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Federal Home Loan Bank
The Effect of Basel III on MPF® ProgramParticipating Financial Institutions
March 11, 2015
“Mortgage Partnership Finance” and “MPF” are registered trademarks of the Federal Home Loan Bank of Chicago
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The contents of this presentation (whether in electronic or hardcopy format) and the remarks by representatives of Wilary Winn during the webinar, including those related to this presentation, are solely authored by Wilary Winn and its representatives. Wilary Winn is solely responsible for the content of this presentation and its representatives’ remarks during the webinar. The contents of the presentation and the remarks made during the webinar are not the opinion or viewpoint of the Federal Home Loan Bank of Chicago or any other Federal Home Loan Bank (collectively, the “ FHLBs”).The FHLBs make no representations or warranties about the accuracy, suitability or reliability of any information in this presentation or webinar discussion. Neither the presentation nor remarks made during the webinar are intended to constitute legal, accounting, investment, financial, professional advice or services of any kind. You should consult with your accountants, counsel, financial representatives, consultants and/or other advisors regarding the extent these materials or discussions may be useful or applicable to you and with respect to any legal, tax, business and/or financial matters or questions.
Disclaimer
Response to Financial Meltdown• More and higher quality equity – address systemic risk• Other reforms undertaken
– Dodd Frank – reliance on the ratings agencies– Qualified Mortgage, Qualified Residential Mortgage– True sale – variable interest entities– Derivatives
• This presentation is based on the Final Rule – Regulatory Capital Rules: Regulatory Capital, Implementation of BASEL III, Capital Adequacy, Transition Provisions, Prompt Corrective Action, Standardized Approach for Risk-Weighted Assets, Market Discipline and Disclosure Requirements, Advanced Approaches Risk-Based Capital Rule, and Market Risk Capital Rule
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Basel III Objective Key ProvisionsIncrease regulatory capital Quantity •Increased minimum regulatory capital percentages for
selected existing regulatory capital categories.
Increase regulatory capital Quality
•Introduction of a new Common Equity Tier 1 (“CET1”) category that will essentially require a higher percentage of Tier 1 regulatory capital be comprised of common stock and retained earnings.
•Stricter definitions of what is included in regulatory capital.
•New deductions and percentage limitations on certain so-called “threshold items”.
Promote regulatory capital Conservation•Introduction of a “Capital Conservation Buffer” which serves to restrict certain activities (i.e. dividends and executive bonuses) unless a certain buffer is maintained over and above the Capital Adequacy minimums.
Improve regulatory capital Risk – Sensitivity•Increased risk-weightings and credit conversion factors assigned to certain categories of loans, unfunded loan commitments and mortgage-backed securities.
Major Victory for Community Banks• Available For Sale (AFS) opt out – discuss on slide 14• Risk-weighting of single family mortgages remains the
same• Trust Preferred Securities (TruPS) issued prior to May
19, 2010 – banks under $15 billion remain as additional Tier 1
• Phase-in of capital deductions
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New Rules Became Effective January 1, 2015
• New net worth ratio – Common Equity Tier 1 (CET1)• Changes to capital adequacy and prompt corrective
action thresholds• Net worth deductions and adjustments• Capital preservation buffer• Changes to calculation of risk-weighted assets
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New Capital Ratio Component, CET1, for bothCapital Adequacy and Prompt Corrective
Action (PCA) Purposes
CET1 includes:• Qualifying common stock instruments• Retained earnings• Accumulated other comprehensive income (AOCI)
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New Definition of Tier 1 Capital
• CET1 per previous slide plus “Additional Tier 1 Capital”• Additional Tier 1 Capital includes:
– Qualifying noncumulative perpetual preferred stock– Instruments issued under the Troubled Asset Relief Program
(TARP) or Small Business Lending Fund Program (SBLF) that qualified as Tier 1 capital when issued
– TruPS issued before May 19, 2010 for banks under $15 billion – subject to a maximum of 25% of Tier 1 capital
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CET1 Deductions • Goodwill• Intangibles (other than Goodwill and Mortgage
Servicing Rights (MSRs))• Deferred tax assets related to net operating loss
and tax credit carryforwards• Gain on sale in connection with securitization
exposure• Equity investments in financial subsidiaries
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CET1 Regulatory Adjustments• AOCI opt-out
• Gain or loss related to the change in fair value for liabilities measured at fair value from changes in the bank’s own credit risk
• Certain investments in capital instruments (TruPS)
• Reciprocal cross holdings of capital in financial institutions
• Non-significant investments in the capital of unconsolidated financial institutions
• Significant investments in the capital of unconsolidated financial institutions that are not in the form of common stock
Accumulated Other Comprehensive Income (AOCI) Opt-Out
• Opt-out election for AOCI.
