A long list of new and old regulations, legislative items and even a few rumors are counted among the things to watch if you're a mortgage servicer. Like many things originating out of Washington, D.C., some of the items will sound very familiar.
Few industries are as sensitive to changes in laws, regulations and accounting rules as mortgage banking. Loan servicing is one area that's frequently affected by governmental or quasi-governmental activity. It's so pervasive, it is hard to imagine what servicing would be like without an annual dose of new regulations to accommodate.
Yet, the changes in servicing operations and markets that are the offshoot of these legal and regulatory developments affect the profits of all mortgage bankers. This is the case whether the business strategy focuses on loan servicing, origination or both.
To survive and prosper in today's dynamic environment, it is important to keep abreast of current legislative and regulatory issues and to understand their impact on mortgage servicing and the mortgage banking industry.
An issue that first emerged in 1992 was the Financial Accounting Standards Board (FASB) exposure draft regarding accounting for certain investments in debt and equity securities. On April 13 of this year, FASB finally issued its new standard, which creates three classes of securities: held for maturity, available for sale and trading instruments. This change could prompt a swing toward ARM financing and thus produce a new abundance of ARM servicing, which would have an impact on industry profits.
The way it works is that assets in the held-for-maturity category are held at book value. Securities falling into the available-for-sale category must be marked-to-market quarterly, with price differences added or subtracted from equity. Securities classified as trading instruments must also be marked-to-market quarterly, with changes in value added or subtracted from earnings.
Currently, financial institutions hold some mortgage-backed securities (MBS) at the lower of cost-or-market valuation, but many are held at their original book value. Under the new standards, most MBS and other financial instruments will fall into the available-for-sale or trading-instruments categories. The effect will be greater volatility in a financial institution's capital position, due to increased use of mark-to-market accounting.
This change will probably cause holders of mortgage-backed securities to shorten the maturities of their portfolios, to avoid fluctuations in capital caused by marking to market. This could increase the attractiveness of ARMs over fixed-rate loans.
As institutions shorten the maturities of their securities, the spread for longer term maturities could widen, making long-term interest rates less attractive to the consumer. To the extent that ARM financing becomes more attractive, market share could swing back to thrifts.
Furthermore, to the extent that consumers actually show a preference for ARMs over fixed-rate loans, lenders will be making loans for which the servicing value is approximately half the value of fixed-rate servicing. All other things being equal, industry profits would be hurt because the cost to originate either loan type is the same and ARMs are generally more costly to service.
It will be interesting to watch the effects of this change during the next year or two.
PMSR capital treatment
In late 1992, the Federal Reserve approved a uniform rule relating to purchased mortgage servicing rights (PMSRs) and their capital treatment. The Fed decided that purchased mortgage servicing rights may be included in capital if the aggregate amount does not exceed 50 percent of Tier 1 capital. Interestingly, the Fed may view the excessive holding of PMSRs as an unsafe and unsound practice.
The rule goes on to state that the original purchase discount rate, or …