WE’RE HEARING the word optimism can be used in the same sentence as “mortgage servicing rights” again.
That’s right. With housing markets starting to recover and credit quality strong on newly minted loans, people who retain mortgage servicing rights are starting to feel good again. And it’s boosting the market value of the servicing asset, on bulk as well as flow deals.
That’s good news for many of the executives gathering in Dallas this week for SourceMedia’s seventh annual mortgage servicing conference.
Mortgage Industry Advisory Corp. noted that servicing rights on mortgages with over a half trillion dollars in notational value changed hands in the last quarter of 2012, a good indication that demand is strengthening even as some large companies—Bank of America, for instance—are trying to reduce the size of their huge MSR portfolios.
Michael Carnes, a senior vice president in the capital markets group at MIAC, told me that optimism about servicing rights has been building over the last couple of quarters, with concern about negative equity diminishing in many areas.
That comes on the heels of a five-year period of stressful times for servicing executives. During that period, ancillary income from things like late fees diminished, float income declined because of low interest rates, and costs skyrocketed as more loans defaulted. Now, the tide is turning in favor of servicing rights, especially for the sale of “flow” deals on newly created product.
“It’s kind of exciting to finally have people talking optimistically about mortgage servicing rights. We’re seeing that show up in the number of deals that are being traded and in the prices that people are paying for the asset,” Carnes said.
MIAC, which tracks generic servicing values for different loan types, has found that while servicing values—which are typically measured as a multiple of the servicing fee—have improved, they have yet to return to the sometimes heady level seen before the mortgage crisis.
“Firms got very aggressive for a period of time, when you were seeing multiples of five and even up to six,” Carnes said.
Today, multiples on new 30-year, agency-backed loans are typically in the 3.5 to 4.0 range.
Carnes remains optimistic about the outlook for MSRs going forward, noting that a lot of new investors have entered the MSR arena in recent years. In some cases, they buy and manage the financial asset but outsource the loan administration to a subservicer, which has created growth for that business.
Another boon for subservicers has been “opportunistic retention” by companies that don’t typically retain the servicing asset but have started to do so anticipating that values will rise later. Many of those engaged in opportunistic retention are small banks or lenders that don’t have the capital or infrastructure to service the loans themselves, so they also outsource servicing functions.
While the growth of “specialty servicers” that help resolve defaulted or seriously delinquent loans has not had much direct impact on MSR values, it has helped the industry clean up a backlog of troubled loans. Some lenders, fearing more “put-backs” of bad loans from the agencies that bought or guaranteed them, have turned to specialty servicers to cure the loans, even if it results in a loss to the lender. In many cases, curing the loans is less costly than a put back would be.
The HARP program has also been good for the mortgage industry, because it has allowed lenders to refinance many loan in their portfolio at a time when secondary market spreads are still relatively high by historical standards, Carnes said.
Despite the optimism, there are still some potential clouds hanging over the servicing industry, especially on the regulatory front. And while delinquency rates have improved, they remain above historic averages.
“The one concern that all owners of this asset have and will continue to have is certain regulatory changes,” Carnes said. “Basically, we have put the future of the housing finance business in the hands of the regulators.”
The qualified mortgage and qualified residential mortgage rules could affect what is originated, he noted. Increased regulation may impose higher costs on servicers. In addition, large servicers have to consider the amount of capital that they are required to hold against their servicing asset under the new Basel III environment.
P.S. Another note Carnes made is that the drop in rates to historic lows has highlighted the importance of interest rate risk management alongside credit risk management. Some servicers didn’t hedge against 30-year mortgage rates falling below 4%, figuring that could never happen. Well, it did happen, and the firms that discounted the possibility have paid a price in the form of portfolio runoff and MSR impairment.
Ted Cornwell has covered the mortgage markets since 1990. He is a former editor of both Mortgage Servicing News and Mortgage Technology.