• One-time made on March 31, 2015 with the call report filing for community banks and the FR Y-9C (if applicable).
• Note: FR Y-9SP not applicable since opt-out will not apply to bank holding companies under $500M.
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CET1 Limitations the 10% and 15% rules
• Mortgage Servicing Assets (MSAs)
• Deferred Tax Assets (DTAs) related to net operating loss carrybacks
• Significant investments in the capital of unconsolidated financial institutions in the form of common stock
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CET1 Limitations the 10% and 15% rules
• MSR Assets, Deferred Tax Assets and Significant Investments
• Limited to 10% of CET1 individually and 15% collectively
• Eligible portion subject to risk-weighting of 250%
• Amount of assets deducted reduces Risk-Weighted Asset (RWA) denominator
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10% and 15% Deductions Phased-in:
• 40% reduction in 2015, then 20% per year
• 100% risk-weight on eligible portion until 1/1/2018
• After 1/1/2018, risk-weighted at 250%
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New Definition of Total Capital (Tier 2)• Tier 1 Capital per page 7 plus:
- Subordinated debt and preferred stock meeting certain criteria
- Allowance for loan loss not exceeding 1.25% of RWAs
- If AOCI opt-out election, 45% of pretax unrealized gains on Available For Sale preferred stock classified as equity
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Adequately Capitalized
Well Capitalized Adequately Capitalized with Buffer
2014Startingin 2015 2014
Startingin 2015
Fully phased in startingin 2019
Total risk-based capital 8.0% 8.0% 10.0% 10.0% 10.5%
Tier 1 risk-based capital 4.0% 6.0% 6.0% 8.0% 8.5%
Common equity Tier 1 risk-based capital
N/A 4.5% N/A 6.5% 7.0%
Tier 1 leverage capital 4.0% 4.0% 5.0% 5.0% 6.5%
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Payout Limitations
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Capital Conservation Buffer (as a percentage of standardized or
advanced total risk-weighted assets, as applicable)
Maximum Payout Ratio(as a percentage of eligible
retained income)
> 2.5% No payout ratio limitation applies
≤ 2.5% and > 1.875% 60%
≤ 1.875% and > 1.25% 40%
≤ 1.25% and > 0.625% 20%
≤ 0.625% 0%
Capital Conservation Buffer• Banks will look for ways to avoid limitations on capital
distributions and restrictions.– Potentially choosing to hold substantial excess capital over well-
capitalized levels
• S-Corp banks will need to factor any restrictions on distributions to shareholders for tax payments into their capital planning
• Possible limitations on payments of discretionary bonuses
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Changes to Risk-Weighting• Risk-weighting changed for a number of asset
classes• No change in 1-4 family residential mortgage
loans• 50% weight for current loans and 100% weight
for loans 90+ days delinquent
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• Credit enhancing representations and warranties
120 day safe harbor retained for single family 1-to-4early default representations and warranties andservicing released premiums
• Mortgage banking derivatives Subject to credit conversion factor – if less than one year 0% risk-weight
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MPF Program is considered a synthetic securitization:
“The agencies believe that these exposures that tranche credit risk meet the definition of a synthetic securitization and that the risk of such exposures would be appropriately captured under the securitization framework.” (pg 346)
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PFIs have options when calculating the risk-weighted assets related to theCredit Enhancement (CE) Obligation:
1. Simplified Supervisory Formula Approach (SSFA)
2. Gross-up approach under general risk-based capital rules
3. Multiply the CE Obligation by 12.5 (dollar for dollar capital impact)4. Supervisory Formula Approach (SFA) (for largest institutions only –advanced approaches)
The SSFA and Gross-up approaches are subject to a risk-weighted assets floorof 20%.
