Rep and warrant risk relief key to booming MSR movement
Demand for mortgage servicing rights began to boom when Fannie Mae and Freddie Mac agreed last year to shield new buyers from the representation and warranty risk leftover from origination, according to market participants.
Tightening Basel III requirements and skyrocketing servicing costs have also persuaded larger financial institutions to unload, but the ability of the government-sponsored enterprises to negotiation was the biggest driver.
Roughly $60 billion in MSRs changed hands in the first three months of 2012, compared to between $1 billion and $5 billion the same period last year, according to Darren Hadlock, chief investment officer at mortgage financier Residential Credit Solutions.
"It's up dramatically. I don't think Basel III has as much to do with it, yet," Hadlock said. "What we've seen is that larger banks are selling placate Fannie and Freddie. Last year, Fannie and Freddie began bifurcating the rep and warrant risk. In some instances, it won't travel with the MSR once it's sold. The new purchaser does not get the risk transferred from the origination on the loans."
In the past, banks could apply 100% of the value of MSRs to their Tier 1 capital ratios. But under Basel III, banks will only be able to count a portion, according to commentary from financial law firm SNR Dention. Specifically, under Basel III, MSRs will be limited to 10% of a bank's common equity when calculating Tier 1 capital.
But Basel III requirements are still years out. And Attorneys General settlements, consent orders and new standards are pushing costs up now, forcing larger banks, where most of the servicing concentrated to sell.
Bank of America (BAC) has been one of the biggest sellers, particularly of GSE servicing rights. According to the Fannie Mae year-end financial filing, BofA serviced 21% of its outstanding loans, down from 26% the year before.
In the third quarter, Fannie even bought $74 billion of its own MSRs from BofA and resold it to smaller servicers.
"Before they negotiated the rep and warrant risk out, it just was too much a risk for smaller shops to buy them," Hadlock said. "If you board these loans and take your 25 basis points servicing fee, and all of a sudden their putting back these loans to you, as a smaller shop you're not only making less money, it's probably costing you money. It kept the accelerator off of MSR transactions."
Gus Altuzarra, CEO of Vertical Capital Markets Group, is one of these buyers. In fact, they're buying MSRs from large and small financial institutions, packaging them into investment vehicles for individual investors in a private placement format. This means, people can boost their retirement accounts with profits from servicing delinquent loans from the housing crash.
"We can buy at a discount and capture 60 to 65 cents on the dollar. You can't do that on all all the loans, but it happens frequently," Altuzarra said. "There seems to be an investor appetite. It could be there for the next three years."