Higher regulatory risks that are forcing many U.S. banks to sell their subprime mortgage servicing rights are throwing these assets into the lap of specialty servicing nonbanks.
According to Fitch Ratings, the trend started becoming evident in 2012 when mostly due to Basel III capital requirements for U.S. banks that own subprime mortgage servicing rights more than $500 billion in unpaid principal balance MSRs were sold to nonbank servicers.
As banks “migrate to Basel III, where the maximum value of MSRs a bank can count toward Tier I capital is effectively 10%,” analysts wrote in a recent report, institutions whose capital level is approaching the thresholds mandated by regulators “will likely reduce their servicing assets to take into account the deduction from capital.”
Regulatory risks, they argue, will continue to drive banks to reduce their subprime MSR portfolios, even exit subprime and distressed mortgage servicing market and most likely “create temporary growth opportunities for nonbank servicers.”
A growing number of new, smaller servicers “that may over time mitigate risk associated with a concentrated servicer landscape” have also entered the market.
Analysts warn, however, this window of opportunity will close due to lack of new originations since 2007.
Another reason why this is not a long-term growth opportunity, according to Fitch, is the declining size of the subprime market.
As the housing market improves and the balance of distressed loan MSRs diminishes larger subprime servicing specialists “will eventually be driven toward increased origination activity” and in the process modestly increase balance sheet risk.
Challenges, according to Fitch, include the growth and outsized scale of larger nonbank servicers may pose to a potential orderly transfer of servicing.
For example, the ratings of high investment-grade structured finance bonds show “a potential large portfolio transfer of servicing may have negative rating implications for these bonds.”
In evaluating the merits of MSR acquisitions, analysts note, it is important to recognize that not all transactions are alike.
Given the different risk level of mortgages assumed and vintages, “an analysis of repurchase obligations, litigation risk, and a servicer’s ability to successfully integrate the portfolio are essential.”
