The FDIC's Other Friday Gambit
Fridays seem to have become the day to dump bad news as a consequence of the lazy tendency of some members of the Fourth Estate to head out early to start their weekends. (There is a reason it isn't FDIC Failure Tuesday- part of it involves the ease of moving retail deposits to their new home, but reporting plays a role as well). For those who are, instead, actually looking for the sort of things that might encourage concealment, Friday has become like a recurring birthday 52 times a year. There are always a few presents bouncing around on the same day. The FDIC is an especially active user of the Fourth Estate Friday gambit. Today is no exception, even before the bank failure list hits the wire. Witness the vaguely titled: Agencies Issue Final Rule for Mortgage Loans Modified Under the Home Affordable Mortgage Program.
To summarize, banks are generally allowed to risk-weight certain first-lien residential mortgages (and some additional second-liens) at 50%. Loans not meeting the requirements get slapped with a 100% risk weighting requirement. Reasonably, the Office of the Comptroller of the Currency (the "OCC") generally considers mortgage loans that have been modified to be "restructured" for the purposes of the rule. The same applies to loans 90 days or more past due. The Board of Governors of the Federal Reserve has a similar rule. Obviously, if you've modified the terms substantially you are looking at a riskier bit of paper. "Restructured" loans or loans 90 days or more overdue generally have to be held at 100% risk-weightings. This would have the effect of doubling the loan's capital requirements for the holding bank. Not anymore.
Since late June of this year, an interim rule has permitted modified loans to be held at their original risk weightings. Today that rule has been made "final." Perhaps the most interesting part of the release is this passage:
Consistent with the FDIC’s general risk-based capital rules, if a mortgage loan were to again be restructured after being modified under the Program, the loan could be assigned a risk weight of 50 percent provided the loan, as modified, is not 90 days or more past due or in nonaccrual status and meets the other applicable criteria for a 50 percent risk weight.
Perhaps we are just being befuddled by the FDIC's legalese, but this sounds to us like re-modifying a loan resets the 90 day clock, and so long as modification continues every 89th day, one could keep a troubled loan in the 50% bracket indefinitely. You also seem to be able to get 100% weighted loans down to 50% via modification.
Astute readers will also want to look at footnote 44 which appears to expand the term "Prudent underwriting standards" to permit LTV to be calculated against the "most current appraisal." Sounds great until you consider that these are almost certainly bubble-era appraisals. (What bank is going to force new appraisals in this environment and post the attendant write-downs?)
Question: When a bank does the HAMP modification is it required to reflect the reduced principal amount as a loss 100% in that quarter? What's the accounting treatment for making a $100K loan at 5% then reducing it to a $70K loan at 2%? When and where does the bank have to show that $30K loss of principal?
Obviously, this all has the effect of making bank balance sheets even more opaque than they already were and significantly increasing loss risk. (Been wondering why the loss ratios for recent bank failures have been so high?) But, then, you expected that on a Friday. Didn't you?