The GSEs are looking at how to better align servicing fees with the servicer’s cost structure and how to create a servicing asset that is more capital friendly under Basel III.
The servicing disconnect is yet another issue that the housing market needs to sort out if mortgage lending is to take off in a meaningful way again.
"We actually believe that there is consensus on the fact that the mortgage servicing fee structure is inappropriate for the current environment," Amherst Securities Group (ASG) wrote in a research report.
According to analysts, the best way forward might be through lowering fees on performing loans and raising fees on nonperforming loans in a way that safeguards the interests of investors as well as provides the correct set of incentives for servicing nonperforming loans.
Under the current system, servicers collect a minimum percentage of the loan balance annually, paid out of the interest stream. The servicers are paid 25 basis points regardless of the loan. If they make loans to lesser-quality borrowers, they pay 25 basis points as they would be making loans to top-quality borrowers.
"What they have found is that at the lower end the fee isn't enough and at the higher end the fee may be too much," a market analyst said.
ASG analysts reported that that the current 25 basis points fee on a $250,000 loan garners $625 per year or $53 per month per loan.
One servicer the analysts spoke with estimated his costs of servicing a performing loan at $4 per month or $48 per year. By contrast, the costs of servicing a nonperforming loan were about $900 per year.
"The cost of servicing has gone up, both from a primary servicer and special servicer side of the equation," a market source said.
The current system also created a mortgage servicing right (MSR) asset that is difficult to manage; and that will become even more difficult to manage, particularly for large banks under Basel III. MSRs, ASG analysts said, are part of the goodwill and intangible component of shareholders.
"MSRs are very volatile, and there are times when liquidity can dry up, making the MSRs difficult to value, " analysts said.
They said that the bank regulatory authorities outside the U.S. were against any part of this component counting toward Tier 1 capital and their institutions do not hold MSRs. The U.S. banking regulators said that MSRs may be volatile, but clearly have value.
Basel III allows MSRs to be recognized only up to 10% of the common equity component of Tier 1 capital but this pending 10% may prove to be an upper bound for many financial institutions, the ASG analysts said.