U.S. banking regulators’ easing of the capital rules on certain banks is a credit negative for the affected firms, says Moody’s Investors Service.
In a new report, the rating agency said that measures adopted last week by U.S. banking regulators, which aim to “simplify” the capital rules for banks that don’t use the “advanced approaches framework” for calculating their regulatory capital requirements, is a negative for those banks.
Overall, Moody’s said that the changes will allow banks to use a greater proportion of lower-quality or more volatile assets to make up their capital structure.
For instance, the new rules will increase the portion of banks’ common equity tier 1 capital that can be composed of lower-quality assets — such as mortgage servicing assets (MSAs), certain deferred tax assets (DTAs) and investments in the capital instruments of unconsolidated financial institutions — from 10% to 25%.
“We consider DTAs to be a relatively low-quality asset, and therefore a low-quality source of capital, compared with most other components of tangible common equity,” Moody’s said.
And it said that MSA valuations can be volatile because they tend to be “highly sensitive” to mortgage rates.
“A decline in mortgage rates can lead to an increase in mortgage prepayments, causing a sharp reduction in MSA valuations,” Moody’s said, adding, “MSAs also can be difficult to hedge.”
“If a bank’s capital structure included a higher proportion of MSAs, it would heighten risks regarding a bank’s business concentration,” Moody’s explained.
The new rules take effect in April 2020.