rules provide favorable treatment for low loan-to-value (sub-50%) loans, so it's possible that banks could offer better rates on low-LTV adjustable-rate mortgages that they can hold on balance sheet."

The note pointed out that prior to the Great Financial Crisis, many banks and thrifts focused on making portfolio ARMs and a more favorable capital regime could revive some of this.

However, many market observers give a large percentage of the blame for the crisis to payment-option ARMs, a portfolio product which had high rates of default.