Ginnie Mae risk-based capital rule is unworkable

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In 2022, Ginnie Mae first surfaced the new risk-based capital requirements for independent mortgage banks. The amended rules go into effect at the end of 2024, that is, in six months time. That's right. Most larger issuers have figured out how to comply, but many smaller IMBs could be driven out of business by the new rule from the Biden Administration.

Through the RBC proposal, the risk function at Ginnie Mae is telling more moderate-sized issuers to change their business model or exit the industry. The key change imposed by the RBC rule is the calculation of capital, which effectively limits the amount of leverage on the mortgage servicing rights to 50% vs 65 to 70% today from banks and investors. Banks are willing to leverage the MSR up to 70%, but Ginnie Mae says this amount of leverage is unsafe. 

This proposed change essentially demonizes the MSR and particularly the "excess servicing strip," or ESS. This represents the difference between the cost of servicing the loan and the rest of the servicing income, which averages about 32 basis points of UPB annually. It takes less than 5 basis points annually to service a performing loan, but that cost can increase ten-fold or more for delinquent credits.

Ginnie Mae has apparently decided that allowing independent mortgage banks to retain most or all of the servicing asset is unsafe and unsound, thus IMBs must subtract the the excess servicing strip from capital to calculate the new minimum. Ginnie Mae officials did not respond to questions for this column. By subtracting the ESS from capital, Ginnie Mae is essentially forcing independent mortgage banks to sell their excess servicing.

The notion that IMBs should be forced to sell the excess servicing strip to investors in order to comply with the new RBC rule is crazy on several levels. The whole reason that the FHA/VA/USDA pay government issuers higher servicing fees is so that the issuer can fund loss mitigation in a recession. The ESS is a capital reserve, not a risk. 

Issuers are paid better on government loans than on conventionals, but often lose money on servicing. But the risk function at Ginnie Mae apparently thinks that selling the ESS to a third party is a superior choice. Yet if you look around the mortgage industry, it is the issuers that have historically retained the entire servicing strip and also eschewed hedging for the MSR that are now in a strong position. 

In my upcoming biography of Freedom Mortgage founder Stan Middleman (Seeing Around Corners: Achieving Success in Business and Life Hardcover – September 17, 2024), we talk about the importance of the MSR as the central part of an effective strategy for IMBs to build permanent capital. The Ginnie Mae RBC proposal ignores the obvious example of Freedom, which now uses its internal cash flow to acquire new MSRs. 

If you look around the industry at Bayview or Mr. Cooper or Rithm Capital, you see the same focus on acquiring the income-producing servicing asset when rates were low as a store of value and income for the IMB now that rates are high. And yet the radical changes in leverage proposed by the Ginnie Mae RBC rule are causing some disturbing changes in issuer behavior.

Aside from ignoring the role of MSRs as an important capital asset for independent mortgage banks, the Ginnie Mae rule is causing more and more issuers to sell their excess servicing strip and thereby reduce internal cash flow. Various types of ESS transactions have been proposed by issuers to Ginnie Mae, but there is as yet no discernable template for issuers to follow. 

The Mortgage Bankers Association has been engaged with Ginnie Mae on behalf of the industry on the question of ESS, but after months of discussion there is still no general agreement on how much excess servicing issuers should sell and whether Ginnie Mae will give issuers credit for sales vs RBC. 

Incredibly, Ginnie Mae is apparently telling issuers that they can achieve "true sale" on an ESS transaction, even though getting a clean lien on a government servicing asset is impossible. Since there is only one "asset" in government lending, it is impossible to create a perfected lien on the MSR as a separate asset.

An obvious issue in excess servicing strip trades is whether an investor buying a participation in an MSR from a Ginnie Mae issuer must suspend payments in times of high loan delinquency. Another issue is what happens to the investor in the MSR participation if Ginnie Mae seizes the asset as with Reverse Mortgage Investment Trust?  Texas Capital Bank learned this lesson the hard way in 2022.

One of the obstacles that we predicted early on is that the diversity of IMB business models is making a universal, "simple" rule for capital an extremely elusive goal for the team at Ginnie Mae. In a presentation to the Mortgage Bankers Association that has not been released to the public, Ginnie Mae notes that almost 20 issuers are now trying to use ESS to meet the risk-based capital rule. But each of these firms has a different business model and therefore a different use case for ESS.

Ginnie Mae has apparently decided that an issuer can retain only 15 basis points of an MSR and still be in compliance with the rule, but what if that issuer must advance principal, interest, taxes and insurance to protect a delinquent asset? Is retaining just 15 basis points of the MSR really sufficient? If the issuer sells the excess servicing to an investor that takes responsibility for advancing, on the other hand, then 15 basis points is probably more than sufficient.

The MBA notes regarding the risk-based capital rule that "Ginnie Mae should explore potential unintended consequences for Issuers, including adverse impact on pricing, MSR valuations, or a [disproportionate] effect on liquidity for borrowers with lower loan amounts."  This is a polite understatement. Three years later, the RBC rule still makes no sense either financially or as public  policy.

Since Ginnie Mae proposed the RBC rule in 2022, the agency has tried heroically to make it work, but the reality is that the diversity of independent mortgage-bank business models is making this impossible. There are simply too many different flavors of IMB to easily accommodate a Basel III style capital rule that starts by deleting the excess servicing strip. 

Back in September 2022, Ginnie Mae stated in the FAQs for the rule: "A standardized ESS purchase and sale agreement developed and implemented by market participants would be helpful to Ginnie Mae in implementing capital relief in those instances when a meaningful transfer of risk has occurred." There is no sign of a standardized template in sight and the growing numbers of ESS requests are overwhelming Ginnie Mae's limited resources.

It is some measure of the chaos and confusion that prevails at Ginnie Mae with respect to the risk-based capital rule that the FAQs that were posted on the Ginnie Mae website in 2022 apparently have been removed in the past week. Before the level of delinquency rises further in government loans, Ginnie Mae should abandon the RBC proposal and go back to the drawing board. As one senior industry official told NMN: "Implementation of the RBC rule as it stands today will be a disaster for Ginnie Mae and the industry."