In July, the Federal Deposit Insurance Corp. and, later, the Office of the Comptroller of the Currency (OCC) and the Federal Reserve Board approved a final rule on capital requirements and the Basel III guidelines. The approvals came after nearly a year of comment from community banks and others who were concerned that the rules would negatively impact mortgage lending. Some industry experts say they are satisfied with the final rule, even with its shortcomings.
‘We are finding the community banks are content with it,’ says Christopher Cole, senior vice president and senior regulatory counsel for the Independent Community Bankers of America in Washington, D.C. ‘They were hoping they would get totally exempted. That did not happen, but there were some victories.’
Among the victories was that the final rule does not implement the proposed framework for risk weighting for residential mortgages. The proposed risk weighting would have been based on underwriting, product features and loan-to-value (LTV) ratios and would have created eight different risk weights for residential mortgages, ranging from 35% to 200%.
‘Community banks were objecting because the proposal was far too complicated,’ Cole says. ‘They would have had to keep up with the loan-to-value and shift from one category to another.’
Instead, the final rule assigns two risk weights. First-lien residential mortgages that are prudently underwritten and typically have a low risk of default are risk weighted at 50%, and residential mortgage exposures that have a higher risk are risk weighted at 100%.
Charlie Dawson, policy representative for financial services for the National Association of Realtors (NAR), says the Chicago-based association was concerned that the LTV ratio's effect on the risk weights would have negatively impacted not only smaller lenders, but also certain borrowers. ‘Our initial concern was that the proposed capital requirements for residential mortgages would increase the cost of mortgages to all home buyers, particularly for first-time home buyers and minorities and people who do not pay a 20 percent down payment.’
The existing requirements have worked well for a number of years, Dawson says. He adds that NAR does support strong capital requirements, but the proposed Basel III rules would have been redundant with the upcoming qualified mortgage (QM) standard under the Dodd-Frank Act. The QM rule, which bars risky products such as interest-only loans, negative amortization loans and loans that last more than 30 years, will go into effect on Jan. 10, 2014.
‘The cumulative effect of all these new mortgage regulations would make the proposed rule under Basel III unnecessary,’ Dawson says. ‘You have rules out there keeping mortgages safe.’
Cole says another victory for community banks was the regulatory capital treatment of Accumulated Other Comprehensive Income (AOCI). AOCI generally includes accumulated unrealized gains and losses on certain assets and liabilities that are designated as available for sale. With the new rule, banks with under $250 billion in assets may opt not to include certain AOCI components in common equity Tier 1 (CET1) capital.
That option will save the smaller banks much effort, Cole says. ‘Any securities you have in your portfolio that were available for sale, if you have any gains or losses quarter to quarter, you would have to include that,’ he explains. ‘That would have a lot of volatility, especially in this interest rate environment.’ He adds that 95% of community banks will probably opt to exclude AOCI.
Also related to Dodd-Frank, banks with assets of less than $15 billion will be allowed to grandfather in to Tier 1 capital most existing Trust Preferred Securities that were issued prior to May 19, 2010. According to the OCC in a press release, ‘This treatment will provide greater consistency with related provisions of the Dodd-Frank Act that limit inclusion of such securities in regulatory capital.’
There are constraints on mortgage-servicing assets as a percentage of CET1, a restriction that displeases small and large banks. ‘Regulators have addressed a key issue that would have inhibited mortgage lending, but the treatment of mortgage servicing will drive a wedge between mortgage borrowers and lenders,’ Frank Keating, president and CEO of the American Bankers Association, said in a statement. ‘More needs to be done to reduce Basel III's complexity, allow adequate time to comply and ensure the rule is less punitive for banks that are trying to make good loans to creditworthy business and personal borrowers.’
The phase-in period for the Basel III capital requirement rules will begin on Jan. 1, 2014, and institutions have until 2019 to implement all the rules. The phase-in period for smaller banks will begin on Jan. 1, 2015.
The OCC offers a New Capital Rule Quick Reference Guide for Community Banks that can be accessed here.
Nora Caley is a Denver-based freelance writer.