Reprinted with permission from the May 2013 issue
The DL On MSRs
Your company may want to consider retaining its mortgage servicing rights
By Tom Farmer
Over the last couple of years, independent mortgage bankers have flocked in droves back toward a business practice that was predominant until the mid-1990s: selling loans to the agencies while retaining mortgage servicing rights (MSRs). Global and domestic governance policies such as the gradual implementation of Basel III have helped to morph the competitive environment to the point where servicing retention is an economically feasible consideration for smaller mortgage firms.
Of course, the path back to this business model presents significant challenges, costs and risks that must be considered. It requires thoughtful planning, commitment and discipline. Even when all the requisite pieces are in place for selling loans servicing-retained, many of these mortgage companies find that they have neither the capital nor the “operational stomach” to actually build more than a modest portfolio.
Initially, newly minted sellers/servicers are often surprised and underwhelmed by the raw agency whole loan pricing relative to the servicing-released bids they are used to seeing from aggregators or correspondent investors.
However, this is not to suggest that getting your Fannie or Freddie approval is a wasted operational exercise or a practice that will not deliver a good return on investment. Rather, for many mortgage bankers, having the capability to sell directly to the agencies and the potential to build a servicing portfolio is a savvy insurance plan in the event a key correspondent relationship disappears or becomes economically unviable.
Even though some mortgage bankers may not fully utilize the capability, having the approvals and processes in place lends a high degree of credibility, endorsement and organizational maturity to the mortgage company. From an external perspective, an independent mortgage banker with government-sponsored enterprise (GSE) seller/servicer approvals has created additional inherent value that will likely appeal to interested investors or acquirers.
Furthermore, practicing GSE sellers/servicers will surely be some of the most sought after correspondents by aggregators looking to participate in the return of the private securitization market. For these reasons and others, even though a mortgage banker may initially plan to sell only a small percentage of overall volume servicing-retained, the capability for this type of execution is an important “arrow in the quiver” for a forward-thinking lender.
For independent mortgage bankers, adding the ability to sell loans while retaining servicing first requires getting agency approvals. While the GSEs have worked to increase their relationships with a broader swath of mid-sized mortgage companies, the time and effort required for approvals has increased. On one hand, the Federal Housing Finance Agency has encouraged a leveling of the playing field by flattening the spread between the guarantee fees of larger and smaller lenders, while on the other hand, the agencies have raised the cost of entry for new sellers by requiring increased staffing, capital requirements and documented processes.
Nonetheless, new seller/servicer relationships with the agencies are growing at a reasonable clip. It is important to note that approval times can range widely depending on the quality and preparation of the application. Leveraging support and pre-submittal review from a consultant, a hedging firm or other business partners familiar with the application process is prudent to ensure faster approvals. Once approved as a seller/ servicer, it is important to determine an appropriate internal valuation of MSRs so that a servicing-retained execution can be incorporated into a best-execution analysis.
The playing field
As with any market, there are trends that ebb and flow as the economic environment evolves. Here are some observations concerning this sector.
While agency-direct execution is not universally on par with most actual servicing-released bids in the market, it does appear to be particularly strong in certain products and note rates. In other words, in some specific cases, investors pay very little for the servicing, and selling servicing-retained to the agency is very close to the all-in pricing offered.
This is the “no-brainer” scenario that allows mortgage bankers to build a servicing portfolio at little or no incremental impact on cashflows. Notably, this situation often occurs with products and note rates that have a higher propensity to pre-pay.
Also, aggregators and investors tend to pay much higher MSRs for specialized products. Unless very well capitalized with a strategic plan to build a higher value servicing portfolio, independent mortgage bankers tend to sell these products through a correspondent channel. The investment to retain these products has such a significant impact on cashflow that it is required for most independent mortgage bankers to sell these loans at an all-in bid.
Furthermore, reduced credit overlays can be compelling, but they can also be a slippery slope. Correspondent investors have developed their credit policies over vast experience in lending, but they do not always make sense on an individual loan. GSEs can be a good outlet for loans that fit the agency box but might be challenged or hit in price by other purchasers.
Rising interest rates and a corresponding decline in refinance volume will keep pressure on service release premiums (SRPs). As production volume falls in line with reduced forecasts, correspondent investors will use SRPs as a tool to remain competitive and attract volume.
The consideration of retaining servicing requires much thought. But despite the risks and challenges, it is imperative for forward-thinking lenders to consider moving to a model that allows servicing-retained execution as their company matures.
Tom Farmer is vice president of sales and marketing at San Diego-based Mortgage Capital Trading Inc. He can be reached at firstname.lastname@example.org.
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