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Loan servicing: The Rise of the Non-Bank Servicer

Adapting to the changing marketplace

Faith Schwartz    |    Housing Policy

Seven years removed from the collapse of the housing market, estimates for growth are optimistic; meanwhile, the “act” of originating and servicing a loan continues to evolve. The amendments to the Truth in Lending Act, Real Estate Settlement Procedures Act, addition of the Qualified Mortgage and Ability to Repay rules (QM/ATR) and loan officer compensation rules have changed the face of originations, which in turn is also having an effect on loan servicing. In particular, loan servicing is transitioning away from the banking system into non-depository institutions. There has been and may continue to be a material shift in the concentration of top ten residential loan servicing entities to non-depositories and this raises important questions. Why have depository institutions been releasing their mortgage servicing rights? And, of what importance is this shift to consumers or investors? The answers to these questions must be found as we continue to look at ways to establish both a healthy and balanced housing finance system.

Today the majority of investment financing in housing is contributed through government programs. The food chain of housing finance is fluid and the latest trend of transferring servicing from banks to non-bank servicers can most likely be attributed to regulatory changes, reputational risks and basic economics. Consider the following:

Regulatory Changes:

  1. BASEL III implementation places capital constraints on many U.S. institutions that have sizeable mortgage servicing rights (MSRs) holdings. Banks were previously able to contribute the value of MSRs to their Tier 1 capital, the financial strength of the bank from the perspective of regulators, but  modified accounting treatment of MSR s under the new capital standards have led depositories to rethink their holdings approach. This will continue to cap the growth of loan servicing for large scale depository operations.
  2. Regulatory compliance and oversight is a core tenet of loan servicing and default management. The Consumer Financial Protection Bureau (CFPB) servicing guidelines and QM rule require extensive processes established around default servicing, borrower engagement and documentation management.
    • Penalties have been swift and severe from regulators and investors with over $100 billion being paid out in settlement for crisis era activities.

Ginnie Mae Issuers 2011 to 2014

Ginnie Mae Issuers 2011 to 2014

Reputational Risk:

  1. Reputation risk remains high with regard to any and all foreclosures.  Some institutions with more diverse portfolios of revenue may retrench from high reputation risk activities such as loan servicing mishaps.
  2. The housing crisis provided ample ammunition to regulators and policymakers to consider legislation specific to loan servicing.  While the function of payment collection and processing of mortgage payments has worked well in the years leading up to the downturn, the crisis strained the collection and default services (non-performing loans) execution for many loan servicers.  Exacerbating the issue were a number of challenges that magnified industry problems far more than anticipated.  These included a combination of… light contact with the borrower, collection of pertinent information from the borrower, and the challenge of creating uniform processes inside institutions. These challenges coalesced around a problem that became more magnified than the industry anticipated.

The Economics:

  1. Dialing forward, many state consumer protection laws were enacted to slow down the foreclosure process and ensure there were adequate procedural protections for consumers. The regulators and investors responded by issuing rules and policies around default servicing and how to interact with the consumer. The world changed from a traditional loss mitigation role to that of a borrower solution provider. The Dodd-Frank Act then became final, which established the CFPB and led to the issuance of new rules for loan servicing, vendor oversight and rules of engagement.
  2. When you combine the activities that comprise “loan servicing” and overlay investor and government litigation, the overall cost to service loans has skyrocketed. The Mortgage Bankers Association and Urban Institute estimate that the cost of servicing performing loans has risen from $59 (2008) to $156 (2013) and non-performing loans have risen from $482 *(2008) to $2,357 (2013).

See the attached map for foreclosure timelines that are elongated and varied across the country. This plays a role in the cost of servicing and value of the MSR’s being traded in the market today.

State Foreclosure Timeline in Months

State Foreclosure Timeline in Months

All of this then raises another, perhaps even more important question. How do we know if a loan servicer is both competent and compliant? Loan servicers will share that they are the most regulated entities around. A few metrics that are out there today to monitor performance include: 1) rating agencies, 2) CFPB complaint data base, 3) Treasury HAMP ratings, 4) Fannie Mae STAR rating system, 5) Prudential regulators, 6) State regulators.

Potential Impacts of the Shift

Why do we care if servicing institutions are shifting to more non-depositories?

From a consumer perspective, there should be little difference regarding who is servicing the loan. The rules are clear on how to engage with the consumer. There should be an ombudsman for difficulties and the CFPB consumer complaint database is an avenue for airing grievances.

For investors, the shift in counter-parties to non-depositories can add additional risk as they are institutions with less capital than banks.  But that can and is being managed, as agencies such as the Federal Housing Finance Agency and Ginnie Mae continue to issue guidance and rules around minimum capital requirements and adapt to these changing players in loan servicing.

Summary:

There are sizable shifts to the players in the servicing marketplace. There are reasonable causes for why this is occurring, partially due to the nature of the institutions’ capital requirements. The shifts should not have a material impact on the industry as long as there is sufficient capacity for quality servicing. There are numerous metrics that remain in place to manage and monitor activity on behalf of the investors as well as the consumer. An area of caution regarding the role of servicing is that the cost of default servicing, as evidenced by recent studies, will materially impact the cost of access to mortgage credit. As housing finance continues to heal, there is an important role for investors and consumers to ensure there remains strong confidence in how the loan servicing market functions as, it is a key component to a healthy and sound housing finance marketplace.