David H. Stevens, the CEO of the Mortgage Bankers Association, stood before the large crowd in Orlando. During the speech to gathered mortgage servicing industry professionals, he held up a copy of HW Magazine and said the final rule of the qualified mortgage may yet be changed.
And then switching from the tone of hope, he later would add: “MSRs are no longer servicing rights, they are mortgage servicing risks.”
As Nationstar CEO Jay Bray said in the March issue of HousingWire, the flight to purchase mortgage-servicing rights was a “land grab” in 2013.
Financing these MSRs via advanced receivables can help these large companies stay liquid, but securitization can’t solve all the problems.
Of course, the industry has its alternative solution to make what Stevens calls risks ultimately become their rewards.
It’s called MSR lending, and it’s a renewed phenomenon in the mortgage marketplace today.
With the refinancing boom effectively over, a lot of lenders are left with excess warehouse capacity. Mix in an interest-rate environment where interest rates are more likely to go up than down and what you get is the opportunity to realize servicing revenues on new mortgage servicing rights for a significant period of time.
At least 15 lenders are looking to get into MSRs, according to Bob Rubin, the managing director of Detroit-based The Business Loan Connection. Rubin works with numerous warehouse, wholesale and correspondent lenders, and was once a broker and a lender himself. “There are a lot of emerging people in this space,” said Rubin. “There are some who don’t know anything about it but want to get into it.”
Rubin, in his day-to-day operations, matches up mortgage bankers with warehouse lines of credit. He recalls that not so long ago “liquidity was horrible in this space. Servicers were very anxious to get lines of credit because very few banks were in that space at the time,” he said.
On the books, 2012 went down as the year of servicer consolidations, as many participants exited the business following the financial crisis. 2013 was marked by continued mortgage servicing rights acquisitions.
And 2014 is likely to go down as the year of mortgage servicing financing.
“Getting the business plan right in 2014 will be critical,” said analysts at Sterne Agee in a February report on the sector. “Returns on servicing are lower than in past periods, and efficiency and effectiveness at servicing loans and reducing servicing advance and capital debt cost are expected to be the real determinants of success.”
Banks selling off their mortgage servicing rights is a trend of the last two years and has been largely driven by changes in capital definitions for U.S. banks involving mortgage servicing rights.
Under Basel III, banks will be allowed to include only a maximum 10% of mortgage servicing rights in their capital measures. Any amount above that is deducted; and then, in combination with financial holdings and deferred tax assets, that can only be up to 15% of aggregate capital.
“The sluggish comeback of the mortgage market and new loan production has led many servicers to grow their servicing portfolios through the acquisition of both third-party servicing and, more extensively, by the purchase of MSRs. This dynamic has been especially aided by the fact that the large banks are actively looking to minimize their MSR exposure and move delinquent loans from their portfolios,” according to DBRS.
Some of 2013’s largest MSR acquisitions included Ocwen Financial Corp.’s acquisition of more than $90 billion from Ally Bank and approximately $72 billion from OneWest Bank.
These transactions included both agency and non-agency loans. Nationstar Mortgage acquired more than $215 billion of MSRs from Bank of America Corp., of which approximately 47% were comprised of agency loans and 53% loans in private label securitizations. Walter Investment Management Corp. acquired more than $93 billion of agency loans from Bank of America Corp. and Quicken Loans acquired approximately $43 billion of agency loans from Ally Bank.
Over the last few years, the cost of servicing has been increasing steadily due to the high-touch nature of handling severely delinquent loans and the expenses of complying with regulatory requirements. Effective Jan. 10, 2014, the cost of servicing became even greater under the new Consumer Financial Protection Bureau rules.
Acquisitions of large-bank MSRs by smaller, less-capitalized servicers will continue to stress the ability of these firms to remain profitable. In addition, servicers will now be under increased regulatory scrutiny from the CFPB and will be held responsible for servicing-related deficiencies as evidenced by the recent settlement reached between Ocwen and the CFPB, under which Ocwen agreed to pay $127.2 million and provide $2 billion in principal forgiveness relief for outstanding loans over a three-year period.
Sterne Agee analysts said this year acquired servicing will need to be done in conjunction with a capital source than can absorb the lower 8-12% ROCs expected.
MORTGAGE FINANCING CHOICES
Servicers have two choices of what to do with the mortgage servicing right. They can keep it and collect a sliver of interest from now until the mortgage is either paid off or defaults. Or the servicer can sell it to someone else in return for cash up front.
Selling the mortgage servicing right up front allows the servicers to receive a servicing release premium, or a lump-sum payment that is paid in return for the stream of cash flow from the mortgage servicing right that is sold.
But the meltdown in service release premiums that saw the multiples drop from 4x the mortgage fee a few years earlier to as low as 0x has made selling mortgage servicing rights a less appealing option.
Real estate investment trusts have increasingly become a financing option for nonbank servicers.
Both Nationstar and Ocwen have access to REIT partners that can co-invest in servicing transactions. “The data suggest that NSM’s capital partner, New Residential, is targeting return on equity (ROE) of 12-15%,” according to Sterne Agee.
