Capital proposal may drive banks further away from mortgages

A divisive capital proposal released Thursday could lead banks with $100 billion or more in assets to further distance themselves from the housing finance business.

The proposal specifically adds higher risk weightings for portfolio products with elevated loan-to-value ratios. It also more generally raises capital requirements in a manner expected to deter investment in mortgage servicing rights, which have had a high risk weighting.

"This is a disincentive for banks to make higher LTV loans," said Pete Mills, senior vice president of residential policy and member engagement at the Mortgage Bankers Association, of the new proposal. 

"I think we need more time to dig into how this might impact warehouse lending and MSRs," he added. "I would say for MSRs, in the context of a rule that raises capital standards by 15 to 20%, institutions are going to potentially shed assets that have such high risk weights."

The MBA and others interviewed for this article said they also are continuing to study what the details of the rule might mean for securitized mortgages.

For now, the central concern of mortgage and housing industries in the proposal appears to be the new LTV risk weightings, which officials have specifically called out for comment, noting that it was not their intent to hurt the low- and moderate-income housing markets with them.

However, that's likely what they'd do, said David Dworkin, president and CEO of the National Housing Conference.

"The rule would significantly discourage banks from lending to people with lower down payments. These are generally first-time homebuyers who don't have the multigenerational wealth or home equity to afford a 20% or greater downpayment," he said.

Some wealthier borrowers with high-balance mortgages could be impacted as well.

"Depending on the LTV of those jumbo mortgages, this could impact the bank's willingness to do high LTV jumbo or change the cost of how they price those loans relative to the rest of the market," said Jon Van Gorp, chair at law firm Mayer Brown.

There's some precedent for higher risk weighting for elevated LTVs from a credit perspective. Borrowers with less equity may be less incentivized to continue paying. International capital rules also have LTV distinctions, but those in the U.S. proposal are 20% higher, Van Gorp said.

Currently, lenders generally risk-weight well-underwritten, first-lien mortgages held in portfolio by 50%, although that number can go up to 100% or more for a home loan outside of that box, said Van Gorp.

The proposed U.S. scale of risk weighting goes down as low as 40% for LTVs of 50% or lower. But any mortgage with less than a 20% down payment will end up with a risk weighting of 60% or higher, hurting any affordability buyers in that category. 

Dworkin called the approach "not consistent with modern mortgage underwriting or the true risks to the financial institution for making lower down-payment loans," noting that "modern mortgage underwriting considers a wide range of factors, not just one."

The proposal further compounds concerns about the ability of low- to moderate-income borrowers to access the mortgage market because it does not appear to provide any breaks for mortgage insurance, a standard offset to low down payments, Dworkin said.

"The rule ignores that basic reality in mortgage finance," he said.

There also are concerns that the new LTV-based requirements could lead to increased taxpayer risk in government-related programs and nonbank mortgage concentration if it ends up funneling these loans away from banks and into those markets.

If the current capital requirements moved forward, "basically, we would be telling banks, we want to encourage you to allow lesser-regulated independent mortgage banks to control even more market share than they do already," he said.

The LTV risk weightings also could be an impediment to Community Reinvestment Act lending requirements that banks have, Dworkin added.

All these arguments could be compelling to banking officials, but they'll likely have counter-considerations like the experience during the Great Recession, when particularly loose underwriting decimated the performance of an excessive number of particularly high LTV loans.

The banking crisis this year also appears to be weighing on the minds of policymakers and accounts for the reduction in the asset threshold for banks to $100 billion from $250 billion, since it involved some players in that size range, as well as some mortgage concerns.

However, arguments can be made in response that reforms in underwriting and the Great Recession have drastically improved loan performance, and the more recent banking crisis was linked more to things like runs on uninsured deposits and asset-liability mismatches than mortgage credit risk, said Andy Duane, attorney at mortgage law firm Polunsky Beitel Green.

"If the industry comments on those LTV requirements that are over and above what was required in the international framework, I think we might have that ability to stop higher prices and higher rates down the road," he said.