New Capital Rule Changes Treatment of Mortgage Servicing Rights
In late May, the bank regulators finalized provisions that would simplify the calculation of regulatory capital under Basel III for certain institutions. But these changes may result in higher capital requirements for some banks that have mortgage servicing rights portfolios.
New Threshold
Under the existing rule, mortgage servicing rights, net of related deferred tax liabilities, that are in excess of 10% of common equity or when combined with certain other deduction items are in excess of 15% of common equity are deducted from Common Equity Tier 1 (CET1) capital.
Under this new rule, the threshold will be raised to 25% of common equity. This is great news for institutions with growing mortgage servicing portfolios.
Risk Weighting Change
The original Basel III capital rule included a transition provision that allowed mortgage servicing rights that were not deducted from capital, those below the threshold, to be risk weighted at 100% for regulatory capital purposes for a period of time. That provision was set to expire after 2017, but was temporarily frozen and mortgage servicing rights have continued to be risk weighted at 100%.
With the finalization of this new rule, those mortgage servicing rights that are not deducted from capital will begin to be risk weighted at 250%. So while some institutions may be able to count more of their mortgage servicing rights towards capital, all institutions with mortgage servicing rights including those with relatively modest portfolios will be required to carry more capital as a result of the higher risk weighting.
Looking Forward
This new requirement is scheduled to take effect on April 1, 2020. This is around the same time that we anticipate that many institutions may begin transitioning to the Community Bank Leverage Ratio (CBLR) assuming that the new proposals are finalized shortly. For institutions that opt in to the CBLR, this change will not have an impact since the CBLR eliminates risk weighting of assets and does not subtract mortgage servicing rights in calculating capital.
Institutions that do not plan to adopt the CBLR will want to review their capital plans and discuss how this change may impact their bank.
CLA is here to help you analyze this change. Please contact us.
Amanda Garnett is a principal in the financial institutions practice of CliftonLarsonAllen (CLA) from Peoria, Illinois. She currently leads the firm’s Midwest financial institution tax team and serves institutions ranging in size from $15 million to $3.5 billion in total assets. In addition to tax compliance, Amanda assists clients in the areas of tax consulting, mergers and acquisitions, and regulatory reporting. She also routinely teaches courses for banking associations across the country.
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