Ocwen Financial spun-off Home Loan Servicing Solutions (HLSS) in 2010. Founded by Ocwen’s Executive Chairman William Erbey, HLSS was created to acquire mortgage servicing assets including servicing rights, rights to fees, and other income from servicing loans. Ocwen through HLSS has executed a number of servicing advance securitizations. [SEE HOUSINGWIRE FEBRUARY FEATURE, page 48]
In February, the nonbank servicer said it planned to package a pool of mortgage servicing rights to sell to investors on the capital markets. The deal is called OASIS, which is short for Ocwen Asset Servicing Income Series IO MSR-Secured Notes Series 2014-1, and it sells the interest only-strip on the MSRs. When OASIS priced, it was undersubscribed by investors, showing the market still has some trepidation.
Selling of the interest-only strip of the MSR to the REIT as a form of financing is likely to gain some momentum this year. It’s a great option for nonbanks to get liquidity without diminishing the ownership and yet use the opportunity to make money.
Rubin explains that the option means the servicer doesn’t create a taxable event “and secondly they still have an asset that can potentially grow. On the chance that the asset did get smaller they are not stripping out the whole value of the banks hold if that happens.”
Nationstar Mortgage through its REIT Newcastle Investment Corp. has sold “excess mortgage servicing rights.” Nationstar buys the MSRs, and then services the underlying loans. The Lewisville, Texas-based mortgage company is owned by Fortress Investment Group which shares a chairman, Wesley Robert Edens, with Newcastle. Nationstar did not return emails to confirm if, like Ocwen, it also sold the I/O strip off of MSRs.
However, David C. Stephens, COO/ CFO at Denver-based United Capital Markets, said that while Ocwen and Nationstar have each sold “strips out of a piece of the mortgage servicing rights and sold it to the REITs that they control,” they could also opt to sell that IO strip to other owners.
UCM provides innovative risk management services to institutional clients, primarily hedging investments in mortgage servicing rights.
The company provides risk management services to companies ranging from a few 100 million to over 100 billion in notional MSR balances.
Ocwen did not confirm if, in its latest sale mentioned earlier in this story, it would sell the strip to another owner.
“This option of financing will continue and grow,” said Stephens. “It’s a type of financing of the MSR, helping nonbanks to leverage their MSR investments.”
Rubin said that borrowing on the IO strip means that the servicer won’t create a taxable event. “There are people who are using it as collateral to get money and there are people using it to raise money, and investment houses buying this stuff who don’t have servicing capabilities and the servicing stays with the selling party.”
Such is the case with Two Harbors. The REIT said during its 4Q2013 earnings call in February that it increased its mortgage servicing rights assets to $514 million at year-end from approximately $16 million as of Sept. 30.
In late December, the REIT announced a substantial bulk MSR deal with Flagstar Bank with an unpaid balance, principal balance of $40.7 billion. This bulk deal consisted of Fannie and Ginnie production with largely post-2010 production. Flagstar will provide the ongoing sub-servicing for the mortgages. “This raise then represents an exciting step towards building a meaningful MSR portfolio and it aids greatly in our hedging to both interest rate and mortgage basis risk,” said William Roth, chief investment officer of Two Harbors, during the February earnings call.
The REIT also has a three-year flow arrangement in place with PHH Mortgage. Under the arrangement, Two Harbors will purchase 50% or more of PHH’s MSR on new origination production, subject to pricing terms and agency approvals, with PHH providing the sub-servicing.
PHH announced during its 4Q2013 earnings call that along with the sale of MSRs to Two Harbors, it is also planning a MSR funding vehicle. Glenn Messina, president and CEO of PHH, said during the call that secured funding could be applied for MSRs relating to post-2009 loan origination that would essentially mimic an I/O strip or the servicing fees associated with those MSRs.
Roth said that the REIT plans to continue its acquisitions of mortgage servicing rights through relationships like PHH or through the bulk acquisitions, like Flagstar. The REIT said that it’s eyeing “other midsize and small originators.”
REITs don’t buy servicing directly because it’s an “active” real estate investment income. Roughly 90% of REIT income must be “passive” real estate investment income. The IO strip is passive because the owner has no direct obligation to service the mortgages. REITs have owned MSRs in the past (it was done in the 1990s by Capstead through its subsidiary called Capstead Mortgage Corp.), but it had to be limited to 10% or less of their income. “They don’t want to risk disqualifying REIT treatment because income is only taxed at the shareholder level,” said Stephens.
ENTER THE MINI-CORR
Another trend emerging, according to Rubin, is companies that are coming up with “other capital structures” and luring in brokers and correspondent lenders to join them, the so-called mini-correspondent space.
Trade groups representing mortgage brokers argue there are risks of effectively becoming mortgage bankers that most brokers don’t fully appreciate.
On Oct. 28, 2013, Green Tree Correspondent and Wholesale Lending announced that it added a mini-correspondent delivery option for smaller correspondents and mandatory delivery options for larger customers. These mandatory delivery options include flow-forwards and live trades, and will allow Green Tree to be a full-service conduit for their correspondent customers.
The company said that it had added “MSR acquisitions to those options, bringing the experience of the whole loan acquisition team together with a servicing platform.”
Green Tree is a wholly owned subsidiary of Walter Investment Management Corporation, which acquired Ally Bank’s business lending operation and now operates as Green Tree Correspondent.
