Ocwen Financial’s regulatory woes are creating further uncertainty about bonds backed by receivables for the funds that mortgage servicers advance to investors, once considered a promising asset class

Sales of these bonds, which have helped fund purchases of servicing rights from banks by Ocwen, Nationstar Mortgage, Select Portfolio Servicing and others, have stalled since Standard and Poor’s decided to revise its approach to rating deals.

One of the most recent rated transactions came from New Residential, which sold $1.8 billion in March via a pair of deals managed by Bank of America, Credit Suisse, and Morgan Stanley. The deal followed its purchase of $3.2 billion of servicing rights from Nationstar Mortgage in December.

Since April, when S&P announced that it would be evaluating its ratings methodology, servicers have had to rely on unrated deals and other kinds of financing, such as variable rate notes and unrated securitizations.

On June 18, Home Loan Servicing Solutions [HLSS] issued its first unrated deal, a series of four-year notes.

According to Hunton & Williams partner Tom Hiner, who has advised on a number of such transactions, issuance for 2014 stands at approximately $4 billion, $2 billion of which has been done on an unrated basis.
S&P published a new methodology on Oct. 31, and will review the impact on existing deals that it rates over the next six months.

The latest blow to the asset class comes from New York’s top banking regulator, which claims that Ocwen sent more than 6,100 borrowers notices of possible foreclosure only after their payment deadlines had passed. The systems failures that Ocwen outlined previously as “isolated” are much greater in scope than what the company had previously disclosed, according to Benjamin Lawsky, superintendent of the state’s Department of Financial Services.

The crackdown will likely put a chill on future sales by banks to nonbanks. Lawsky had already put Ocwen’s purchase of $39 billion in mortgage-servicing rights from Wells Fargo on hold, indefinitely. Now there’s concern that the other deals could be affected as well.

“It will be hard for Bank of America, Wells or JPMorgan [Chase] to not only sell to Ocwen, but to Nationstar [Mortgage Holdings], or the smaller servicers like Specialized Loan Servicing, too,” said Abhishek Mistry, an analyst at J.P. Morgan Securities.

Nonbanks service approximately 74% of private label mortgage securitizations by loan count compared with 48% 10 years ago. As of June 30, 2014, the top five nonbank servicers are Ocwen, Nationstar Mortgage, Select Portfolio Servicing, Green Tree and PHH Mortgage account for 64% of non-agency servicing, according to a Sept. 16 Fitch Ratings report.

Nonbank servicers still expect as much as $2 trillion in mortgage servicing rights to trade hands in coming years because banks face tough new Basel III capital requirements. International policymakers expressly crafted banking accords that would force banks to move those assets off their books. U.S. banking regulators adopted those rules.

But the now year-and-a-half-long deluge of servicing rights to nonbank buyers has unnerved U.S. consumer protection regulators, so sales have slowed to a trickle.

“Mid-size and large servicers have been financing acquisitions, mostly of chunks of servicing rather than entire business servicing portfolios, through advance financing facilities,” said Hiner.

“We’ve also seen smaller servicers, acquiring pieces of smaller portfolios, mostly Fannie, Freddie and Ginnie servicing, finance through loans secured by MSRs mostly provided by private equity lenders, but these acquisitions have not been financed as much through advance facilities,” he said.

Mortgage servicing is a capital intensive business. Servicers don’t just collect interest and principal payments and distribute them to holders of mortgage-backed securities; they also advance funds to investors when borrowers miss payments. These advances are eventually reimbursed, but it can take months, and in some cases years. 

Nonbanks need access to the capital markets to fund advances because, unlike banks, they do cannot rely on cheap deposits.

So even if banks stop selling servicing rights, nonbank servicers will need to refinance existing securitizations. Since HLSS sold its unrated deal in July, two of its previously issued deals totaling $550 million have reached their expected maturity. The first deal (HSART 2013-T4) was expected to mature on Aug. 15, according to a report published by Barclasy that month, and the second (HSART 2013-T6) on Sept. 15.

HLSS stated in a second-quarter regulatory filing that it would need to either refinance its existing bonds backed by servicer advance receivables or draw on its variable funding notes (it had over $1.7 billion of available capacity as of July 2014) to pay off the two series of ABS.

And in August, Barclays published a report saying that HLSS had recently discussed engaging other rating agencies to rate its servicer advance ABS deals, suggesting that the company was at least considering tapping the ABS market with a rated transaction over the next several months.

Almost $4 billion in renewals have also been executed this year via bank financing, but some of these assets could eventually turn up in fully rated term ABS issuance, now that S&P has revised its methodology, according to Hiner.

S&P revised its ratings criteria because it was concerned that its existing methodology did not adequately reflect the potential for extended timelines on advance reimbursements, the liquidity risk of the notes under stressed conditions, and the servicer’s ability to continue advancing based on its credit quality. It has extended reimbursement timelines for advance receivables based on historical loan-level performance data. Timelines are further adjusted based on the actual recent experience of the servicer in recouping advances.

The new methodology also includes a more stringent liquidity reserve requirement for each series of servicer advance ABS that is dependent on the geographic diversification of receivables in the master trust, according to a Barclays report.

Haircuts will be applied against advance receivables that do not have a general collections backstop, as well as receivables that do not have a first- in/first-out reimbursement policy. However advance receivables that benefit from a general collections backstop are assumed to be fully recoverable under all scenarios.

The ratings agency also capped weighted-average advance rates across each ratings category.
In August, the rating agency said that the changes could result in upgrades for potentially 20% of the servicer advance deals that it rates and downgrades for another 30%. The average movement in ratings is expected to be one to two ratings categories; deals with high fixed-rate coupons or those with floating-rate coupons would likely be most vulnerable to downgrades.

Historically, S&P has been the most involved in the rating of servicer advance securitization. “That means they have the most developed criteria on the asset class,” said Rudene Haynes, a another partner at Hunton & Williams.

"It’s not terribly surprising that when they issued a moratorium on ratings, that really put a dent on the rate of issuance of rated advance receivables backed term ABS.”

Matt Scully contributed to this article.

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