Servicing: A Valuable Asset
For decades, servicing residential mortgages attracted little attention. Set up a department of detail-oriented personnel, open the mail from borrowers in your portfolio, record that you received the monthly payment, and deposit the checks. If something went wrong, refer the issue to someone else in the next cubicle. I remember when the first company I worked for hit $ billion in servicing, and everyone received a slice of cake. A billion dollars was a big number! And the value of servicing (termed a “mortgage servicing right” or MSR) was pretty much pegged at one point.
That changed in recent decades, of course. (Though not the hankering for a piece of cake, of course.) There are trillions of dollars of unpaid principal balances (UPBs: outstanding servicing balances). Collecting those payments, and late fees, has value. Paying someone $15 to do a task that earns $30 is a money maker, especially if the cost can be driven down to $10 or $5. And if something has value, and can be transferred, it can be bought and sold. It can be financed. Often times the bulk of a lender’s net worth is based in the value of its servicing. Companies set up retention departments to “mine” their portfolio’s borrowers and refinance them before competitors can. Lenders can opt to service their own loans, hire a subservicer, or sell the servicing to an aggregator or company that specializes in only servicing loans.
Regardless of a lender’s servicing retention strategy (which can change week to week), it is a good idea for residential companies to understand what is going on out there in this segment of the industry. The industry’s view of Fannie Mae or Freddie Mac servicing is different than that of FHA & VA servicing. The demand for certain types of servicing determines the value of that servicing, and that, in turn, directly impacts the rate and price on rate sheets for borrowers.
After the wild days of March and April of 2020, mortgage servicing rights sellers are finally able to come to the MSR bulk market with sizable portfolios of recent vintage Fannie and Freddie originations that are at, or below, a three percent weighted average coupon (WAC) on the 30-year fixed rate product. As one would expect, the “buy side demand” is elevated for this low coupon servicing since it expected to have a long duration. And the longer a loan “stays on the books” as the borrower makes their payments, the more profitable that loan is.
Seth Sprague, CMB, a principal with the STRATMOR Group, had some observations about the current market. “Large deals ($10 billion or more in UPB) from well-capitalized sellers receive premium bids, above a four multiple for Fannie Mae and Freddie Mac. And although Ginnie Mae liquidity lags Fannie/Freddie, a limited pool of buyers does exist. Aggregators are back in the market and also paying up for low coupon originations, especially for Fannie Mae and Freddie Mac. Co-issue (flow) deals for Freddie and Fannie servicing are trading back to pre-pandemic levels (above a four multiple in many cases).”
This observation that “aggregators are back in the market” bears examination. Let’s start with a basic premise: if something is worth $1 to you, but someone else is willing to pay you $1.10 for it, basic business sense suggests that you sell it to them. If a company like AmeriHome or PennyMac or Wells Fargo is willing to pay a lender more for servicing than the lender is valuing those potential cash flows, it makes sense to sell the servicing to that aggregator. This has indeed been the case in recent months as lenders have seen the aggregator bid for servicing improve, leading to lenders retaining less servicing.
Another recent trend has been a shift in who is holding servicing. In recent years, the big banks (think Wells Fargo, Chase, Bank of America, Citi, and US Bank) held the bulk of UPBs. In the last year or two, however, this has changed, and now estimates point to depository banks holding 54 percent of UPBs servicing and non-depository, aka independent mortgage bankers, and non-bank servicing companies holding 46 percent. Given the trendlines, by the end of 2021 these percentages may actually flip. With the expected margin compression on the origination side, non-depositories will need to revisit their servicing strategy and once again balance the entity-wide value of retaining the servicing customer versus the immediate cash needs of the company. Many expect that the FHFA, the conservator of Freddie and Fannie, will re-issue new non depository capital & liquidity rules for servicing, possibly as soon as late February, or early March.
STRATMOR’s Seth Sprague also took note of Agency shifts impacting servicing. “The recent US Treasury /FHFA announcement (effective Jan 1, 2022), limiting the annual cash window deliveries to $1.5 billion to each agency (a lender can deliver $1.5 billion to Fannie Mae and $1.5 billion to Freddie Mac, for a total of $3 billion in window execution), further emphasizes the need to understand servicing cash flows, including potential advance requirements. Every lender and servicer should have a comprehensive entity wide viewpoint on the role servicing customers play in executing their mortgage strategies.”
Mortgage bankers like numbers and names, so let’s take a look at some recent deals and figures. If anyone doubts the growing presence of non-banks, servicing watchers have taken note that United Shore (aka, United Wholesale) has the same size MSR portfolio in terms of UPB as Truist at the end of 2020 ($188 billion in UPB). During 2020 United Shore grew its servicing portfolio 159 percent while Truist’s portfolio has declined 14 percent. (Wells Fargo’s declined 19 percent and JPMorgan Chase’s dropped 15 percent.) And helping those deals, or buying servicing themselves, are names that have become well known in recent years: MIAC, SITUS, Incenter, and Phoenix Capital. Some MSR sellers go directly to MSR buyers to direct negotiate and/or use a servicing broker/advisor to directly negotiate with a select subset of buyers and don’t publish a public offering.
Servicing loans, and the buying or selling of servicing, is not the faint-hearted or non-quantitative in our industry. Not only is servicing an asset whose value changes nearly daily, but servicing a portfolio of loans brings a company in direct contact with the consumer, a favorite subject of study for the Consumer Finance Protection Bureau. Jobs dealing with servicing have become a specialty within the industry. Going into that segment of residential real estate can be profitable if done well and with adequate resources. If a lender is not prepared to do that, it is best to leave servicing to others or use a reputable subservicer.