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"We know there are banks still in the market to purchase servicing rights," says Mark Mason of HomeStreet Bank, a reluctant seller.
"We know there are banks still in the market to purchase servicing rights," says Mark Mason of HomeStreet Bank, a reluctant seller.

Believe It or Not, Some Banks Still Want to Buy Servicing Rights

MAY 28, 2014 4:07pm ET
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All other things being equal, Basel III capital requirements discourage banks from holding mortgage servicing rights. But all other things are not always equal.

"A handful" of banks with room in their Tier 1 capital ratios have started to buy servicing, attracted by the yields, the potential to cross-sell products to the borrowers and other factors, a servicing broker says.

"Banks are looking to buy and sell the asset," says Matt Maurer, a managing director at MountainView Servicing Group, a Denver firm that brokers sales of portfolios. "Large holders of the legacy servicing appear to be mostly more than willing to sell, but regarding the newer production, it's interesting. We are starting to see some bank buyers come back into the market."

Basel III is the reason HomeStreet Bank in Seattle is planning to sell about 25% of its MSRs, but other banks are still buying, says CEO Mark Mason.

"We know there are banks still in the market to purchase servicing rights. Every bank is in somewhat different capital position. I think every bank is going to go through its own analysis," Mason says.

While the $3-billion-asset HomeStreet would prefer to keep all its servicing, "the new capital rules have a fairly significant negative impact on us, though we're doing a number of things to mitigate that," such as ramping up the growth of other assets. The bank doesn't want to end up "simply selling servicing to accomplish our goals." HomeStreet serviced about $12 billion of home loans at the end of 2013, according to mortgagestats.com.

While much has been made of capital pressure on banks to sell servicing rights, absent the Tier 1 capital constraints, there are some compelling reasons for banks to be buyers, Maurer says.

For example, the relative yield on servicing rights has been more attractive for banks than it is on whole loan purchases, he says. "Servicing puts capital to work at 9% to 10% yields, whereas portfolioing whole loans may only get them a 2% to 4% return."

And because they enjoy a low cost of funds, banks can realize better returns from servicing rights than can nonbank entities like private equity firms, says Maurer.

"The MSR asset is more appealing to banks than anyone else," he says.

Banks traditionally have preferred originating mortgage assets because this has a tax advantage over purchasing MSRs. But with market conditions tougher when it comes to origination, buying servicing rights can be more preferable today.

"It's harder to originate," Maurer says. "You can't originate $1 billion of loans in bulk, where you can buy $1 billion in servicing at a time."

Servicing also is currently attractive because it can help a bank market its other financial products and services to borrowers, although market observers increasingly find today this strategy works better in some situations than others.

"Cross-selling opportunities are real, they're absolutely real, but cross selling successes have been mixed," says David Lykken, managing partner of the consulting firm Mortgage Banking Solutions.

Some banks with room in their capital ratios have been selectively buying servicing rights on mortgages in regions where they have branches, with an eye toward cross-selling, says Maurer.

"Certain banks look for servicing in their footprint," he says. "If you buy MSRs in your footprint, there is a higher likelihood that you are going to turn them into bank customers."

Mortgage servicing rights have been unfairly "demonized" by regulators who don't understand them, says Christopher Whalen, senior managing director at the New York-based Kroll Bond Rating Agency Inc. "There's nothing wrong with this asset, if you know what you're doing," he says.

However, Whalen questions whether it is really Basel III that is the main deterrent to buying. Rather, heavier servicing compliance burdens and reputational risk have more to do with why banks that otherwise might be willing to invest in this asset have not been doing so, he says.

Also, servicing prices have risen in recent years, so banks also have been taking that into account. They are currently generally valued around four to six times cash flow, but they fell as low as two a few years back, Whalen says. The higher price of servicing has driven several banks and other lenders with dwindling loan volume to generate revenue by selling servicing, he notes.

"If you originate from your own operation it's cheaper, but it takes time," he says.

Regardless of whether MSRs are originated or purchased, depositories' interest in them can only go so far with Basel III coming in 2015, says James Kendrick, a vice president at the Independent Community Bankers of America in Washington.

"To the extent that community banks are continuing to acquire mortgage servicing rights—either for loans they originate or in terms of acquiring them in the marketplace—those opportunities are very limited," he says.

There is a chance community banks that benefit most from MSRs could buy more widely again if given an exemption from Basel III's more onerous risk weighting, but the chances of this appear slim, he says.

"We've asked for capital relief from the regulators, but we don't believe they will provide it at this time," says Kendrick. "Mortgage servicing rights provide a lot of value to the bank, but we think that value is not being fully appreciated by the regulators."

Related:

Mortgage Lenders Sell Cash-Cow Servicing Rights to Survive

Bankers Fighting to Change Basel Treatment of MSRs

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