Basel may encourage more nonbank mortgage lenders to go bank

• Key takeaway: If proposed changes to bank capital rules take effect as written, some mortgage companies may consider acquiring a bank to diversify their businesses. But industry stakeholders caution that the process can take years, requires significant preparation and does not guarantee regulatory approval. 
• Expert quote: "The best of intentions in crafting legislation and regulations can sometimes end up with the most unintended consequences." —Tom Piercy, director of MSR advisory at Mortgage Capital Trading

WASHINGTON – Proposed changes to bank capital rules could have the perhaps unintended effect of encouraging more independent mortgage bankers — nonbank mortgage companies known as IMBs — to acquire banks or bank charters.

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The proposed modifications to the Basel III capital framework would eliminate the threshold-based deduction for mortgage servicing assets, instead applying a 250% risk weight to all such assets. That change, while subtle, could make bank charters more attractive to IMBs with large servicing portfolios by changing how those assets are treated for regulatory capital purposes.

Although some nonbank mortgage lenders have added banking operations to their businesses, the strategy remains relatively uncommon. Stringent regulatory and liquidity requirements have made obtaining a bank charter difficult and the outcome undesirable for many IMBs.

Tom Piercy, director of MSR advisory at Mortgage Capital Trading, said the proposed Basel changes could expand the role of banks already participating in the mortgage market, but is unlikely to bring many banks in from the sidelines of the market. But it could end up encouraging more nonbank lenders to acquire bank charters, Piercy predicted.

"The best of intentions in crafting legislation and regulations can sometimes end up with the most unintended consequences," said Piercy, who is advising IMBs on pursuing bank charters.

A June paper by the Urban Institute estimates that four to eight IMBs could pursue bank charters over the next five years if the Basel reproposal takes effect. The largest IMBs — among them giants like Rocket Mortgage, United Wholesale Mortgage and PennyMac — may be best positioned to make the transition because of their scale and ability to manage higher funding costs, according to the paper. 

"The elimination of the MSR threshold deduction makes it more feasible for nonbanks in the mortgage space to secure bank charters than it has been in years," the paper argues. "Midsize IMBs with $1 billion to $10 billion in equity can now acquire small to midsize banks for deposit funding and charter access without becoming regulatory-capital insolvent."

A bank charter would allow servicing-heavy IMBs to extract greater financial value from their servicing portfolios by using deposits to fund lending and developing cross-selling opportunities, said Rich Swerbinsky, founder of Onward & Upward Consulting. It would also allow IMBs to tap federal funds via the Federal Home Loan banks.

"Once you're a bank, the servicing book works a lot harder," Swerbinsky said. "Escrow balances become your own cheap deposits instead of sitting at somebody else's bank. Every borrower you service becomes a deposit and cross-sell relationship. And your recapture engine runs on deposits instead of a warehouse line."

Those benefits don't come cheap, however, as banking charters bring with them greater regulatory scrutiny and supervisory hassles — and that's after the considerable burden and uncertainty surrounding obtaining a bank charter in the first place. 

Ari Karen, a partner at Mitchell Sandler, said oversight of nonbanks can vary in scope and frequency, while banks face more consistent regulatory scrutiny.

"Whether it's the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corp. or the Federal Reserve, you are going to be more regularly audited, and those audits are going to be fairly deep," Karen said. "There's a greater degree of responsibility, particularly if you're going to be dealing with an institution that's insured by taxpayers." 

Karen also added that attaining the bank charter itself requires jumping through a handful of procedural hoops that can take years, including creating a business plan and building out the right management team that is reviewed prior to approval.

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The application process can also take years, requiring prospective banks to develop a business plan and assemble a management team that regulators deem qualified to operate a banking institution, Karen said. 

"They're not just going to hand the keys to that car to anybody," said Karen. "Regulators want to see levels of experience in managing these types of businesses. They want to see acceptable risk profiles. They want to see the way you've managed your business."

Still, Karen said clients who have acquired banks have generally been satisfied with the decision. 

Cornerstone Capital Bank is one example of an organization that transitioned from an independent mortgage bank to a bank in 2022 via the acquisition of Roscoe Bank. Adam Laird, CEO of Cornerstone Home Lending, the bank's mortgage division, said the move helped "derisk the organization" by diversifying its revenue streams.

"As just an IMB, there's less diversification in terms of revenue streams, and so you've got greater risk to long-term stability," Laird said. "Our objective at Cornerstone was to build a more diversified platform that has mortgage banking and loan servicing at its core, and then create additional core businesses of commercial banking, institutional banking, insurance."

The transition took years of planning. The process began in 2019 and involved regulatory examinations and stress tests, Laird said. He cautioned that even after completing these steps, a bank charter is not guaranteed. 

Laird said the proposed Basel changes, which are expected to be finalized by the end of the year, could spur greater interest among IMBs in pursuing bank acquisitions. But he cautioned against making such a consequential decision based solely on a regulatory change.

"It's going to take a real strategic commitment," Laird said. "And becoming a bank and the strategic vision to become a bank shouldn't be done just because of a single rule change. It really requires a larger focus on the long term."