WASHINGTON — The Federal Deposit Insurance Corp. approved a rule Friday designed to simplify and expand deposit insurance coverage for mortgage servicers' accounts to relieve investor anxiety about the possibility of steep losses as a result of a bank failure.
"This simplification of the coverage rules for mortgage servicing accounts will help prevent losses to otherwise insured depositors and prevent withdrawals of deposits for principal and interest payments from depository institutions," said FDIC Chairman Sheila C. Bair.
Before the rule change, borrowers would make principal or interest payments to a servicer, which would insure them in the name of the investor that holds the mortgage. Tax and insurance funds, on the other hand, were insured in the name of the borrower.
As mortgage securitizations grew more complex, uncertainty developed over who would take the first losses on principal and interest payments passing through a bank if it were to fail. The accounts, which can have balances in the hundreds of millions of dollars, were uninsured, because they were not attached to specific individuals.
The situation led Fannie Mae, under a leadership team installed after the government takeover, to require problem institutions to pass on their funds immediately to the government-sponsored enterprise, instead of holding them in accounts. That requirement drew protest from bankers, who said it would make it harder for them to carry out daily operations by reducing liquidity.
Fannie announced Friday, after the rule change, that it would end that practice and allow servicers to hold their principal and interest payments again.
Under the new rule, funds received as taxes and insurance will be insured on a pass-through basis and added to borrowers' already established accounts and insured "to the applicable limit." That is designed to make it easier for banks to hold more money in their accounts without having investors worry that the funds would be lost of the bank failed.
The FDIC said the funds in the accounts were guaranteed up to $250,000 for the same temporary period it has agreed to guarantee other bank deposits above the normal $100,000 cap. The coverage hike will expire Dec. 31, 2009.
Industry representatives praised the move.
"Mortgage servicers were concerned about this," said Karen Thomas, the Independent Community Bankers of America's executive vice president for government relations. "We are extremely supportive of the move. It mirrors some other accounts now that are covered on a pass-through basis, such as pension accounts, where each beneficiary on an account has separate insurance."
Robert Davis, executive vice president for government relations for the American Bankers Association, agreed that "the FDIC action addresses both security of customer funds and any potential concern about counterparty risk in the mortgage servicing process. We believe this resolves all potential concerns regarding the security of mortgage servicing payments."
Former FDIC Chairman L. William Seidman said the action made sense.
"It's part of the FDIC's program to spread their protection as far and wide as they can," he said, "The more they can do to provide the players with assurance that they're truly going to get paid, the better."