W.J. Bradley Mortgage Capital LLC executives find deciding whether holding or selling mortgage servicing rights is worthwhile for the company in the long run both tough and rewarding.
“It’s a tricky business,” the firm’s head of servicing, Michael Kime, told this publication.
Over the past few years the executive team of the Centennial, Colo.-based privately held independent mortgage lending firm that was founded in 2002 has been restructuring the company through measures that focus on MSR transactions.
The team assessed the advantages and disadvantages of buying, selling or continuing servicing a specific portfolio making decisions that by the end of the first quarter had augmented W.J. Bradley’s mortgage loan portfolio to $5 billion. Forward-looking expectations are to double the loan volume to about $10 billion by the end of 2013.
Investments the firm makes “are opportunistic in nature,” he said. “If we think the portfolio is undervalued we tend to keep it, unless it becomes more profitable to sell—which is what most mortgage banks try to do these days.”
MSR pricing and liquidity continue to be challenging for small- to medium-size banks, he says, as many smaller firms that cannot sell the rights to the agencies are forced to do the servicing. “But many small banks do not really have a good feel of what it really means,” how it will impact their origination business, or do not have the extra capital needed for longer-term mortgage loan servicing.
These challenges have opened an MSR window of opportunity for investors.
“It’s a really good time for those who can,” Kime says, since there is a big gap between the haves and the have not’s among the companies that are approved to own federal agency backed loan servicing rights. “Very few are capitalized to do that. In addition to that Basel III capital requirements and other regulatory demands create added challenges.”
Compliance burdens helped reduce the number of companies that are able to own MSRs but are operationally inept, or face mandated limitations. “It creates a squeeze, really,” he said. “There’s a lot of money in the sidelines, there’s investors who like the asset but cannot really access it, and so on.”
The reason why W.J. Bradley can be active in the MSR market is because it has put together the required structural capabilities to own such assets is specializing in this type of operation and has assembled the capital required to own MSRs, he explained.
The firm already has created “some structures to create liquidity” that supports such investments through bank financing and new capital. “It allows us to continue to grow that portfolio as it makes sense to us.”
Given the new rules about owning MSRs, especially Basel III, adds president of W.J. Bradley Financial Services, Kent Usell, going forward “it is really important” for W.J. Bradley to have the ability to own servicing is really important “regardless of their economic value today, which we like, but on a go-forward basis.”
Retaining that capability of owning servicing appears to be key for any firm operating in the MSR market today. It will protect W.J. Bradley from any market disruptions going forward, he explained, while a typical mortgage banker may have to rely on JPMorgan Chase, Wells Fargo or another major bank to sell their correspondent loans. “That is something we did not want to do.”
Back in 2010, Usell recalls, MSR assets were trading at zero gain. “Some people may call it spread widening but the effect was the same, we were selling loans to Wells and Chase and writing them a check for servicing, versus being able to pool them, is something that as a firm we cannot allow to happen again.” Building up this type of capability “was strategically important” for the stability of the price W.J. Bradley can provide going forward, he said.
These indispensable structural adjustments that aligned the firm’s business model with its long-term strategic goals are ongoing. The executive team has been preparing to take advantage of the current market and take some hits as the market changes in the future.
“Most mortgage companies like ours do not have sufficient capital, in other words the capital was brought into the business to grow it not to own MSRs,” says Kime. To properly monetize the mortgage asset and allow the liquidity to grow smaller-size banks have to continue to capitalize. Finding ways to replenish the capital is really the problem “that whole middle market industry, the nonbanks are facing today.”
W.J. Bradley was able to secure bank financing for the MSRs, “but more importantly, we’ve created a structure and are in the process of creating a company that will enable us to sell the MSRs to another company, sort of in our family of companies,” he said. “It’s a kind of balance sheet manager strategy, that brings efficient capital into the MSR market,” and does not use up all the capital a mortgage company needs for growth.
Getting ready to own MSRs takes time and a short to long term plan, says Usell, thetypical capital markets department of a mortgage company sells loan servicing released to the aggregators as well as to megabanks like Chase.
“To own servicing efficiently and be able to make choices about what servicing you like, you need to have the ability to pull MBS, with Fannie, Freddie, Ginnie,” he explained, so since 2011 when the firm first started holding servicing “W.J.Bradley has made significant investments in the infrastructure and talent in the capital markets department, as well as in getting the proper approvals to securitize and create our own MBS pools.” Once a mortgage company creates its own MBS pools it also gains the ability “to pick and choose what servicing you want so you can add value to it.”