Recourse Loans May Face Tighter Rules
Regulators may soon try to impose tighter capital rules on certain credit enhancements, adding a new wrinkle to asset sales.
Under current rules, when banks sell a loan with a recourse provision they must set aside capital as if they continue to own the loan.
However, a letter of credit equal to the recourse exposure shifts risk from the lender to the letter of credit issuer - who has to set aside capital only against the amount of the recourse provision.
Uneasy about this capital gap, the Federal Financial Institutions Examination Council is preparing to release a proposal as early as this winter to boost the capital requirements on letters of credit, according to Owen Carney, senior adviser on investments at the Office of the Comptroller of the Currency. The proposal could begin circulating this winter.
"This is going to be a real kick in the butt for some of the banks who provide letters of credit," one regulator said.
If adopted, the rule change also could hurt banks that are active in mortgage servicing. Along with fees for collecting mortgage payments, loan servicers sometimes accept liability for any recourse provisions.
Citicorp, Fleet/Norstar Financial Group, and NCNB Corp. are three of the biggest mortgage services in the United States, although they vary in how frequently they acquire recourse provisions.
An official at Citicorp Mortgage Inc., which was servicing $66 billion in loans at the end of 1990, said his bank seldom acquires recourse exposure with servicing rights.
Eric Ross, a vice president at Fleet Mortgage Corp., said Fleet does purchase loans to service from time to time, but few of them have recourse provisions. The Providence, R.I., bank was servicing $52 billion in mortgage loans as of last December.
Discussions about such a rule began when regulators realized the capital charges for so-called acquired risk were lower than those of original risk.
For example, say, a bank sells a $1 million commercial real estate loan with 10% recourse. Because the recourse means the bank is effectively keeping the original risk intrinsic to the loan, the bank's capital requirement would be tied to the full face amount of the loan. In this example, the selling bank would have to keep $80,000 in capital under the fully phased-in, risk-based capital rules.
If the bank wanted to eliminate its capital requirement, it could go out and buy a $100,000 letter of credit to cover its 10% exposure on the $1 million loan. At that point the bank would have no risk left from the loan sale, and it would no longer have to keep capital against the loan.
Under current rules, the letter-of-credit provider would have to keep capital - but only against the $100,000 letter of credit. In this example, the capital requirement would be just $8,000.
But the regulators want to change the rules because in such a case, they believe, the letter-of-credit provider is actually acquiring all the risk in the loan. They are gearing up to propose a rule change that would require the letter-of-credit provider to keep as much capital as the original seller of the loan - in this case, $80,000.