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Board of Governors of the Federal Reserve System
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Report to the Congress on the Effect of Capital Rules on Mortgage Servicing Assets

Regulatory Approaches for Mortgage Servicing Assets

The federal banking agencies have established minimum regulatory capital requirements to ensure that banking institutions have a capital base that allows them to operate in a safe and sound manner as credit intermediaries in the economy. Well-capitalized banking institutions contribute to the stability of the financial system by operating as credit intermediaries even during adverse financial conditions.

In 2013, the federal banking agencies issued a revised capital rule for banking institutions that, among other things, strengthened the eligibility criteria for regulatory capital to ensure it is able to absorb losses.41 In addition, the regulatory capital framework has long limited the inclusion in capital of certain assets (e.g., intangible assets and certain deferred tax assets) that have values that may be difficult to realize or may not be realizable at all under adverse financial conditions.

Mortgage loan servicing can be an appropriate activity for banking institutions when conducted in a safe and sound manner with appropriate operational controls and risk-management processes. As described earlier in this report, however, MSAs pose certain risks. Accordingly, the federal banking agencies have limited the inclusion of MSAs in regulatory capital for many years to address the high level of uncertainty regarding the ability of banking institutions to realize value from MSAs, especially under adverse financial conditions. Other precedent exists for a cautious approach to the financial statement recognition of MSAs. Prior to 1996, GAAP did not allow firms that originated and sold mortgages, while retaining the servicing, to recognize an MSA for those serviced mortgages. Limiting the amount of MSAs in regulatory capital mitigates the risk that market value fluctuations of these assets will adversely affect banking institutions' regulatory capital bases and undermine their safety and soundness. Moreover, the FDIC, as receiver of failed institutions, has found MSAs of troubled or failed institutions to be generally unmarketable at book value during periods of market volatility.

The federal banking agencies use two primary approaches in their capital framework to address the risks of MSAs: (1) requiring deduction from regulatory capital of amounts of MSAs above certain thresholds, and (2) applying risk weights to MSAs that are not deducted from regulatory capital.

Under the federal banking agencies' previous regulatory capital framework, MSAs (combined with non-MSAs and purchased credit card relationships) were limited to 100 percent of tier 1 capital (net of goodwill, other intangibles, and other disallowed assets), and the amount of an MSA that a banking institution was able to include in regulatory capital was the lesser of 90 percent of the MSA's fair value or 100 percent of the MSA's carrying amount.42 Amounts not deducted from tier 1 capital received a 100 percent risk weight.43

The limitation of MSAs to 90 percent of their fair value under the previous regulatory capital framework could result in an effective risk weight of up to 215 percent for MSAs to the extent that a banking institution either (1) used the fair value measurement method to determine the carrying amount of the MSAs or (2) used the amortization method and took an impairment on the MSAs to bring the carrying amount down to fair value.44 This effective risk weight is because a deduction or haircut approach (e.g., the 90 percent fair value haircut under the previous regulatory capital framework) is broadly equivalent to a 1,250 percent risk weight, assuming an 8 percent regulatory capital level. Specifically, for $100 of MSAs, applying a 1,250 percent risk weight to $10 (i.e., $125 in risk-weighted assets) and a 100 percent risk weight to the remaining $90 (i.e., $90 in risk-weighted assets) could result in an effective risk weight for the $100 of MSAs of 215 percent (i.e., $215 in risk-weighted assets).

After considering certain lessons learned during the 2008 financial crisis, the revised capital rule established standards to improve the quality and increase the quantity of regulatory capital. For instance, the treatment of MSAs became stricter under the revised capital rule reflecting the high level of uncertainty regarding the ability of firms to realize value from these assets.

In developing the current regulatory approach to MSAs, the federal banking agencies considered diverse perspectives on MSAs, and took steps to ensure that the approach was adequately informed in all significant respects. In this regard, the federal banking agencies took into consideration MSA-related statutory requirements, conducted impact and regulatory burden analyses for the revised capital rule, and considered issues raised through the public comment process prior to finalizing the current regulatory approach to MSAs. In particular, the federal banking agencies evaluated a range of appropriate treatments during the rulemaking process, including fully deducting MSAs from regulatory capital, deducting MSAs above a certain threshold (or thresholds) and risk weighting the amount not deducted at 250 percent, and risk weighting all MSAs at a level substantially higher than 100 percent (for example, 250 percent). The agencies ultimately decided on and continue to support the approach of deducting MSAs in excess of certain thresholds and risk weighting the MSAs that are not deducted. In contrast, the revised capital rule requires a full deduction from capital of all other intangible assets.

Specifically, under the revised capital rule any amount of MSAs above 10 percent of a firm's CET1 capital must be deducted from CET1 capital.45 In addition, any amount of MSAs, certain deferred tax assets arising from temporary differences, and significant investments in the capital of unconsolidated financial institutions in the form of common stock (collectively, "threshold items") above 15 percent of a firm's CET1 capital must also be deducted from CET1 capital.46 Starting January 1, 2018, any amount of the threshold items that is not deducted from CET1 capital will be risk weighted at 250 percent.47

NCUA's previous capital requirements applied a 100 percent risk weight to MSAs. Under NCUA's revised capital framework (issued in 2015), MSAs will receive a 250 percent risk weight, starting January 1, 2019.48 Federally insured credit unions are not required to deduct any amount of MSAs from regulatory capital. Since 1998, federally insured credit unions have been prohibited from purchasing MSAs.49


41. NCUA issued a revised regulatory capital framework in 2015 that will apply in 2019. Return to text

42. See, for example, 12 CFR part 225, appendix A, section II.B.1 (Federal Reserve) and 12 CFR 325.5(f) (FDIC). Return to text

43. See, for example, 12 CFR part 225, appendix A, section III.C.4 (Federal Reserve) and 12 CFR part 325, appendix A, section III.C.4 (FDIC). Return to text

44. A banking institution will initially record the amount of the MSA at fair value and then subsequently measure the MSA under either the amortization method or the fair value measurement method. Under the amortization method, the MSA is to be amortized in proportion to, and over the period of, estimated net servicing income for assets (servicing revenues in excess of servicing costs). The MSA is to be assessed for impairment or increased obligation based on fair value at each quarter-end report date. Under the fair value measurement method, MSAs are measured at fair value at each reporting date and changes are reported in fair value in earnings in the period in which the changes occurred. A banking institution can elect to use either measurement method for different classes of MSAs within the banking institution's portfolio, but the same measurement method must apply to each MSA in a class of MSAs. Return to text

45. 12 CFR 3.22(d)(1) (OCC), 12 CFR 217.22(d)(1) (Federal Reserve), 12 CFR 324.22(d)(1) (FDIC). Return to text

46. 12 CFR 3.22(d)(2) (OCC), 12 CFR 217.22(d)(2) (Federal Reserve), 12 CFR 324.22(d)(2) (FDIC). Return to text

47. Ibid. As discussed elsewhere in this report, the federal banking agencies determined that, based on the conservative treatment of MSAs under the revised capital rule, statutory factors were consistent with a determination that the 90 percent of fair value limitation could be removed. Return to text

48. In establishing the MSA capital requirements for credit unions that goes into effect in 2019, NCUA relied upon the analysis published by the federal banking agencies, conducted its own impact analysis, and considered issues raised during the comment period prior to finalizing the regulation. Return to text

49. NCUA instituted the prohibition on the purchase of MSAs in 1998 after the National Credit Union Share Insurance Fund was exposed to significant losses related to purchased mortgage servicing operations obtained by a federally insured credit union. 12 CFR 703.16(a). Return to text

Last update: August 12, 2016

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