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More analysts are joining the chorus line of thought that Basel III will cause lenders to refuse to venture beyond originating plain vanilla residential mortgages.
Fitch Ratings said Wednesday that any Basel III-driven proposals addressing capital requirements would, if adopted, push banks away from all but the most conventional and low risk forms of mortgage lending.
Regulators’ notice of proposed rulemaking, or NRP, the firm believes, could increase borrowing costs for "plain vanilla" mortgage products, which are classified as category 1 loans. And nontraditional mortgages, viewed as high risk by regulators, may be effectively eliminated from broad availability at regulated banks.
Nontraditional products such as loans amortizing for more than 30 years, negative amortization mortgages, and loans lacking verification of a borrower's ability to repay would all be assigned category 2 risk status under the NPR, forcing banks to hold two to three times more capital than presently required.
For example, current capital rules place a 50% risk weighting on mortgages with an 85% loan to value. However, under the NPR, the same loan could generate a 150% risk weighting if classified as a category 2 loan.
A category 2 loan is similar to the idea of a qualified mortgage and a qualified residential mortgage pursuant to the Dodd-Frank Act. The Dodd-Frank Act enhances regulatory burden via credit risk retention for loan securitizations and compliance requirements.
“Together, the Dodd-Frank Act and the NPR are expected to sharply curtail the ability and willingness of banks to underwrite or purchase loans that regulators view as high risk,” Fitch said.
Three Dodd-Frank rules that will govern how banks shield themselves from capital risks in the future could cause lenders to back-pedal on plans to offer various loan-product types, law firm K&L Gates said in June.
The long-term effect could be a market where lenders refuse to go beyond the issuance of "plain vanilla residential mortgage loan products," the firm believes.
Amherst Securities Group, however, maintains a favorable outlook on impact of the Basel III-driven capital requirement proposals.
Fitch adds that the NPR heightens risk sensitivity by imposing risk weights against credit-enhancing representations and warranties for both category 1 and 2 loans that are sold.
As a result of the proposed capital changes, banks will continue to meet demand for traditional loan products and pass along the additional cost of capital to borrowers.
“However, given the stricter treatment of category 2 loans in the NPR and Dodd-Frank Act, it is unlikely that banks will continue to originate or sell significant volumes of nontraditional mortgage products, thereby reducing availability of credit to many borrowers,” Fitch said.
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