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MSR Financing Makes a Comeback, with a Synthetic Twist

JUN 25, 2014 11:46am ET
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Mortgage companies are exploring ways to finance their servicing rights, a notoriously difficult asset to fund, and at least one has tried to build a better mousetrap.

Ocwen Financial introduced a novel derivative financing structure with Freddie Mac's blessing early this year, offering a rare window onto a corner of the market that tends to operate privately. Stonegate Mortgage also has received Freddie Mac approval for a more typical funding facility from Barclays to finance the publicly traded mortgage company' MSRs.

Other players large and small have recently been increasingly looking into MSR financing as well as selling MSRs, says Tom Millon, president and chief executive of the Capital Markets Cooperative in Ponte Vedra Beach, Fla.. Selling is easier, but financing provides more flexibility.

"It's been interesting to see some of these financing structures come back to life," says Millon. "It seems like really all of a sudden people are trying to get creative in terms of how to finance the mortgage company's balance sheet."

While larger players may need financing for growth and hedging, some smaller companies that are originating also are considering them as they look for ways to raise funds to offset their loan volume declines, he says.

"It seemed like for maybe the last half of 2013 everybody was really just retaining [servicing rights]. Maybe they figured out, 'Oh my God, I need cash,'" says Millon.

Excess servicing financing structures originated in the private market, says Millon. And it has been more often done "on the QT," according to Dan Thomas, a managing director at Mortgage Industry Advisory Corp., a New York firm that brokers servicing rights and other asset sales. So it's notable when public companies bring innovatively structured excess servicing financings to light.

The Ocwen Asset Servicing Income Series, or Oasis, is unusual because the notes are not directly related to the MSRs but rather mirror a position in them. The MSRs stay on Ocwen's balance sheet, but the notes transfer their prepayment risk to investors.

"The synthetic nature of the Oasis deal is what made it different," says Laurie Goodman, director of the Urban Institute's Housing Finance Policy Center in Washington. Noteholders receive an amount equal to 21 basis points per year of interest based on the stated principal balance of a reference pool of servicing rights over 14 years, according to Ocwen. So if a loan prepays and diminishes the principal balance noteholders will receive less of a return. The average servicing fee for the reference pool is 31 basis points per year.

Selling the interest rate risk removes a big uncertainty for holders of these assets, Thomas says.

"The prepayment part of it is the great unknown," he says.

Ocwen issued its first Oasis deal with Freddie Mac's acknowledgement in February. It would like to do more with the structure if it could get Fannie Mae to sign off on it as well. If not, it might innovate even further in this area, president and chief executive Ronald Faris told attendees at a recent Keefe, Bruyette & Woods investor conference in New York.

"If we donít think that approval is going to come, we have other ways to move forward very soon," he said.

Agency approval has always been a sticking point when it comes to financing secured by Fannie Mae and Freddie Mac mortgage servicing rights, according to Millon. It's why MSR financing is not readily available.

"The big rub on MSR financing is the fact that Fannie and Freddie are in first lien position and make no bones about it," he says. "There really aren't any real exceptions at all to the Fannie and Freddie acknowledgement agreements that are out there. There's some talk about Fannie and Freddie relaxing some pieces of it, but really everybody in the chain of title has to fully agree that Fannie and Freddie have first lien rights to the servicing, and that's rough. "

Ocwen can overcome this hurdle because it is a large, publicly traded company, says Matt Maurer, a managing director at MountainView Servicing Group, a Denver firm that brokers sales of portfolios.

"It takes a larger, well-known well capitalized institution to pull off an Oasis-type structure because of the counterparty risk," he says.

Fannie Mae likely wants to provide approval to Ocwen, says Millon. But with momentum building in MSR financing and Fannie being the busier of the two agencies, it may have more players to accommodate and a longer timeline for approvals than Freddie Mac.

The Oasis structure is unique and designed to fuel Ocwen's growth as it buys MSRs from banks that face disincentives to hold the asset under new capital rules, and to help finance the diversification of its business. (Regulatory concern related to the sizable transfers of MSRs to nonbank servicers like Ocwen could slow the pace of its MSR purchases.) But there are signs others are trying to get agency approvals for more common structures and facing a wait as well.

Stonegate has been awaiting Fannie Mae's approval for the Barclays vehicle. The Indianapolis lender also plans to look at "other vehicles to optimize true value of these assets going forward," Stonegate's founder and chief executive, Jim Cutillo, said at the KBW conference.

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