The proposed capital rules under Basel III would limit capitalized mortgage servicing assets (MSAs) to essentially 10% of Tier 1 capital. This could adversely impact servicing market values. Accordingly, I took a quick look at whether or not there may be a problem. My conclusion is that there may be some dislocations at the bank level, but there is not a substantial systemic risk to servicing values.
There were 7,941 banks and thrifts in the United States as of 3/31/2010. Of these, 1,137 had capitalized servicing (MSAs) on their books. 67 of these institutions had MSAs that exceeded 10% of Tier 1 capital, the remaining 1,070 were under 10%. The bad news is that in order to reduce their MSAs to 10%, the 67 institutions would need to reduce their holdings by $24.8B. This equates to approximately $2.8T of mortgage servicing principal balance at an assumed value of 90 basis points. The good news is that the remaining 1,137 institutions, that are under 10% concentration, have adequate capital to absorb essentially all of this $2.8T ($2.6T anyway) if so desired. This assumes that the banks that currently have no servicing wish to remain that way (a good bet for the most part). It also assumes that non-bank mortgage servicers will not absorb some of this product. This is probably not the case.
There are several ways an institution can address their overage:
- Sell part of the portfolio – Only 28 of the 67 “over limit” banks are over by greater than 10% of Tier One capital and may need to sell. Their overage aggregates only $350B of servicing principal balance.
- Accelerate amortization and sell more loans servicing-released – It is conceivable that the other 39 institutions will manage their concentrations down through a more accelerated amortization combined with more servicing-released sales. Additionally, normal prepayments and curtailments will also reduce their exposure materially before the proposed regulations take effect in 2012.
Implementation of these capital limits, while non-sensical, should not create a large supply/demand imbalance and, therefore, should have little impact on servicing value.
NB … please let me know if you would like to see the bank level data that went into this analysis. Also, I would appreciate your thoughts on this subject.