Can we rescue Ginnie Mae's risk-based capital proposal?

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As October wanes and mortgage lenders gather in Denver for the Mortgage Bankers Association annual meeting, many are wondering if Ginnie Mae intends to press on with its risk-based capital proposal for independent mortgage banks. The new proposal, which in theory will be published in the Ginnie Mae Guide, is viewed by many in the industry as unworkable.

Over the past year, IMBs and the trades have met privately with the risk function at Ginnie Mae to understand the final proposal, yet there does not seem to be a final proposal – yet. Issuers spent millions to restructure companies, sold mortgage servicing rights and issued debt to meet the prospective requirements. But was all this work and expense for naught?

We asked a number of mortgage executives and analysts how the industry can help get the RBC proposal over the finish line without doing serious financial damage to IMBs. They spoke off-the-record for fear of retribution by HUD and Ginnie Mae, which forced issuers to sign non-disclosure agreements regarding these discussions about a public rule after our last column. 

"The stated goal is setting RBC and leverage capital, but the rule as proposed penalizes non bank capital by deducting excess MSRs," notes a veteran industry analyst. "The easiest fix to the rule is to eliminate this requirement and instead raise the net worth requirement."

There are numerous ways to address the flaws in the RBC rule if we could start over, but Ginnie's proposal is public, so fixes have to be relative to what was published in 2022 in APM-09. A big part of the trouble with the RBC rule is that Ginnie Mae is essentially using its limited legal authority to qualify government issuers to impose sweeping changes on how IMBs operate. 

"I wish Ginnie Mae would stop trying to change the industry to suit their view of reality and let us run our business," the analyst complained in an hour-long interview with this columnist. Ginnie Mae did not respond to requests for comment for this piece and refused to confirm when the RBC rule will be made final.

Another CEO of a Ginnie Mae issuer speaks bluntly about the RBC proposal. "The mortgage servicing asset is the lifeblood of the industry, whether you are a bank or nonbank. The cash flow from MSRs insulate issuers during recessions. This proposal forces us to sell MSRs and ignores past HUD policy which encouraged all issuers to maximize servicing."

Mortgage executives argue that Ginnie Mae seems fixated on the short-term, modeled fluctuations of the "fair value" of the MSR, but the agency fails to distinguish between market movements with the actual impairment of the asset. MSRs rarely trade after the initial sale, thus the modeled GAAP present value of the future cash flows is interesting but unimportant from a credit perspective.

For example, the interest rate rally in Q3 2024 caused MSR valuations to fall and lending volumes to surge. The subsequent 50 bp increase in 10-year Treasury yields in October will raise MSR values and slow lending. But nothing has changed from a credit perspective. 

The real risk on MSRs is a change in incremental revenue, not the loss of principal that drives risk-based capital weights for Basel III. A possible fix for the RBC rule identified by several financial analysts would be to recalibrate the risk weighting on MSRs. 

"The MSR is a cash flow stream with limited credit risk," notes a veteran analyst in New York. "Cash is 0% risk weight under Basel, so are Treasury securities and Ginnie Mae MBS. Bank exposures to IMBs have a risk weight of 100% and commercial real estate is weighted 150% for banks. Why is the risk weight assigned to MSRs 250%?" 

There are several risks with MSRs, such as loss of servicing revenue and the cost of advances, which point to a risk weight above 100% but well-below the 250% in the Ginnie Mae proposal and Basel III. Since there is no credit risk in the MSR, common sense suggests a risk weight for MSRs of ~ 150% for IMBs with no deduction for excess MSRs. 

Likewise the U.S. bank regulatory view of MSRs is misaligned with actual market default experience, but why is Ginnie Mae following bank capital rules for IMBs? Nobody knows. Ginnie Mae should have a better understanding of MSRs than do bank regulators, yet instead Ginnie Mae compounds the error by borrowing an inappropriate capital risk weight for banks to use for IMBs.

Another concern raised by issuers is the Ginnie Mae RBC proposal will reduce effective leverage under the MSR from 65% to below 50%, making the asset far less valuable to issuers and reducing overall issuer profitability and liquidity. Several issuers say that they expect to be forced to sell their MSRs because of the rule, effectively turning them into brokers with credit lines.

One fear voiced by several issuers is that Ginnie Mae may be using this draconian capital rule "as another enforcement lever for us," to paraphrase one senior Ginnie Mae official in a meeting with issuers. One smaller issuer said they believe that the RBC rule is a weapon for Ginnie Mae to cull the herd and eliminate smaller issuers who are seen as "a resource drain."

If Ginnie were open to starting from scratch, then a minimum capital requirement with a secured bank line-of-credit on MSRs would likely be sufficient to address 90% of the potential risks, argues one analyst. Underwriting and appraisal standards have changed and materially reduced the risk of mortgages and MSRs.

For many smaller Ginnie Mae issuers that chose to retain MSRs in 2020 and 2021, when the servicing assets were essentially being given away for nothing, the RBC rule will force them to sell an asset that they ought to instead retain and grow. Selling excess servicing strip participations to investors only helps in part because the full value of the MSR remains on the books of the IMB.

"The RBC rule and the misguided focus on ESS as a 'problem' screws up our accounting," complains an industry CFO. "We hold the full value of the MSR as an asset, but then pay out part of that value as a liability via ESS participations? The only beneficiaries of the Ginnie Mae RBC rule are lawyers and accountants." 

One major red flag raised by several issuers is the impending change by HUD to allow only one loan modification and partial claim for delinquent FHA loans each year. If the change goes through, say several executives, then default advances by government issuers will spike and corporate cash balances will fall dramatically. 

If Ginnie Mae forces IMBs to sell ESS as default servicing liquidity requirements are rising, the result could be a trainwreck for IMBs. The negative impact of the RBC rule could include credit ratings downgrades on some of the larger issuers, loss of market access and eventual liquidity problems when delinquency rates rise.  

The only silver lining in this scenario is that former President Trump is leading in the polls for the general election in a week's time. If Trump wins, then many things will be changing for civil servants at HUD, Ginnie Mae and throughout the federal government as a result of Trump's Schedule F plan. Stay tuned.