Many Ways Possible to Change Fees on Servicing
When the Federal Housing Finance Agency announced its interest in overhauling how servicers are paid, it didn't provide much in the way of public detail.
But particulars are starting to trickle out from discussions Fannie Mae and Freddie Mac have held with various constituencies.
In an FHFA-hosted meeting with analysts recently, Fannie and Freddie officials laid out four possible changes to the 0.25% servicing fee that has long been the foundation of servicer pay, according to people with knowledge of the discussion.
The smallest step, cutting the fee in half, would reduce the size of mortgage servicing rights by more than 50%. This would alleviate the capital constraints that servicing-heavy banks now face from coming international capital standards, but leave the general structure of industry pay in place.
A second option is lowering the fee to a nominal amount, perhaps as low as 3 basis points. Below even the largest servicers' cost of servicing a performing loan, this could be expected to wipe out MSRs entirely, eliminating the need to hedge and hold capital against them.
A third possibility is to completely scratch a basis-point servicing fee structure, replacing it with a per-loan stipend or payment for specific services rendered. This approach would mimic the already existing pay model for subservicers.
Finally, the GSEs raised the possibility of replacing a basis-point structure with an alternative minimum servicing fee, in which the servicer would have a 1% stake in the principal of the loan being serviced. Pushed by some servicers in the second half of the last decade, this idea was neglected as the industry fell into disarray during the crisis.
Those options resembled ideas floated at the Mortgage Bankers Association's summit on mortgage servicing.
Given the nature of the invitees to the analysts meeting, most of the discussion dealt with the effect of any changes on the market for Fannie and Freddie-guaranteed securities. The GSEs stressed that whatever changes occurred would have to be acceptable to investors and maintain liquidity in the marketplace.
The drive to change servicing fee structures stems from two separate motivations. One is the Basel Committee on Banking Supervision's coming restriction on valuing "intangible" assets such as mortgage servicing at above 10% of a bank's overall capital, a change that could potentially put many servicing-heavy banks into a regulatory capital squeeze.
The other is the perception that servicing fee structures have made it harder to address the housing crisis. Because servicers get most of their income from performing loans, and book the profit from servicing at the time of a loan's origination, critics have argued that they invested less money and effort into dealing with troubled loans than they otherwise might have.
"The current model has not motivated mortgage servicers to invest the time, effort and resources needed to fully explore all options to help delinquent borrowers avoid foreclosure," Treasury Secretary Tim Geithner and HUD Secretary Shaun Donovan wrote in a joint letter to the FHFA.
"There appears to be a pretty powerful consensus among the regulators that they don't like the basis-point servicing structure," said Jeff Naimon, an attorney for BuckleySandler LLP.
The FHFA declined to discuss potential options with American Banker beyond its initial statement that it is seeking to cooperate with all interested parties in an effort to replace the 25 basis point model sometime after 2012. It is expected that FHFA Chief Ed DeMarco will address servicing fee structure issues at the MBA's servicing conference next month, providing a fuller view of various options.
The most obvious ramification of the initial proposals is that they would at the very least reduce the impact of international regulatory restrictions on what portion of a bank's capital may be tied up in "intangibles" such as servicing rights. This could prove a significant boon for banks with a heavy concentration in servicing, among them giants like Wells Fargo & Co. and Bank of America Corp. But which entities would gain or lose the most from changes to the basis-point fee structure is still unclear.
None of the proposals, by themselves, would necessarily diminish how profitable it is in the aggregate to originate and service a mortgage. Because banks book servicing revenue at the time of a loan's origination, the line between origination and servicing income is often viewed as hazy. Conceivably, lost servicing revenue could be compensated for by either higher market prices for loan production or richer compensation for performing specific services in relation to a mortgage.
"I don't think this changes the economics for servicing," said Bose George, an analyst for Keefe, Bruyette & Woods, Inc. who has been following the servicing fee discussion. "It should be more cash up front, less MSR, which would align cash [income] and GAAP [accounting practices] a lot better. And there would be less capital tied up [by MSRs], so it's a very important issue for the mortgage banks from that perspective."
Though the reduction of MSRs' importance would be good for the mega servicers, George said, it is possible that a servicing fee structure change could create openings for more competition in the industry, something regulators have said they want to see.
"If you don't need to have a huge MSR amount tied in servicing, it should open it up to efficient, high-touch processing companies," he said.
But other observers, including Naimon, worried that changes to the structure could have unintended consequences or put some institutions at a competitive disadvantage.
"I was on the phone with bankers at a community bank in Maine," he said. "Their average loan size is $60,000, and if you were to pay them 10 basis points on that, that doesn't pay for anything. There are some issues with just ratcheting [basis point fees] down to a really low level."
"I'm just wondering whether this will further put pressure on [servicing costs controls]," Naimon said, "so you have to be the low-cost servicer, which favors the big-box servicer.