When you “navigate the waters” in mortgage servicing rights (MSRs), monitoring your asset is the key to identifying opportunities to sell strategically.
The main takeaways from the “Navigating the Waters” Servicing Panel at the Western States Loan Servicing and Technology Conference were the different strategies for growing your servicing portfolio.
In this event recap, we have highlighted the important comments from this educational panel that will explain your best strategies for retaining or selling MSRs. After attending this panel live, we have had the opportunity to interview Phil Laren, who has elaborated on the topics discussed to increase the educational value of this article.
If you have any more questions, please contact us to learn more.
About the Western States Loan Servicing and Technology Conference
The Western States Loan Servicing & Technology Conference is California MBA’s signature event for residential mortgage servicing.
This conference attracts industry leaders from across the country to discuss the latest on forecasts, business operations, regulatory compliance, technology and industry trends.
Topics Covered in Panel
- General State of the 2017 Market for Servicing
- What makes mortgage originators decide to retain or sell Servicing Rights?
- Defining Smaller vs. Larger Servicers
- Why do smaller originators need approval to sell to Fannie or Freddie?
- How can I leverage my balance sheet to help me decide the best course to navigate with MSRs?
- How do you identify opportunities as a servicer to sell strategically?
- Managing Risks for a Positive Servicing Asset
Q&A Format of Event Recap
The main points of this panel were restructured in a Q&A format to give clarity and focus to the topics discussed. Several quotes of the panelists were gathered by an attendee and later refined during a post-panel interview with Phil Laren.
“Navigating the Waters” Panel with Phil Laren of MCT
As the three panelists settled into their seats, a large, well lit assembly was pensive and focused on the speakers. Invited by the CMBA to showcase their expertise in servicing, the presenters included Stephen Fleming, Managing Partner of Phoenix Capital, Phil Laren, MCT’s Director of MSR Services, and Bob Dowell of Incenter Mortgage Advisors.
The panel was given only an hour’s time on this particular subject but it was evident that the topic could span an entire day. Stephen Fleming opened the discussion by explaining that this was a self-moderated panel and that they would adhere to a discussion-based format to explore the following questions.
What is the general state of the 2017 market for servicing?
Stephen Fleming: “From where I sit on the desk in Denver, it feels like we are in a very slowly rich time as far as data points are concerned. This is kind of the part of the textbook that does not have any pictures, because there is just too much going on.”
The Federal Reserve has elevated benchmark interest rates 3 times since December and rates are rising. The image I get, if you ever watch an Indy race or a Nascar race when the tires are wet, the driver is veering around – that is how servicing rates are going so far in 2017. We have improvement but we also have some rate slippage.
We have been existing in that environment for some time, it’s almost like we are waiting for something to move on that chess board to really define what our next move is going to be.”
Phil Laren: “Back in the day, you would be able to get a much more substantial earning. If you were an originator, banks would in turn lend you back that money, since you gave it to them for free, and they would lend it back to you at a very reduced cost.
Today there is a lot less of that going on. The Fed is continuing to raise rates and they are not offering that substantial earning for the last 6 or 7 years. Holding the escrows is not as valuable at this time because of low interest rates but may be in the future due to increasing rates.”
What makes mortgage originators decide to retain or sell servicing rights?
Phil Laren: “This is a key question for our set of clients because we probably have about 160 hedging clients that use us to sell loans but out of those 160, only about 60 have some kind of approval to sell either to Freddie, Fannie, or Ginnie. Out of of those 60, every month, only about 20 or 30 are regularly selling to Freddie, Fannie or Ginnie. You may be asking: Why 20 out of 160? Why not all 160? What makes someone decide to sell to the agency or not?
In the first place you have got to be large enough to be approved by Fannie or Freddie. Once you’re approved then the question becomes, do I want to hold the servicing or not? Because when you sell to Fannie Mae it’s a different process than when you sell to Wells Fargo or another large aggregator. When you sell to Fannie you have to service for yourself, you can’t sell the whole loan. So there are benefits to each.”
How do smaller or larger originator scenarios differ in regards to servicing?
- Smaller originators sell to aggregators such as Wells Fargo, Amerihome, Pennymac, or others. Unlike Fannie or Freddie, they will also take on the servicing rights to the mortgage, so there is a benefit in “being done with it” and not having to worry about retaining the servicing.
- Larger originators can sell directly to Fannie or Freddie, but these agencies will not take your servicing rights – so the originator will have to decide, do I retain the servicing myself, or do I hire a subservicer who will monitor and maintain it for me?
Stephen Fleming: “Once you have made the decision that you are going to create that servicing right, then you can bulk it up. A lot of the smaller servicers will continue to accumulate the asset for a while, it grows on their balance sheet, it helps the company with overall value, it builds corporate value, but again, you’re tying up a lot of capital with that MSR asset. So as you build that asset it’s still going to throw off cash flows every month, and a lot of people like those cash flows, but every month you’re also increasing the size of that asset on the books. At some point a lot of these companies say, how can I sell some of this asset?”
