The concept of a “fee for services” model, including a flat cash payment, has been kicked around for the past 10 years, but is finally gaining traction as the mortgage industry and regulators look for a better way to compensate residential servicers.
As for what ultimately will be decided, no one knows. In fact, in the end very little may change regarding the minimum 25 basis points paid to Fannie Mae and Freddie Mac servicers.
But for now, servicing compensation is the hottest topic in the processing industry with regulators—the Federal Deposit Insurance Corp. in particular—pushing the issue.
If a fee for services (FFS) model is adopted that means servicers will be paid on a sliding scale based on the quality and performance of loans. The servicer’s fee would increase as a loan moves from 30 days delinquent to 60 days delinquent and back down again if the loan is cured.
Several large banks are attracted to this idea because it would give them cash in hand, while eliminating the risk and costs involved in hedging MSRs. (Banks, already, are wary of coming Basel III capital rules that cap how much MSRs can count toward core capital. The rule might force some to dump their MSRs in a weak market.)
While the FFS concept is just one idea being bandied about, there is little in the way of details. “A full-blown proposal has never been placed on the table,” said one servicing advisor. He noted that it’s unclear whether such an approach would alleviate the obligation of servicers to make advances on delinquent loans — a feature that would be very attractive to nonbank servicers.
The Mortgage Bankers Association (MBA), whose members rely heavily on servicing income for their profits, is taking on this task of developing the FFS model as it explores several options to revamp compensation. Trade group president John Courson noted that servicers have been compensated out of the interest rate of a mortgage for the past 50 years. “We are going to restructure the economics of mortgage servicing and that’s huge,” Courson declared at the end of a recent MBA summit on the issue.
“The current model doesn’t work in times like this,” he said. “It has put a lot of risk on servicers’ balance sheets.”
Panelists at the MBA conference were quick to point the shortcomings of the current compensation model, including the financial strain of making advances on millions of delinquent loans. “Advances always have been a sword hanging over the servicer’s head,” said Richard Dorfman, managing director of the Securities Industry and Financial Markets Association (SIFMA). He told the MBA meeting that moving to a “fee for services” approach would be acceptable to the TBA (to be announced) MBS market.
But the SIFMA managing director noted that advances are critical to securitization structures and the government should consider providing a backup for such advances.
Another Wall Street veteran, Tom Deutsch, executive director of the American Securitization Forum (ASF), expressed concerns that a FFS model might produce a “tiering” of servicing fees based on the performance of prime and nonprime loans. “One of the keys for investors is the simplicity of the structures,” he said, adding that it doesn’t have to be the same, but it must be simple. (Deutsch, like others, noted that advances are “necessary and critical” to investors in MBS.)
The ASF executive director said nonbank servicers have faced challenges in accessing credit lines for advances during the financial crisis. But improvements have been made in reimbursing servicers for loan modifications on a timely basis.
“I think there are still additional tweaks nonbanks would like to make to servicing advances. But by and large, I think it is a structure that over time will survive,” Deutsch said.
Other compensation options under consideration involve a zero or minimum servicing fee of 5 to 10 basis points. Also on the table is an alternative servicing fee where the servicer retains a 1% principal and interest strip, as opposed to a MSR that is an interest-only strip.
A few years ago there were discussions about adopting an alternative servicing fee structure, according to Fannie Mae senior vice president of capital markets Andrew BonSalle, but the idea was scraped when the financial crisis struck in 2008.
“A P&I strip has less volatility, less cost to hedge, and is pretty well supported among most stakeholders,” BonSalle said.
Ginnie Mae president Ted Tozer noted that the traditional servicing fee is important in transferring servicing—and appeared to raise concerns about a zero or minimum serving fee. He said it could become difficult to transfer servicing rights from a troubled mortgage banker if there is no readily available income stream for the new servicer.
A servicing broker who counts Fannie and Freddie among his clients told National Mortgage News that maintaining a 25 basis point minimum servicing fee gives seller/servicers “skin in the game.” He noted that it provides the GSEs “something they can hang over the head of the servicers.”
As for when the MBA might unveil an FFS proposal, that’s an open question. The trade group has not yet offered a time table. Courson said that by mid-March, he wants to “take the temperature to see where we are.”
Meanwhile, the Federal Housing Finance Agency last week directed the GSEs to work on a new servicing compensation system, which complements MBAs initiative.
“We are really happy...that Fannie, Freddie and Ginnie are doing the same thing. I have talked with them,” Courson said. “And we are right on point with them on what we need to work on.”