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Recourse resurfaces.

While much of the media coverage regarding the future treatment of asset sales with recourse has subsided, the issue has not lain dormant. An interagency task force composed of federal bank and thrift regulators continues to work on a proposal that could affect numerous transactions, including the retention and sale of GNMA servicing and certain wholesale transactions.

Since 1990, when the Federal Financial Institutions Examination Council (FFIEC) requested comments on the appropriate reporting and capital treatment of asset sales with recourse, the interagency task force has been devising a structure for applying risk-based capital to different levels of recourse risk.

Application to secondary market transactions

Generally, the bank regulators maintain that any risk retained by an institution on the sale of its assets constitutes a recourse transaction, regardless of the remoteness of the risk. Such a sweeping interpretation without limitation could encompass all secondary market sales, even those currently viewed as nonrecourse sales, because investors reserve the right to demand repurchases for deficient mortgages.

The regulators recognize this problem and have indicated unofficially that if a repurchase is not automatic, in the event of default, and the risk of repurchase can be controlled by the seller, the transaction is not a recourse arrangement. While most non-recourse contracts do not pose a problem, some agreements allow the investor to demand repurchase on all early payment defaults. For example, Freddie Mac's guide includes an automatic repurchase provision for loans that become delinquent within the first four months after origination and subsequently, result in a foreclosure action. The inclusion of such a provision might technically constitute a recourse transaction. The regulators, however, are not implementing recourse treatment because in practice, Freddie Mac requires repurchases only when a default occurred because the loan was not of investment quality. The originator can control its underwriting performance and, therefore, control its repurchase risk. Freddie Mac plans to amend its guide to conform with its practices. Fannie Mae's language on repurchases currently conforms to the regulators' unpublished standard. However, not all wholesale contracts conform. As a result, some wholesale lenders that purchase loans from subsidiaries of depository institutions are considering revisions to their contracts to avoid recourse treatment.

In spite of this exemption, the regulators have indicated in the past that VA and FHA servicing should be treated as recourse arrangements because lenders cannot control VA no-bids and because the FHA guarantee is conditional on properly followed claims procedures. Most lenders would disagree with the regulators' characterizations, especially regarding FHA servicing. FHA's full faith and credit guarantee is incontestable. Once granted, the insurance cannot be terminated. Furthermore, failure to follow FHA claims procedures does not jeopardize the lender's loan principal.

It is likely that a grandfather clause may be provided for existing FHA and VA servicing retained by an institution. Transfers of VA or FHA servicing between financial institutions are likely to be treated as "acquired recourse" and subject to the capital provisions. On servicing transfers, the principal balance of the loans serviced, not the price received for the servicing, would be the likely basis for applying the capital requirement.

Structure of the recourse rule

One approach being considered by the interagency task force is a multilevel approach to assigning risk-based capital to recourse transactions. The regulators recognize that there are different degrees of exposure to risk and are considering three tiers of risk: first, second and third "dollar of risk" categories. Each tier will require different capital levels.

A lender that has sold an asset and retains a first-dollar-of-risk exposure would be required to hold more capital than a lender that retains a second dollar of risk. In first-dollar-of-risk situations, the institution's funds are the first at-risk in the event of a borrower default. A lender that has a second- or even third-dollar-of-risk exposure does not risk the institution's funds unless the losses are greater than the insurance or guarantee covering the loans or pools. Less capital would be required because the insurance or guarantee protects the institution from all or a portion of losses associated with a default.

There is a point where an institution retains such a small, subordinated risk that capital support should not be required. In recognition of this fact, the regulators are considering whether or not to develop a last-dollar-of-risk category, where no capital support would be required. The Mortgage Bankers Association of America (MBA) believes that insured or guaranteed loans sold in the secondary market should fall in this last-dollar-of-risk category, especially because servicers reserve for expected losses.

The MBA continues to believe that regulatory agencies should adopt generally accepted accounting principles (GAAP) for determining when transactions can be treated as a sale-of-assets. Under GAAP, sale treatment is provided if an institution is able to estimate the amount of expected losses and establishes a reserve to cover the losses. As a result, Fannie Mae and Freddie Mac recourse transactions and GNMA servicing would be given sale treatment. VA servicing should be specifically excluded from recourse treatment because a borrower default does not automatically trigger a nobid. VA no-bids represent a small percentage of all VA loans being serviced, and lenders establish reserves for nobid risk. FHA servicing also should be excluded from recourse treatment because of the incontestable nature of the guarantee.

Unfortunately, GAAP treatment mav not be obtainable. If GAAP is not applied, VA and FHA servicing should be placed in the last-dollar-of-risk category because the government insurance and guarantees protect the lender's principal interest.

The FFIEC board is likely to receive the staff recommendation at the end of March. If the board approves the recommendation, a proposed rule will be issued for comment. Whether or not the staff keeps the multilevel approach to recourse remains to be seen. The interagency task force has not reached a consensus on the multilevel approach, and some falling out may occur. If the approach is dropped, the agencies are likely to apply a single capital measure, which may result in a greater capital impact.
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Article Details
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Title Annotation:Secondary Market; asset sales with recourse
Author:Vidal, Vicki
Publication:Mortgage Banking
Article Type:Column
Date:Mar 1, 1993
Previous Article:Restoring equity to rescissions.
Next Article:Mortgage insurers and HMDA.

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