At the recent Mortgage Bankers Association National Secondary Conference & Expo 2005 held in San Francisco, one of the hot topics was the right level for minimum GSE servicing fees. Although no GSE representatives were present - as neither Fannie Mae nor Freddie Mac has formalized its stance on whether to reduce the 25 basis point minimum servicing fee - discussions centered on the differences between the required servicing fee for prime and private label MBS.
Diane Pendley, a managing director in the operational risk group at Fitch Ratings and a panelist at the MBA conference, said that although there is no direct correlation between GSE minimum servicing fees and servicing fees in private securities, many of the same seller/servicers participate in both types of products. Some of the biggest proponents for servicing fee reduction operate on economies of scale, which reduces individual unit cost.
"Most of the servicers who have spoken to us regarding the reduction of servicing fees are in the prime areas," Pendley said. "This product is less costly to service and is typically seen in larger portfolios." On the other hand, subprime mortgages, which are typically smaller loan sizes, may be found in more specialized and often smaller portfolios. Furthermore, although there may be subprime product in the portfolios of larger servicers, this usually makes up less of a percentage.
In the GSE product the loans are more homogenous, but the variety of products in the private-label securities is one of the reasons why some feel a single minimum servicing fee would not apply. "The GSEs could be reasonably assured that there would be a market for their servicing portfolios, should the need arise, and almost every servicer understands this product," said Pendley. This is in contrast to private securities "where you have a wider band of loan types and asset quality. You need to be reasonably assured that qualified servicers will have an adequate fee stream to entice them to take on an existing portfolio should it become necessary."
Pendley added that servicing needs are driven by several factors, including the complexity of the product, the servicing cost, and the loan's default probability. "As defaults increase, obviously the cost of servicing in subprime increases by a higher margin compared to prime collateral." She added that Fitch, as part of its analysis, tries to anticipate the servicing costs as a transaction matures into its third or fourth year when much of the deal may have paid off, the collateral that is left is moving into higher non- or sub-performing status, and/or the loan programs call for additional adjustments or monitoring. "Servicers are expected to plan ahead what fees they will need to cover the later part of a transaction, considering that it would cost more to service the deal after the first two years," Pendley said. She said that it would make sense to incorporate both sides of the argument - for lowering or maintaining current minimum servicing fees - depending on the product in the transaction, or by working out a formula where lower fees are charged during the initial part of the deal, with fees gradually increasing as the transaction reaches its peak, although this might be more complicated in terms of reporting and accounting.
The determination of adequate servicing fees gets more difficult with the recent influx of new products. Pendley said that for many of these new affordability products there is less history in terms of their potential to default, prepayments, or borrower participation in available choices, and that it would therefore be harder to determine adequate fees to compensate for servicing these loans over time. In addition, for instance, in servicing option ARMs, not all servicers have the systems in place to handle this collateral type, and this could restrict the transferability of the loans.
Pendley added that although there are typical servicing levels established for all existing product types, Fitch still looks at transactions on a case-by-case basis. Some deals on the prime side have had as little as 20 basis points in servicing fees, although most fixed-rate prime deals still carry a 25 basis point servicing fee, and prime ARM deals, which are costlier to service, typically see a servicing fee of about 37.5 basis points. It is difficult to say whether any of these deals could possibly get done with a12.5 servicing fee, which is the level proposed by some market players for the GSE product. However, if fees are materially lowered, it is expected to only be in the highest credit quality, larger balance, and standard products, Pendley said.
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