For more than a year the Mortgage Bankers Association has tried to persuade first Congress, then the FDIC, to adopt a rational treatment for federal deposit insurance coverage as it relates to principal and interest (P&I) custodial accounts. MBA had originally tried to get Congress to adopt the FSLIC interpretation requiring that P&I custodial accounts be issued up to $100,000 per borrower, instead of the FDIC's position limiting such coverage to $100,000 per investor. Unfortunately, the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA) did not incorporate MBA's position. FIRREA allowed the FSLIC interpretation to exist for at least another nine months by which time the FDIC was to adopt a uniform rule on this standard.
Several months ago, the FDIC made its decision which takes effect on October 27, 1990. The uniform interpretation adopted was not the one MBA wanted. The FDIC has decided to limit FDIC insurance of P&I custodial accounts to $100,000 per investor instead of $100,000 per borrower.
MBA had warned the FDIC that if the current FDIC proposed rule is adopted, custodial accounts will likely be underinsured, thus placing investors' monthly remittances at risk and possibly causing servicers to be in violation of contractual provisions. We anticipated that to reduce risk exposure, investors would be likely to either terminate servicing contracts or further tighten requirements for custodial depositories by implementing criteria for the transfer of custodial accounts to highly rated depository institutions. Even though the per investor insurance coverage does not apply to T&I escrows, these funds would suffer a similar fate as the custodial funds because they are generally held in the same institution.
The FDIC policy is now causing investors to restrict where custodial and escrow accounts can be placed. Fannie Mae, Freddie Mac and GNMA have issued guidelines requiring servicers to place custodial and escrow funds in depository institutions that receive acceptable ratings by certain rating agencies. Failure to receive the necessary rating will make these institutions ineligible to hold custodial and escrow accounts (except in the case of GNMA) on behalf of the agencies. Below are the agencies' rating requirements:
* Fannie Mae requires depository institutions to be rated
75 by IDC or "C/D" by KBW. Fannie Mae, however, will
permit institutions to continue holding funds if they are
rated 50 by IDC and meet a 3 percent leverage ratio as
determined by GAAP. * Freddie Mac requires institutions to be rated 75 by IDC
or "C/D" by KBW. Starting July 1, 1991, however,
depository institutions must be rated 125 by IDC and "C" by
KBW. * For banks, GNMA requires the same IDC rating as
Fannie Mae, or will accept a "C+" rating by Sheshunoff.
GNMA will also permit a "C" rating from Sheshunoff or
"50" from IDC if the institution has a 3 percent leverage
ratio. Thrifts, however, must be rated 75 or better by
IDC, or be rated 30 by Sheshunoff. Thrifts do not have
the option of a 50 IDC rating if they maintain a 3 percent
leverage ratio as completed by the OCC. GNMA agreed
to MBA's request to limit the restriction to P&I funds,
not escrow T & I accounts.
If servicers are forced to transfer funds as a result of investor demands, it is possible that all custodial and escrow accounts will be placed in a handful of institutions. This concentration of custodial and escrow accounts in a few institutions may actually increase risk to the insurance fund. Furthermore, a requirement based on ratings will adversely affect small-to-medium sized banks and thrifts without direct access to the capital markets as a result of the forced withdrawal of deposits from these institutions. It is estimated that an IDC rating of 75 or better will disqualify 1,236 depository institutions from holding agency deposits. The Freddie Mac rating requirement of 125 that goes into effect in 1991 would disqualify nearly 5,000 institutions if it were in effect today. We think the higher Freddie Mac requirement is unnecessary and we have asked them to relax it.
The secondary market agencies' restrictions on where mortgage servicers can place funds based on rating criteria will further limit which institutions are able to provide competitive warehouse financing. Currently many mortgage lenders, and especially smaller mortgage bankers, have established warehouse lines with thrift institutions. In the past, thrifts have been instrumental in serving these smaller customers. As thrifts fall out of the market and out of the business of warehouse lending, finding replacement lines will be difficult. Many smaller lenders may be unable to produce the volume of business demanded by large warehouse banks, which will result in limiting credit for these institutions that often serve local communities. Institutions that are able to find replacement financing will most likely see increased cost for warehouse lines, which will result in higher financing costs to the consumer.
The value of mortgage servicing portfolios also would be impacted by the transfer of escrow accounts. An attractive feature of the mortgage servicing asset for depository institutions is the economic value associated with escrow and custodial deposits, one of the most stable sources of deposits. Because many potential purchasers of servicing may be affiliated with an institution that is ineligible to hold custodial and escrow funds, they are effectively taken out of the market as a purchaser or are forced to lower their bid. To the extent that the parent company can no longer maintain deposits on the servicing retained by its subsidiary, the servicing asset will be less attractive.
For consumers, a dramatic change in how custodial accounts are maintained or insured will result in increased mortgage interest rates. This is because more mortgage lenders will lose the economic value associated with these deposits and will, therefore, have to pass on this cost to borrowers.
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|Title Annotation:||federal deposit insurance coverage as it relates to principal and interest custodial accounts|
|Date:||Aug 1, 1990|
|Next Article:||Economic trends.|