Monthly Archives: January 2015
2015: The Year to Refine Mortgage Servicing Rights Retention Strategy
Jan. 13, 2015–Fleig, David
(David Fleig is president and CEO of Morvest, Houston, an investment firm focused on providing capital and strategic solutions to mortgage bankers. MorVest arranged long-term mortgage servicing rights credit facilities for a number of mortgage bankers in 2014; its Analytics Division provides MSR valuations and brokerage services for mortgage banking clients. For more information visit www.MorVestCap.com and/or reach him at DFleig@MorVestCap.com.)
Following the financial crisis and for the first time in nearly two decades, it has again become compelling for independent mortgage bankers to retain mortgage loan servicing rights. It is useful for mortgage bankers to understand both the reasons for and the opportunities inherent in the current environment.
Let’s start with the recent developments favoring MSR retention. Due to an attrition of competition and the contraction in mortgage lending by the majority of the big bank “aggregators”, cash margins in the mortgage industry became historically high for a few years, peaking in 2011 through early 2013. Contributing to the significant aggregator contraction was the Basel III international banking accord, which contains harsh capital treatment for MSRs exceeding certain capital thresholds.
When the big aggregators began to pay their correspondent lenders significantly less in terms of servicing release premiums, many of the mortgage bankers with GSE Seller/Servicer approvals seized the opportunity to retain MSRs rather than give them away for significantly less than fair value.
During this period of fat cash margins mortgage bankers could forgo the SRP and retain the MSRs without creating a liquidity crunch. GAAP accounting rules provide for the capitalization of retained MSRs with a credit to current earnings, so net income doesn’t suffer as the result of retaining MSRs. And the really sweet bonus is that the income associated with MSR retention is backed out for Federal income tax purposes.
However, despite the compelling economics and tax treatment, a meaningful percentage of mortgage bankers eligible to retain servicing did not choose to do so. That was perhaps because the industry is a “generation” removed from most mortgage bankers owning MSRs and due to staffing requirements related to performing the servicing responsibilities (solved by most by hiring a subservicer). Also a concern for some is that MSRs are a volatile asset with impairment charges hitting current earnings if mortgage rates decline significantly.
Then things really changed. Comments by then-Federal Reserve Chairman Bernanke in April 2013 that quantitative easing was coming to a close rocked the bond market and cash margins in the mortgage business contracted significantly back to, or below, long-term historical averages. Consequently, independent mortgage bankers (those not affiliated with a bank) wishing to retain MSRs going forward were faced with potentially significant liquidity concerns, a condition which persists today.
Firms dedicated to building an MSR portfolio addressed this liquidity issue by seeking financing for their MSRs; although to date, only a handful of banks have stepped up to provide such facilities. Nonetheless, borrower demand was met in a meaningful way in 2014 as quite a few companies were able to close on credit facilities secured by a pledge of their MSRs.
During 2014, we saw a number of mortgage bankers come to realization that best execution continues to mean selling direct to the GSEs and retaining MSRs, and these firms have begun to execute on this strategy. Most firms already well into retaining MSRs coming into 2014 have continued to aggressively retain MSRs and look to do so in 2015.
Now, for the important question: If you are still sitting on the fence regarding MSRs, have you missed the opportunity? No, not in our opinion! However, a number of important things should be addressed to maximize the opportunity for success. These include:
• Refine your best execution strategy. All MSRs are not created equal in terms of market value; loan size, product type, term structure and geography influence values among other variables. Seek assistance from a qualified advisor.
• Decide which GSE(s) you want to deal with as an MSR owner. FNMA, FHLMC and GNMA all approach the pledge of MSR differently and the required acknowledgement agreements (tri-party agreement between the mortgage banker, the MSR lender and the GSE) can be a major impediment to securing the financing. FNMA as been the most “user friendly” to date. You should know this world is in flux as we enter 2015, with financing against GNMA collateral very difficult to obtain at the close of 2014.
• Hire a subservicer. However, understand that subservicing is not “high touch” and you must have on staff at least a few folks with servicing expertise to monitor the subservicer and supplement their efforts. Seek to retain control over placement of your custodial cash balances (some subservicers insist on controlling where escrow funds are on deposit).
• Arrange financing. Focus on obtaining a facility that permits you to draw funds as needed over the next year or even longer before the loan “terms out”. Avoid facilities that mature in one or two years in favor of one that better matches the duration of your MSR asset. Don’t bet your business on some bank renewing a facility, regardless of how attractively priced the money appears to be. What if that loan offer leaves or the bank is purchased by an entity not interested in MSR lending exposure?
Finally, carefully review the margin call provisions of the MSR loan agreement and seek a bit of cushion before a cash payment would be required.
The return to MSR retention strategies signals the reconstruction of a 360 degree mortgage banking ecosystem, arguably the most sustainable and ultimately the least risky model for the industry. Participating mortgage bankers can expect some short-term challenges, but they will also experience benefits with long-term potential, not the least of which is access to capital resources to support growth and weather the ebbs and flows of business. It is worthwhile to learn more about these new opportunities.
In a subsequent contribution here, we will take a more in depth look at these strategies for success in MSR retention, including the role played by analytics in plotting a course.
(The views expressed in this article do not necessarily reflect policy of the Mortgage Bankers Association, nor does it connote an endorsement of a specific company, product or service. MBA NewsLink welcomes your submissions; articles and/or Q/A inquiries should be sent to Mike Sorohan, editor, at firstname.lastname@example.org.)
© 2013. MorVest Capital.