Today’s hot topic in the mortgage world is about how loan servicing will be valued. LendingTree’s chief executive Cameron Findlay says it is about time since existing systems—designed for and proven to work well in normal market conditions—clearly are inefficient in the current market.
Everyone’s attention is on directives given by the Federal Housing Finance Agency to HUD and the GSEs requiring they develop more effective mortgage servicing compensation alternatives.
And how can servicers serve better an environment where so many loans are delinquent remains everybody’s guess. Until a consensus is achieved however, loan risk, or at least investor perception about risk, will creep up and so will lending and servicing costs.
Judging from comments from various market insiders interviewed by this publication over the past few years since the crisis started placing the delinquency and foreclosure processing burden on servicers, the most obvious conflict of interest was between high, politically charged expectations that were not accompanied by changes in the servicing incentive structure and on the ground servicing realities.
Many industry veterans would argue that better incentives would help shorten distressed loan processing timelines.
How should and will HUD and the GSEs change some of these rules to accommodate the scale of the demand by simultaneously providing qualitative services for customers and remaining efficient?
As distressed loan management costs skyrocketed, the unprecedented volume and regulatory requirements, especially Dodd-Frank, are adding to that cost pressure.
For example, Findlay argues, Basel III—which came out in September 2010— requires mortgage-servicing rights to be deducted from the common equity “making it hotter for banks to meet their tier one capital ratios.”
One proposal suggests that banks, especially the big ones, support the idea of zero value servicing so that a zero value is deducted from the common equity, he said, to help banks comply with their minimum capital requirements.
But if servicing is valued at zero and that is the servicing value in the actual mortgage asset when sold as a whole unit, “if you can imagine that,” he said, investment risk is much higher.
Investors interested in buying that asset “will demand more yield” for the risk they are taking on, or the servicing stake included in the asset. It is how back-end risk will translate into more front-end costs that ultimately will be shouldered by borrowers.
Findlay sees these well-intended market changes as the main trigger of higher lending and servicing costs additional losses in lending affordability.
Driven by new legislation, future mortgage servicing changes are required at a time when a consensus on what consists “a qualified residential mortgage” is not yet on the table may further increase servicing costs.
The biggest concern on the servicing side is hedging economic value prior to securitization. Servicers want to lock in the economic value of a RE asset into a MBS—which increases MBS default risk and increases the cost of securitization. And as securitizers try to overcompensate that effect through overcharges to mortgage originators and servicers who also will try to hedge the economic value of a transaction, he says, ultimately additional cost burdens once again will fall onto the borrower.
A lower servicing fee will be positive for the mortgage industry, because servicing utilizes less capital—however some companies will be more efficient so the process will be more beneficial than for others who eventually will have to get out of business. The hope is that the overall effect of these developments will bring about an improved mortgage servicing market.
The dust will settle and said changes in servicing will be more clear over the course of first half of this year when a final decision is scheduled.
Meanwhile, the industry is in the process of discussing exactly what impact the FHFA decisions—as the regulator for Fannie and Freddie—will have on the market and also looking for guidance from the public opinion which is expected to play its role in the final outcome.