We note that banks with more than $50 billion in total assets have additionaldisclosure requirements.
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The Move from Basel II to Basel III
Basel II (today)• Three reporting methods
1. Gross-up approach2. Direct Reduction
Method (DRM)3. 50% of the UPB
• Use the lower of the three amounts
Basel III (January 1, 2015)• Three reporting methods
1. Gross-up approach (different from Basel II)
2. Simplified Supervisory Formula Approach (SSFA)
3. CE * 12.5 (same as Gross-up approach under Basel II)
• Use the lower of (with a caveat)
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Final amount goes into the denominator of the RBC RatioRBC Ratio = Risk Adjusted Capital (RAC)/Risk-Weighted Assets (RWA)
The lower the denominator, the higher the ratio8% = Adequately Capitalized; 10% = Well Capitalized; 10.5% = Adequately w/buffer (under
Basel III)
Gross-up approach – Four Inputs• Pro-rata share – for MPF CE Obligation 100%
• Exposure amount – CE Obligation amount
• Enhanced amount – Balance of sold loans in excess of the CE Obligation amount
• Applicable risk-weight – 50% for loans that are current and 100% for non-current loans
If a bank elects the Gross-up approach it must use it for all of its securitization exposures. We note that this approach is not available to entities that are subject to the market risk rule.
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Gross-up approach – Example• Pro-rata share – 100%• Outstanding Amount – $20,311,371• Exposure amount – CE obligation amount - $1,505,554• Enhanced amount – Balance of sold loans in excess of the CE
obligation amount – $18,805,817• Delinquent loans – $710,693 (3.50%)• Applicable risk-weight – 50% for loans that are current and 100% for
non-current loans – (1 - 3.50%)*0.5 + 3.50% = 51.75%• Risk-Weighted Assets = 51.75% * $20,311,371 or $10,511,134
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Gross-up approach – Pros & ConsPros: Cons:1. Benefits MCs with high 1. Calculations should be
CE balances and low DQs. done at the MC level.2. RWA should benefit as 2. PFI must use Gross-up
UPBs decrease. approach for all MCs.3. Easier calculation than the
SSFA method.
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SSFA – Model Demonstration
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MPF ProgramMaster Commitment Detail Report
Report Date: 12/1/2014
PFI: XXX ‐ ABC Bank
Credit Enhanced Master Commitments for XXX ‐ ABC Bank
Master Commitments where Originating PFI and CE Obligation Owner is XXX ‐ ABC Bank
MC # MPF ProductOutstanding Balance of All Loans Sold Remaining FLA
Remaining FLA as a % of Outstanding Balance Remaining CE Obligation
Remaining CE Obligation as a % of Outstanding
Balance
Outstanding Balance Excluding Loans 90+ Days
Past Due
Loans 90+ Days Past Due as a % of Outstanding
Balance Servicing Rights11111 Original MPF $5,302,915 $40,771 0.77% $734,029 13.84% $5,159,856 $143,059 (1) 2.70% Retained22222 Original MPF $12,045,973 $2,015 0.02% $988,408 8.21% $11,705,849 $340,124 (2) 2.82% Retained33333 MPF 125 $9,412,053 $153,652 1.63% $860,732 9.15% $9,412,053 $0 (0) 0.00% Retained44444 MPF 125 $14,059,285 $145,162 1.03% $747,954 5.32% $13,848,790 $210,495 (1) 1.50% Retained
Master Commitments where CE Obligation was Assumed from Others by XXX ‐ ABC Bank
MC # MPF ProductOutstanding Balance of All Loans Sold Remaining FLA
Remaining FLA as a % of Outstanding Balance Remaining CE Obligation
Remaining CE Obligation as a % of Outstanding
Balance
Outstanding Balance Excluding Loans 90+ Days
Past Due
Loans 90+ Days Past Due as a % of Outstanding
