When the Federal Housing Finance Agency (FHFA) announced its interest last week in overhauling how servicers are paid, it didn't provide much in the way of public detail.
But particulars are starting to trickle out from discussions Fannie Mae and Freddie Mac have held with various constituencies.
In an FHFA-hosted meeting with analysts on Tuesday, Fannie and Freddie officials laid out four possible changes to the 0.25% servicing fee that has long been the foundation of servicer pay, according to people with knowledge of the discussion.
The smallest step, cutting the fee in half, would reduce the size of mortgage servicing rights by more than 50%. This would alleviate the capital constraints that servicing-heavy banks now face from coming international capital standards, but leave the general structure of industry pay in place.
A second option is lowering the fee to a nominal amount, perhaps as low as three basis points. Below even the largest servicers' cost of servicing a performing loan, this could be expected to wipe out MSRs entirely, eliminating the need to hedge and hold capital against them.
A third possibility is to completely scratch a basis-point servicing fee structure, replacing it with a per-loan stipend or payment for specific services rendered. This approach would mimic the already existing pay model for subservicers.
Finally, the GSEs raised the possibility of replacing a basis-point structure with an alternative minimum servicing fee, in which the servicer would have a 1% stake in the principal of the loan being serviced. Pushed by some servicers in the second half of the last decade, this idea was neglected as the industry fell into disarray during the crisis.
Those options resembled ideas floated at the Mortgage Bankers Association's (MBA) summit on mortgage servicing last week.
Given the nature of the invitees to the analysts meeting, most of the discussion dealt with the effect of any changes on the market for Fannie and Freddie-guaranteed securities. The GSEs stressed that whatever changes occurred would have to be acceptable to investors and maintain liquidity in the marketplace.
The drive to change servicing fee structures stems from two separate motivations. One is the Basel Committee on Banking Supervision's coming restriction on valuing "intangible" assets such as mortgage servicing at above 10% of a bank's overall capital, a change that could potentially put many servicing-heavy banks into a regulatory capital squeeze.
The other is the perception that servicing fee structures have made it harder to address the housing crisis. Because servicers get most of their income from performing loans, and book the profit from servicing at the time of a loan's origination, critics have argued that they invested less money and effort into dealing with troubled loans than they otherwise might have.
"The current model has not motivated mortgage servicers to invest the time, effort and resources needed to fully explore all options to help delinquent borrowers avoid foreclosure," Treasury Secretary Tim Geithner and U.S. Department of Housing and Urban Development Secretary Shaun Donovan wrote in a joint letter to the FHFA last week.
"There appears to be a pretty powerful consensus among the regulators that they don't like the basis-point servicing structure," said Jeff Naimon, an attorney for BuckleySandler.
The FHFA declined to discuss potential options with American Banker beyond its initial statement that it is seeking to cooperate with all interested parties in an effort to replace the 25 basis point model sometime after 2012. It is expected that FHFA Chief Ed DeMarco will address servicing fee structure issues at the MBA's servicing conference next month, providing a fuller view of various options.
The most obvious ramification of the initial proposals is that they would at the very least reduce the impact of international regulatory restrictions on what portion of a bank's capital may be tied up in "intangibles" such as servicing rights. This could prove a significant boon for banks with a heavy concentration in servicing, among them giants like Wells Fargo and Bank of America Corp. But which entities would gain or lose the most from changes to the basis-point fee structure is still unclear.
None of the proposals, by themselves, would necessarily diminish how profitable it is in the aggregate to originate and service a mortgage. Because banks book servicing revenue at the time of a loan's origination, the line between origination and servicing income is often viewed as hazy. Conceivably, lost servicing revenue could be compensated for by either higher market prices for loan production or richer compensation for performing specific services in relation to a mortgage.
"I don't think this changes the economics for servicing," said Bose George, an analyst for Keefe, Bruyette & Woods, who has been following the servicing fee discussion. "It should be more cash up front, less MSR. which would align cash [income] and GAAP [accounting practices] a lot better. And there would be less capital tied up [by MSRs], so it's a very important issue for the mortgage banks from that perspective."
Though the reduction of MSRs' importance would be good for the mega servicers, George said, It is possible that a servicing fee structure change could create openings for more competition in the industry, something regulators have said they want to see.
"If you don't need to have a huge MSR amount tied in servicing, it should open it up to efficient, high-touch processing companies," he said.
But other observers, including Naimon, worried that changes to the structure could have unintended consequences or put some institutions at a competitive disadvantage.
"I was on the phone with bankers at a community bank in Maine," he said. "Their average loan size is $60,000, and if you were to pay them 10 basis points on that, that doesn't pay for anything. There are some issues with just ratcheting [basis point fees] down to a really low level."
"I'm just wondering whether this will further put pressure on [servicing costs controls]," Naimon said. "so you have to be the low-cost servicer, which favors the big-box servicer."
How the industry would adjust to changes in servicing fee structure was a significant topic at the MBA's one-day conference last week in Washington.
As moderator of a panel on "Secondary Market Perspectives," Garry Cipponeri, the head of capital markets for JPMorgan Chase's home finance division, laid out a set of options very similar to the ones mentioned in the GSEs' talk Tuesday.
Some members of the panel suggested that a greater focus on paying for specific services provided in relation to troubled loans would be essential for both GSE securities and the still-moribund private-label market.
Robert Lee, a senior vice president of the Mortgage Industry Advisory Corp., argued that the industry should at least reduce its reliance on a basis-point fee, which "front-loads" profit and makes responding to distressed loans a money-losing proposition.
Richard Dorfman, head of the securitization group of the Securities Industry and Financial Markets Association, seconded that point and suggested a larger role for loan-specific payments.
"The investor or other party compensates the servicer for services rendered," he proposed. "That way the servicers have some significant chance of varying in their quality and intensity, and that's what you pay for."
Whatever changes occurred would have to pass muster with investors in mortgage-backed securities. On the MBA panel, Ginnie Mae president Ted Tozer said that any changes made to servicing fee-structure should not harm the liquidity of the ultimate securities produced — or the ability to shift one servicer's responsibilities to another.
"Our concern is that the fee is high enough that if we're required to move the servicing that there's enough revenue there to move the servicing," Tozer said.
At least as of now, investors do not appear to have taken a sharp public position on what, if any, concerns or desires they might have for a servicing fee revamp. In the past, some have raised concerns that lowering servicing fees would induce banks to "churn" their portfolios by aggressively selling mortgages to their current servicing customers.
But several sizable government-backed mortgage securities investors told American Banker they expected there would be little fallout in the market for securities and others said it was simply too early to know the significance.
"Of all the things that I'm worried about, this is not on the list at all," said Scott Colbert, the fixed-income director at Commerce Bancshares' Commerce Bank. "We'll deal with any changes they make in terms of the prepayments going forward."
But other investors and analysts said that they expected any shift would be significant for the market.
You do have to pay some price on the [forward mortgage-backed securities market] side — there will be some liquidity loss," George said. Though it could certainly be manageable, George said, "this would be a big transition."
But George and others said it increasingly looked like such a change would take place. The combination of the Basel committee's international capital regulatory restrictions on MSRs and the crisis in the servicing industry has created the momentum for a change, said Andrew BonSalle, a Fannie senior vice president in charge of capital markets and one of the speakers on the MBA's panel on servicing fees.
"It feels like there's a lot more support for us looking at a different structure today," BonSalle said. Changing, he said, offers the prospect of "better service to the consumers, and reducing risk to the servicers through reducing the MSR asset."