MSRs to Boost Special Servicer Opportunities
One major short-term effect of the forward-looking mortgage servicing rules proposed by the Consumer Financial Protection Bureau is enhancing the relationship between servicers and special servicers.
By the time MSRs take effect in January 2013 the most immediate change would be mainly quantitative as top special servicers and qualified smaller-size shops respond to the expected increase in demand from the larger banks.
The switch, according to Fitch’s managing director, operational risk group, structured finance, Diane Pendley, has already started. Which is why over the next several months she expects to see an increase in demand for the special servicers that have been selected to receive high-risk servicing portfolios from some of the large banks.
The actual high-risk loan portfolios likely to be transferred into special servicing are “fairly well known” and moving rather slowly, says Pendley.
The amount of assets being off loaded by the banks as MSRs or subservicing is significant, she added, and as such it appears to put the receiving servicers “into a fairly good position,” because they have the ability to well price their servicing “despite the anticipation of additional changes mandated by the regulators.”
And since “this is a fairly small group of selected servicers,” Pendley argues that “other special servicers currently working hard to be included in this group” will start to emerge into the marketplace between now and January.
It makes sense for a number of reasons, says Rick Sharga, executive vice president of Carrington Mortgage Holdings LLC.
The operations of traditional servicers tend to focus on maximizing loan payment efficiency even though they have always had capabilities to manage distressed loans, so “their systems have been stressed due to the volume and severity of distressed loans in this cycle.”
Specialty servicers were set out to deal primarily with distressed borrowers and “have been revamping their operations” in order to comply with regulations and the requirements of the MSRs.
In fact, the CFPB mentioned this in their announcement, he added. "The new CFPB mortgage servicing proposal appears to have been developed with the intention of moving the servicing of distressed loans from traditional servicers to specialty servicers, which are better equipped to successfully work with these borrowers.”
“It’s a bit of a trend,” agrees Ed Delgado, COO at Wingspan Portfolio Advisors, some large banks already have tossed large pools of nonperforming loans that currently are managed by special servicers. “It seems to be a plausible strategy” for banks struggling to control their loan default rates and equity positions.
Are these rules bound to prompt a greater interest in component servicing? Absolutely yes, he says, "because it’s a strategic complement to the activities that are currently being performed by the banks. It is a high touch, consumer centric response that acts in the best interest of the banks, investors and homeowners.”
It is common knowledge that traditional servicers focus on maximizing loan payment efficiency even though they have always had capabilities to manage distressed loans, says Sharga, their systems have been stressed due to the volume and severity of distressed loans in this cycle.
Specialty servicers, on the other hand, have been built from the ground up to manage troubled loans, and as a result are often able to deliver better results when it comes to successfully modifying distressed loans, or working with those borrowers to execute other nonforeclosure alternatives such as short sales or deeds-in-lieu, he adds.
He finds it has been easier for smaller, more centralized specialty servicers like Carrington to be up to date because they are already implementing many of the practices being recommended by the CFPB. In addition, specialty servicers that have been using the existing HAMP guidelines are “well-positioned to implement the CFPB rules since many of the processes are very similar.”
“It doesn't make much sense for traditional servicing shops to disrupt their usual processes to handle a short-term need,” he argues, given that it may take another two to three years before the volume of foreclosure activity drops significantly.
According to Sharga, after the AG settlement was signed there was an “uptick in interest from traditional servicers” that will continue to build.
The marketplace will eventually absorb the demand, he says, so the next pressing issue to resolve is “how compensation would be structured, in order to compensate for increased costs associated with more complex and rigorous processing, compliance, auditing and reporting."
“Given the complexity of understanding and evaluating risk at this moment in time, the industry should be cautious with the pricing of these MSRs,” argues Delgado.
The CFPB is one of the factors contributing to how servicers will do business in the future. “It has been a seismic shift in how servicing will be pursued for the next generation. The whole landscape is still being forged,” says Delgado. Regulatory oversight and controls, new customer laws, the AG settlement requirements, the influence of consent orders and the emergence of common sense practices “have changed risk management.”
In his view, MSR pricing is key.
“It strikes me as odd that the entire infrastructure around the fee for service model has become perverse.” The traditional servicing system was established to operate under the assumption that delinquencies would never surpass the 5% to 6% rate, that foreclosures will never exceed 1%, and the expectation to have “a reasonable lending and servicing accountability,” that for all intends and purposes there would be a consistent increase of the average household income.
“Now all of that is out of the window, it does not exist,” he says. Unemployment rates continue to be higher than 8% and forecasts indicate next year it will increase to 8.5% to 8.6%, the loan delinquency rate is over 12% forcing banks to deal with wave after wave of foreclosures for the past five years. “But the problem simply doesn’t go away and one of the things we need to adjust is pricing.”