InfoBytes Blog

FHFA outlines MSR guidance for managing counterparty credit risk

On January 12, FHFA released an advisory bulletin communicating supervisory expectations for Fannie Mae and Freddie Mac (the Enterprises) related to the valuation of mortgage servicing rights (MSRs) for managing counterparty credit risk. FHFA emphasized that Fannie and Freddie’s “risk management policies and procedures should be commensurate with an Enterprise’s risk appetite[] and based on an assessment of seller/servicer financial strength and MSR risk exposure levels.” FHFA relayed that while sellers and servicers assign values to their MSRs, the Enterprises should implement their own processes to evaluate the reasonableness of seller/servicer MSR values. FHFA explained that Fannie and Freddie are “exposed to counterparty credit risk when seller/servicers provide representations and warranties that mortgage loans conform with its selling guide requirements,” and reiterated that “[f]ailure to meet such obligations and commitments may cause the Enterprise to incur credit losses and operational costs.”

The advisory bulletin lays out risk management expectations to ensure MSR values are reasonable, objective, and transparent, and provides guidance covering several areas, including (i) objective evaluation of MSR values; (ii) MSR valuations for mortgage loans owned or guaranteed by Fannie and Freddie as well as stress testing; (iii) MSR valuations for mortgage loans not owned or guaranteed by Fannie or Freddie; (iv) market data input; (v) use of third-party providers; (vi) frequency of evaluations; and (vii) discount to MSR values when servicing rights are terminated. The advisory bulletin is applicable only to MSRs for single-family mortgage loans and is effective April 1.

Agency Rule-Making & Guidance Federal Issues Mortgages Fannie Mae Freddie Mac GSEs Risk Management Credit Risk

OCC discusses credit risk management, diversity and inclusion

On December 5, acting Comptroller of the Currency Michael J. Hsu delivered remarks at the RMA Risk Management and Internal Audit Virtual Conference, where he spoke about the current expected credit losses standard (CECL) and the importance of workforce diversity and inclusion. Hsu started by discussing CECL and mentioning that though loan portfolios have generally remained resilient and widespread, “deterioration isn’t currently evident in credit quality metrics, the effects of high inflation, rising interest rates, lagging wage growth, supply chain disruptions, and stress from geopolitical events threaten the unexpectedly strong credit performance observed over the past few years.” He further pointed out that the longer-term effects of the Covid-19 pandemic, such as the shift in preferences toward online shopping and remote work, and other circumstances, can erode business profit margins, debt service capacity, and collateral valuations, in addition to adversely affecting credit risk levels at financial institutions. When speaking about sound practice, Hsu stated that maintaining safe and sound credit risk management practices through this period of economic uncertainty is critical. He also noted that “timely risk identification and ratings, increased focus on concentrated portfolios and vulnerable borrowers, and stress testing and sensitivity analysis are particularly critical risk management activities at this time.” He further warned that the “flexibility” provided by CECL must ensure safety and soundness, arguing that there needs to be “appropriate support and documentation of management’s judgments,” as well as management’s assumptions, decisions, expectations, and qualitative adjustments. He emphasized that the first step to improving diversity, equity, and inclusion requires more transparency from the financial services industry regarding the diversity of their boards and executive leadership, and organizations need to develop diversity plans and monitor outcomes. He also emphasized that financial institutions should actively “foster a true sense of belonging for everyone.” In closing, Hsu stated that “improving diversity and inclusion is a ‘need to have’ for [the OCC] to achieve our mission of assuring safety and soundness, fair access to financial services, and fair treatment of customers.”

Bank Regulatory Federal Issues OCC Diversity Credit Risk Risk Management CECL Covid-19

Agencies will not amend qualified residential mortgage definition

Recently, the OCC, Federal Reserve Board, FDIC, FHFA, SEC, and HUD issued an interagency notice stating that no changes will be made to the definition of “qualified residential mortgage” (QRM) under the Credit Risk Retention Regulations. The agencies also left unchanged a community-focused residential mortgage exemption from TILA’s ability-to-pay requirement, after determining that the exemption serves the public interest by making “safe, sustainable loans” available to low-to-moderate-income communities. An exemption for qualifying three-to-four-unit residential mortgage loans was also left unchanged after the agencies determined that the underlying properties “are a source of affordable housing” and, given the number of mortgages collateralized by three-to-four-unit properties, the exemption “does not appear to be spurring any significant speculative activity in the securitization market.”

