Lenders that also service mortgages face tough capital decisions
December 28, 2018 1:46 PM
Nonbank mortgage servicers must gear up to meet new secondary market requirements and make some tough decisions about whether to buy, sell or hold MSRs as they head into 2019.
Drawing on her years of experience consulting with mortgage bankers on how best to finance their originations and operations, MorVest Capital Executive Vice President Ruth Lee addresses some of the tough questions the industry is facing when it comes to cash flow and costs. Her remarks have been edited for length and clarity.
Drawing on her years of experience consulting with mortgage bankers on how best to finance their originations and operations, MorVest Capital Executive Vice President Ruth Lee addresses some of the tough questions the industry is facing when it comes to cash flow and costs. Her remarks have been edited for length and clarity.
As an MSR financing consultant, can you share your views on how best to make decisions about whether or not to hold onto, sell or finance mortgage servicing rights?
If you have not been holding onto your MSRs, you've missed out on an opportunity to hold onto an asset that is a clear hedge against an origination decrease. If you sell, you'll have the cash in your hand, but once those MSRs are gone, they're gone. If you haven't been holding them, hopefully you've been leveraging them because it's really cheap money you can use to buy more MSRs.
You also need to make sure you are rightsizing your portfolio, though. What are you good at? If you're not great at Ginnies, you don’t want to hold as many, especially if delinquencies are on the rise. You also need to be looking at your tax treatment associated with keeping versus selling.
You also need to make sure you are rightsizing your portfolio, though. What are you good at? If you're not great at Ginnies, you don’t want to hold as many, especially if delinquencies are on the rise. You also need to be looking at your tax treatment associated with keeping versus selling.
What's one significant development we could see in MSR financing next year?
We will have Mark Calabria from the Cato Institute at the FHFA. That means GSE reform will lean heavily toward privatization.
Then you have Freddie testing MSR financing to gain market share. It puts them at cross purposes. Think about the risk there. The entity that is asking lenders for repurchases is also holding their MSR financing. It's an interesting wrinkle. I would imagine Calabria would say let's go closer to the charter than some of these bolder steps that Freddie is taking. In the short term, we are where we are, but in the long term, MSR financing is one of the areas that could increase taxpayer risk.
Everything that would be related to isolating the taxpayer from risk could be on the table next year. The reality is I don't know if FHFA will ever be able to get anything done with GSE reform. You have to talk about in case it happens, but I think it's unlikely.
Then you have Freddie testing MSR financing to gain market share. It puts them at cross purposes. Think about the risk there. The entity that is asking lenders for repurchases is also holding their MSR financing. It's an interesting wrinkle. I would imagine Calabria would say let's go closer to the charter than some of these bolder steps that Freddie is taking. In the short term, we are where we are, but in the long term, MSR financing is one of the areas that could increase taxpayer risk.
Everything that would be related to isolating the taxpayer from risk could be on the table next year. The reality is I don't know if FHFA will ever be able to get anything done with GSE reform. You have to talk about in case it happens, but I think it's unlikely.
What change in the credit outlook for mortgages is most likely to surprise servicers and MSR investors in 2019?
At the end of the day credit quality drives delinquency, and delinquencies drive the valuation on your MSRs. You're already hearing from the agencies that they are thinking about tightening the credit box. We have some pretty high DTIs that are able to flow through Ginnie for a really long time.
In some of the Ginnie pools that we've looked at FHA streamlines and VA IRRLs are coming in with really low FICOs. It's not all of the pools, but there are some, and it's one of the reasons Ginnie really tightened up on churning, and the VA began requiring proof that there is a net tangible benefit when borrowers refinance.
That should siphon off a number of borrowers to the non-QM space if they can afford it. Non-QM is for borrowers who can afford to be different than the credit box the agencies have, and they can afford it by taking up a higher rate.
In some of the Ginnie pools that we've looked at FHA streamlines and VA IRRLs are coming in with really low FICOs. It's not all of the pools, but there are some, and it's one of the reasons Ginnie really tightened up on churning, and the VA began requiring proof that there is a net tangible benefit when borrowers refinance.
That should siphon off a number of borrowers to the non-QM space if they can afford it. Non-QM is for borrowers who can afford to be different than the credit box the agencies have, and they can afford it by taking up a higher rate.
What are some other risks that nonbank servicers are in danger of overlooking?
I think everybody is pretty clear about where the risks are. There are a couple of question marks. From a regulatory standpoint, for example, we are in a state of flux. We have some new people at the helm who are making different decisions and deciding where and how enforcement is really going to land.
The least efficient way we could go about regulating is to have 50 different rules, and some states have definitely decided to put some new ones on the books, so they are going to play a pretty substantive part in regulating.
At the same time, you have the continued risk of a recession. Also Ginnie has sent out some pretty clear messages regarding their new liquidity requirements, and the FHFA has telegraphed that they are going to be requiring all of the agencies to look at their counterparty risk more closely.
The least efficient way we could go about regulating is to have 50 different rules, and some states have definitely decided to put some new ones on the books, so they are going to play a pretty substantive part in regulating.
At the same time, you have the continued risk of a recession. Also Ginnie has sent out some pretty clear messages regarding their new liquidity requirements, and the FHFA has telegraphed that they are going to be requiring all of the agencies to look at their counterparty risk more closely.
Servicing increasingly requires economies of scale and more lenders are selling MSRs and working with subservicers. Could that be a concern next year?
The name of the game in servicing is cost to service. How do you reduce your cost to service? You do that through economies of scale. A lot of nonbank lenders would like to figure out how they can get into the servicing game and not use subservicers.
But at the same time, given the capital requirements, the licensing and the compliance that a subservicer has to take care of, your regular servicer who is not doing billions and billions of dollars of servicing usually has to have access to a quality subservicer instead.
You do have banks and other entities with small servicers, but those servicers are limited. They may only service Fannies or in their local footprint. People who have a subservicer and don't really pay attention are making a mistake. They have to remember they still own the compliance and the loss. They have to remain very close to what their subservicer is doing, particularly given that we are seeing consolidation among subservicers.
But at the same time, given the capital requirements, the licensing and the compliance that a subservicer has to take care of, your regular servicer who is not doing billions and billions of dollars of servicing usually has to have access to a quality subservicer instead.
You do have banks and other entities with small servicers, but those servicers are limited. They may only service Fannies or in their local footprint. People who have a subservicer and don't really pay attention are making a mistake. They have to remember they still own the compliance and the loss. They have to remain very close to what their subservicer is doing, particularly given that we are seeing consolidation among subservicers.