“The bulk market is very active today. We are averaging 8-10 bidders for every portfolio we put out.” – Stephen Fleming
“You have to be very aware of what you create over time. A perfect example would be somebody who is originating and selling to the agencies and they may not retain all of their Ginnie Mae referrals because they don’t like the aggregator pricing, so they build their portfolio then when they go to the ball park and they discover, well, they don’t like that profit either so they’re stuck with that asset that they really can’t sell. So you have to be very careful in managing that asset as you’re growing it, as your servicing it, and understanding everything that’s going in the market so you don’t put yourself in the corner.”
Bob Dowell: “There are a lot of different decisions that you are going to have to make as you retain your asset and understanding the risks of each one of them is a very important deciding factor of the question ‘Should I retain or sell MSRs?'”
Why do smaller originators need approval to sell to Fannie or Freddie?
Phil Laren: “They have to make sure they have the financial wherewithal to service the loans. Originators with more financial responsibility and experience sell to Fannie, as Fannie has to be confident that you can handle the servicing aspect. They also want to make sure that you have a good mortgage hedge advisory.
It takes a few months to get approved and they will monitor you based on your competitors to make sure all the boxes are checked. Once you sell to Fannie Mae they are agreeing to take the risk of incurring a loss if the loan goes bad.”
“As a servicer, you have to do the math, figure out the economics and decide the worth of the servicing relative to the cash you’ll get selling it.” – Phil Laren
As an originator, how can I leverage my balance sheet to help me decide the best course to navigate with MSRs?
There’s a lot of factors when you decide to sell to an aggregator like Amerihome or a big name like Fannie Mae. As we mentioned before, aggregators will buy your servicing rights, but big names like Fannie or Freddie will not, there really are benefits to both.
Here’s an example: Most originators will see that Amerihome will pay them more than the agencies, so they right away decide to sell to Amerihome and then they can be done with it.
The catch is that with Fannie Mae you still own the servicing and there’s an investment value to assess there as well.
In order to weigh these options to decide which will be better in the long run, it will depend on whether you want all the cash from the sale to an aggregator up front, or if you want to reap the benefits of a 20 year servicing retainer that may supersede the immediate gratification of that lump sum over time.”
How do you identify opportunities as a servicer to sell strategically?
Phil Laren: Once you own servicing, you open new doors. The question comes as you start growing and building up your servicing portfolio: How do you identify opportunities as a servicer to sell strategically?
If you are a small servicer you have to keep it all or sell it all, you can’t do these strategic sells. But, if you grow your portfolio, you have these opportunities.
Keeping with our initial example of selling to Fannie or Freddie, once you decide to retain the servicing rights and not give it to an aggregator, then you may service it for a while before deciding it’s time to sell it, and there’s a bunch of strategic options open for you to do that.
The same correlation can be made in an analogy with bonds. With bonds you have the choice to either hold them for investment or you mark them to market. With servicing you don’t have to choose – you have both options. You can retain your servicing right or you can sell if the market gets attractive – so it gives you a lot of flexibility.
Either way, monitoring is crucial to prevent any worst case scenario. Whether you are servicing yourself or you are overseeing your subservicing, there is always room for human error.
“Everyone who is involved in servicing knows that there are a million things that can go wrong.” – Phil Laren
Closing Thoughts: Managing Risks for a Positive Servicing Asset
While there are many worst case scenarios, the panelists made it a point to end the panel on a positive note by reiterating the benefits of retaining servicing rights. The audience was left with the conclusion that if you have the right support and strategy to retain, monitor, or strategically sell your MSRs, then you can reap great rewards.
Phil Laren: “There are a lot of risks and a lot of rewards. You have to manage that risk by staying on top of it from an operational standpoint, from a risk standpoint, and from a legal standpoint, and then it can be a very positive asset to have.”
Explore our Mortgage Servicing Insights Whitepaper Series!
No matter how long you’re in the secondary market, there is always more to learn. If you are interested in learning more about the intricacies of MSR strategies for achieving a positive asset, we encourage you to read the Servicing Insights Series by our industry veteran, Phil Laren.
Learn our detailed strategies for success with the Servicing Insights Series:
- Foreclosure Costs in Servicing Valuation – Servicing Insights Vol. 1
- Late Fee Revenue in Servicing Valuation – Servicing Insights Vol. 2
- Prepayments in Servicing Valuation – Servicing Insights Vol. 3
- Appropriate Discounting Methodology – Servicing Insights Vol. 4 – Risk Management Part 1
- Yield & Arbitrage Theory – Servicing Insights Vol. 5 – Risk Management Part 2
The Servicing Insights Series explains strategies developed by Phil Laren that include detailed aspects of servicing valuation & modeling for experienced mortgage bankers.
We are proud to make the insights of our servicing and modeling expert available through the Servicing Insights Series. Phil Laren leads the MSR Services group of MCT, and provides robust software, consulting, and valuation solutions.
About MCT Panelist – Phil Laren:
Mr. Laren is as a service group leader on MCT’s management team, focused on managing and expanding the company’s MSR Services. MCT’s mortgage servicing software, the Desktop Servicing Model, was created by industry veteran Phil Laren.
Mr. Laren has 29 years of experience in capital markets, predominantly in servicing. He is experienced in all aspects of servicing, modeling, pricing, trading, negotiating, hedging, risk analysis, accounting analysis and operations. Mr. Laren is also very experienced in building teams and managing traders and analysts (mostly Ph.Ds and MBAs who speak more Math than English). Mr. Laren holds advanced degrees in statistics and econometrics.