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In the past several years banking regulators have tried to limit the extent to which mortgage servicing rights can count as capital. The issue first arose in the context of the international risk-based capital formula, the so-called "Basle Accord," among the banking regulators of the western world. The group originally agreed to require a deduction from capital for all intangible assets on the books of financial institutions. Because American institutions were the only ones that had significant intangible assets on their books, we maintained that U.S. regulators should be free to set their own standards in this area. Fortunately, the U.S. regulators were able to persuade the regulators from other countries to go along with this approach. In the months that followed, MBA turned its attention to the actions of the Fed, OTS, FDIC and the OCC. The thrust of our argument with these regulators was that purchased mortgage servicing rights was not like just any old intangible asset--it was special because it was an "identifiable" intangible, not an unidentifiable intangible like goodwill. At the time, 1987, most of our bank and BHC-owned members thought they would be comfortable with a 25-percent limit on PMSR in capital. During the next couple of years, however, wholesale mortgage banking and servicing acquisition strategies of many companies expanded significantly thus placing large amounts of PMSR on the books. Suddenly the prospect of a 25 percent limit didn't look so good anymore. During the next two years the regulators would begin to make their decisions on how to treat PMSR for regulatory capital purposes. The Fed decided to continue its case-by-case review of all intangibles with special scrutiny of these assets when they comprise 25 percent of assets. The OCC established a 25 percent of Tier 1 capital limitation that it is now re-examining. FIRREA required a 10 percent haircut for PMSR on the books of OTS-regulated thrifts and required the FDIC to establish a limitation on PMSR for state non-member banks that the OTS would also have to follow.

In carrying out their responsibilities under FIRREA, last February, the FDIC proposed to limit the inclusion of purchased mortgage servicing rights (PMSR) to 25 percent of core capital. We believed that if such a limitation were allowed to be enacted it would have had a serious negative impact on bank/thrift-affiliated mortgage companies and the value of servicing. On December 11, 1990 the FDIC took final regulatory action on the proposal. We are pleased that the FDIC did not adopt the 25-percent limitation. Instead, the FDIC has adopted a 50 percent of core capital limitation with a limited case-by-case exception granted for well-managed institutions. The limitation is applied after a haircut on the value of the servicing. In addition, the FDIC adopted MBA's recommendation for a broad exemption for all PMSR purchased on or before February 9, 1990, instead of a six-year grandfather rule for rights acquired before August 9, 1989.

Mortgage servicing rights limitation--The FDIC rule limits the amount of PMSR that state nonmember banks can recognize for regulatory capital to 50 percent of core capital. For purposes of calculating regulatory capital (but not for financial statement purposes), the lender will be limited to the lesser of:

* 50 percent of the amount of core capital that exists

before the deduction of any disallowed PMSR; or * The lesser of 90 percent of the fair market value, the

original purchase price paid for PMSR, or 100 percent of

the remaining unamortized book value.

Grandfathering--The FDIC fully grandfathered PMSR exceeding the limitation (i.e., "disallowed PMSR"), provided the servicing was acquired or contracted for on or before February 9, 1990, and amortized on a discounted basis for a period not to exceed 15 years. The grandfather rule is also subject to a required quarterly review of book value. The board voted to include a provision in the final rule that allows the OTS and the FDIC to set a total dollar amount of grandfathered PMSR for well-managed institutions (i.e., MACRO rating of 1, 2, and in some cases, 3). This would allow these institutions to replace PMSR amortized since February 9, 1990 with new servicing purchases. This one-year exemption, subject to OTS and FDIC joint concurrence, allows institutions time to set up special mortgage subsidiaries.

Exemption for certain mortgage banking subsidiaries--PMSR held by subsidiaries that would otherwise be consolidated for regulatory capital purposes can be unlimited provided that: (1) the subsidiary is a separately capitalized mortgage banking company; (2) the parent institution's investments in, and extensions of credit to, the subsidiary are deducted from equity capital when calculating regulatory capital; (3) the institution complies with the rules for covered transactions with affiliates; and (4) the subsidiary discloses in all of its contracts that the subsidiary is not supported or backed by any bank or savings association; and (5) investments in, and extensions of credit to, the subsidiary are deducted from assets and equity capital.

Annual and quarterly market valuations--The FDIC will require an annual independent market valuation of PMSR. This valuation must include adjustments for any significant changes in original valuation assumptions, including changes in prepayment estimates. In addition, the institution will be required to calculate an estimated fair market value for PMSR at least quarterly.

Quarterly determination of book value--The final rule requires PMSR to be carried at a book value that does not exceed the discounted amount of estimated future net servicing income of the rights. Management is required to review the carrying value at least quarterly, maintain a written record of its review and adjust the book value as necessary.

Even though this can be seen as a limited victory, we should not rest on our laurels. The OCC still has a 25 percent limitation on the books, and both the OCC and the FDIC have expressed a desire to regulate excess servicing. Because the FDIC has already adopted a 50-percent limitation, we should ask for more from the OCC, especially if excess servicing is regulated. In this regard, we are recommending a case-by-case approach first. Alternatively, if a temporary percentage limitation must be established, then the limitation on PMSR and excess servicing fees should be not less than 100 percent of total capital.

Michael Taliefero Staff Vice President
COPYRIGHT 1991 Mortgage Bankers Association of America
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Title Annotation:regulators' efforts to limit the counting of mortgage servicing rights as capital
Author:Taliefero, Michael
Publication:Mortgage Banking
Article Type:column
Date:Jan 1, 1991
Previous Article:Market observations.
Next Article:Economic trends.

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