Balance Servicing Rights55555 Original MPF $7,040,294 $66,066 0.94% $552,100 7.84% $6,349,968 $690,326 (3) 9.81% Released66666 MPF 100 $2,043,723 $58,103 2.84% $172,081 8.42% $1,583,506 $460,217 (2) 22.52% Released
Outstanding Balance of Loans 90+ Days Past Due Amount (Count)
Outstanding Balance of Loans 90+ Days Past Due Amount (Count)
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Basel II vs. Basel III Calculations
Master BalanceNo. of Loans FLA CE SSFA
Securitization Gross-Up
Minimum Risk Weight
Multiplier Gross-Up DRM UPB
Minimum Risk Weight
Multiplier1 20,311,371 272 5.40% 7.41% 13.66% 51.75% 2.70 92.65% 49.51% 51.75% 6.68
2 14,433,988 93 3.61% 3.91% 26.64% 50.99% 6.82 48.84% 35.73% 50.99% 9.14
3 14,381,171 107 2.99% 11.00% 37.41% 50.00% 3.40 137.45% 69.86% 50.00% 4.55
4 27,525,571 152 2.30% 2.90% 32.56% 50.00% 11.21 36.30% 24.24% 50.00% 8.35
5 50,286,737 914 1.75% 8.41% 53.45% 51.07% 6.07 105.15% 70.86% 51.07% 6.07
6 128,909,861 625 1.21% 4.65% 50.02% 50.00% 10.76 58.09% 30.88% 50.00% 6.64
7 176,775,313 811 1.05% 4.85% 52.22% 50.00% 10.30 60.68% 29.57% 50.00% 6.09
8 21,334,140 180 0.07% 3.05% 38.06% 50.00% 12.50 38.06% 15.95% 50.00% 5.24
BASEL III Existing Rules
SSFA – Pros & ConsPros: Cons:1. Benefits MCs with high 1. Not “Simple”
FLA balances. 2. Calculations should be 2. RWA should benefit as done at the MC level.
UPBs decrease. 3. Data used is subject to due diligence requirements
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Example
(Column Q) (Column T) (Column U)
(Column A) Totals
(Column B) Adjustments to
Totals Reported in Column A
Exposure Amount
Dollar Amount in Thousands 1250% SSFA Gross‐Up10. Off‐balance sheet
securitization exposures 10,000 9,800 2,500 15,000
Total Risk‐Weighted Asset Amount by Calculation
Methodology
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ExampleMC CE * 12.5 SSFA Gross‐Up1 811,263 714,823 728,630 2 5,814,506 788,447 1,760,227 3 1,974,654 1,798,404 ‐ 4 5,492,959 5,038,018 ‐ 5 3,063,834 ‐ ‐ 6 72,204 ‐ ‐
8,339,692 2,488,857 3,136,038 10,603,651 11,475,730 13,092,508
Plus CE * 12.5Grand Total
Total
Wilary Winn’s Accounting Manual Provides a helpful explanation of the Basel III calculations
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How Wilary Winn Can Help1. Wilary Winn can calculate the increase to risk-weighted assets under the
three allowed methodologies and provide you with the optimal result.
2. Wilary Winn can perform a valuation of a servicer’s entire mortgage servicing portfolio. The valuation will include determining the values of the MSR and the CE Fee Receivable at the loan level and assisting with any questions related to the accounting for the portfolio.
3. For those electing the amortization method for MSRs, Wilary Winn will incorporate the MSR into a loan level basis roll forward file, which will provide information necessary to produce the amortization journal entries going forward. The file will also include a section where newly sold loans can be added and the amount of the new MSR will be calculated; the amortization for these loans will also be calculated.
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Services and Contact Information
• Mortgage Servicing Rights and Mortgage Banking Derivatives:Eric Nokken [email protected]
• Asset Liability Management and Private Label MBS/CMOs, Pooled Trust Preferred CDOs
Frank Wilary [email protected]
• Mergers and Acquisitions, Fair Value Footnotes, TDRs, and ASC 310-30:Brenda Lidke [email protected]
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Wilary Winn LLCFirst National Bank Building
332 Minnesota Street, Suite W-1750St. Paul, MN 55101
651-224-1200
www.wilwinn.com
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