Servicing Is Mixed Blessing for Lenders Due to Exposure

Let’s go back a few decades and take a look at how commercial banks viewed the mortgage industry. In the 1980s and early 1990s Norwest Mortgage (now Wells Fargo) was a top-ranked player in residential finance as was CitiBank, Bank of Boston and Fleet. Otherwise, it was a business dominated by nonbanks and thrifts.

Today, Wells Fargo, Bank of America and Chase (all of which fall into the “megabank” category) rule not only the origination business, but the servicing sector where they (combined) control roughly 55% of the industry by processing $5.36 trillion worth of home mortgages.

A lot has changed since the early days of S&Ls “borrowing short and lending long” and institutions holding onto their loans—instead of selling them into the secondary market, and stripping away the servicing rights.

It would appear that today all the megabanks (and several midsized regionals) love the mortgage business, as do the five or so nonbanks left among the top 20 servicers. But being in love is never easy. Consider this: not only do Wells, B of A and Chase service $5.36 trillion of loans, the servicing contracts they carry on their books have an economic value.

In short, those servicing rights are now an important part of their asset base, worth billions of dollars. If you assign a value of 100 basis points to these receivables (which is my personal, lowball estimate) the resulting figure is $53.6 billion. And if you figure that a majority of the loans they service are guaranteed by Fannie Mae and/or Freddie Mac, you can start to ask this question: What happens to the value of those servicing contracts should Fannie and Freddie (gulp) be liquidated by the federal government?

It’s a fair question—one that has not escaped the Mortgage Bankers Association whose bank and nonbank members realize the economic value of those contracts.

In a recent letter that the MBA sent to the Federal Housing Finance Agency, the trade group implores the regulator to assure the industry that their servicing contracts with the GSEs will not be repudiated in the event of their liquidation by the government.

But who says the GSEs are going to be liquidated? We don’t know that this will happen, but it’s no secret that most Republicans and several Democrats would love to put a bullet in their head because the two caused the housing bubble. (If you believe that, please stop reading this column now.)

As a PR move it’s easy to blame the GSEs instead of the elected officials who protected them for decades and the Wall Street firms that sold them all those crummy alt-A and subprime securities. (Yes, the GSEs are to blame, too, for the housing crisis, but not as much as you might think.)

But mortgage banking (as MBS co-inventor Lew Ranieri once said) is about math. And when you have $5.36 trillion worth of servicing contracts to consider, there will be blood in the streets unless sensible minds prevail. Hence, the MBA is trying to head off an economic disaster, which is a smart move and something the industry should applaud them for.

But what if the government totally drops the ball on the GSEs and decides to liquidate them without guaranteeing the servicing contracts? I’m not saying this will happen, but if it does, you can kiss the mortgage and housing markets goodbye for decades—and along with it the 30-year fixed rate mortgage instrument.

One servicing advisor I spoke to about the issue wonders that without any federal assurances on all those servicing contracts, it could push one of the big three (Bank of America being the most likely candidate) into the funeral home. And if that happens, just who might buy B of A’s $2.2 trillion worth of servicing rights from Uncle Sam? Answer: No one in their right mind.