As part of the Credit Risk Retention Regulations, which were established under Dodd-Frank, federal banking agencies are required to periodically review the QRM definition “to assess developments in the residential mortgage market, including the results of the statutorily required five-year review by the [CFPB] of the ability-to-repay rules and the QM definition.” During their review of the QRM definition, the agencies confirmed that the current QRM definition was “predictive of a lower risk of default” and “did not appear to be a material factor in credit conditions during the review period.”

Agency Rule-Making & Guidance Federal Issues Federal Reserve OCC FDIC SEC FHFA HUD Bank Regulatory Credit Risk Credit Risk Retention Regulation Dodd-Frank Ability To Repay Qualified Mortgage Qualified Residential Mortgage

NCUA to seek information about emerging credit risks

On April 29, the National Credit Union Administration announced that it expanded its Covid-19 outreach to federally-insured credit unions to identify emerging credit risks. The NCUA notified regulated entities that examiners will contact them between May 4 and May 18 to discuss a list of questions concerning operating status, status of cash reserves and withdrawals, liquidity status, loans in forbearance, and balance of loans with outstanding balances.  

Federal Issues Covid-19 NCUA Credit Risk Credit Union Forbearance Mortgages

OCC releases recent enforcement actions

On January 18, the OCC released a list of recent enforcement actions taken against national banks, federal savings associations, and individuals currently and formerly affiliated with such entities. The new enforcement actions include civil money penalties, a formal agreement, and removal/prohibition orders.

Formal Agreement. On December 31, the OCC entered into an agreement with a San Francisco bank to address alleged unsafe or unsound practices related to the bank’s enterprise governance, concentrations of credit, and credit risk management. Among other conditions, the agreement requires the bank to (i) establish a three-year strategic plan outlining goals and objectives related to the bank’s risk profile and liability structure, among other concerns; (ii) receive a “written determination of no supervisory objection” prior to increasing concentrations in unguaranteed portions of Small Business Administration (SBA) loans, and establish a concentration risk management program; (iii) engage an independent consultant to conduct quarterly asset quality reviews of the bank’s loan portfolio to, among other things, identify and stratify risk; (iv) establish and maintain a credit risk rating system; (v) revise its loan policies and procedures, including changes to its SBA lending program; (vi) submit revised policies and procedures concerning the maintenance and documentation of appropriate allowances for loan and lease losses; and (vii) prepare an employee compensation plan, which establishes criteria used when determining compensation levels, including those involving the bank’s SBA managers, business development officers, underwriters, and loan officers.

Federal Issues OCC Enforcement Credit Risk

FDIC issues summer 2018 Supervisory Insights

On September 5, the FDIC released its summer 2018 issue of Supervisory Insights (see FIL-44-2018), which contains articles discussing bank lending to the oil and gas sector and an overview of bank credit risk grading systems. Information and analysis from examiner observations is presented in the article, “Credit Risk Grading Systems: Observations from a Horizontal Assessment.” Sixteen large state nonmember banks’ credit risk grading programs are analyzed for (i) their use of expert judgment based systems and/or quantitative scorecards and models to assign credit grades; (ii) data usage and retention needs; and (iii) governance and risk management frameworks established by grade definitions. The article advises that “a bank’s credit risk grading system should align with the bank’s size and complexity to facilitate accurate risk identification, measurement, monitoring, and reporting,” and should include internal systems to allow for effective risk assessment, timely and accurate reporting, and procedures for safeguarding and managing assets. In addition, the issue includes an overview of recently released regulations and supervisory guidance in its Regulatory and Supervisory Roundup.

Agency Rule-Making & Guidance FDIC Supervision Credit Risk Risk Management