With continuous concerns being raised by many in the industry regarding the potential residential servicing crisis that looms ahead, some creative structuring and flexibility must be brought to the servicing market.
In particular, servicers have found obtaining liquidity for Fannie Mae, Freddie Mac and Ginnie Mae servicing extremely challenging.
There have been many calls for diversification of servicing among more servicers.
At the same time banks have been under pressure to sell servicing due to the punishing treatment of servicing under the capital rules brought about under Basel III.
This has led to greater concentration of servicing in the hands of large nonbank servicers.
However, unlike the banks, the nonbank servicers do not have ready access to inexpensive sources of liquidity to fund advances required to be made under both agency and nonagency servicing contracts.
This problem is magnified for the smaller servicers, who likely have even less access to liquidity.
While there is a somewhat robust market for financing nonagency servicer advances, the market for agency advances is relatively small.
Given the significant size of the agency servicing market, and the shrinking bank presence in the servicing market, steps must be taken to bring liquidity to this sector.
All of the agencies have extensive rights with respect to servicers.
They can terminate servicers for a multitude of reasons, and as the owners of the mortgage loans serviced, absent an agreement to the contrary, may assert rights against the servicers which are superior to any claim of any creditor with respect to servicing advances or servicing fee income earned on account of such mortgage loans.
Servicers therefore face a challenge in being able to fund advances through liquidity sources where the asset itself (i.e., the advances being made or servicing fee income generated) is not attractive collateral to potential lenders.
While there have been moves to structure transactions which involve so-called excess servicing (i.e., the servicing fee income some level above the cost of servicing), these structures still leave the lender at the mercy of the agencies, which nevertheless claim a superior right to the servicing and depending on action taken, can potentially strip the so-called excess servicing asset away from its purported owner or lender.
Similarly, proposals to inject deeper pocket advancing parties into the servicing relationship in exchange for a first priority right to reimbursement of the advances regardless of other servicing issues, have been largely dismissed.
At some point, if more servicers cannot find access to liquidity sources, servicing demand (the amount of servicing required in the market) will exceed supply (the amount of servicing capacity that servicers have available to offer).
At such a tipping point, the market may see significant dysfunction, which could in turn, affect the liquidity of the mortgage loans themselves.
In order to avoid market disruption, it is imperative that the agencies work with third party liquidity providers to devise creative solutions in which those sources of liquidity can have confidence that their collateral will not disappear in the event that a servicing problem or default arises in the future.
In particular, advances made from the servicer’s funds are assets that should rightly be reimbursed to the servicer independently of agency claims.
This alone would spur greater liquidity, which in turn would offer more opportunities for more servicers to acquire servicing.
Without this assurance, liquidity providers will continue to hesitate to provide the servicers the liquidity that they need, which will in turn reduce the amount of servicing that can be acquired by many servicers as well as hamper smaller servicers from entering the sector, ironically leading to the opposite result from what is in the best interest of the mortgage market as a whole.
Karen Gelernt is a partner in the global finance and debt products group at Alston & Bird LLP. Her practice involves the representation of domestic and foreign banks, investment banks and other financial institutions in a variety of financing, mortgage and other financial asset transactions.