FHA loans could face "tidal wave of defaults"

FHA loans could face "tidal wave of defaults"

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MIAC says changing the servicing fee structure makes little sense

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Changing the current service fee structure can have major implications as a stopgap to fix the current issues surrounding mortgage servicing rights and the handling of delinquent loans, according to two analysts at a national trade group. However, using a risk-tiered credit structure could improve the quality of mortgages originated and improve the industry as a whole. The analytics division of Mortgage Industry Advisory Corp. released a report Tuesday that said reducing the service fee would hamper already thin profit margins for mortgage servicing rights and could force some servicers out of business. "With better origination and underwriting guidelines creating much better newly originated product, and with the more delinquent 'high touch' servicing that had significant concentrations in the 2005-2007 vintage pools, does it make sense to change the current service fee structure?" said Robert Lee, senior director at MIAC and one of the authors of the report, in a HousingWire interview. "Or will the new production and the declining percentage of highly delinquent servicing from these earlier vintages work themselves out through modification, cure or through default?" He compiled the report with Mike Carnes, senior vice president of MIAC. The current servicing fee has remained at 25 basis points since the 1980's. But as foreclosure levels continue to break records in 2011, working more closely with the borrower to prevent these foreclosures has turned profits into losses. By changing the servicing fee structure, federal agencies believe these companies will have more incentive to push modifications and other workouts higher. According to the report, servicing fees are generally front-loaded and expenses are back-loaded. A servicer receives more income up front and less further into the life of the loan, as expenses to handle delinquent mortgages increase over time. And while this structure is not too costly for a servicer at a 5% portfolio delinquency rate, when a portfolio ends up at 40% delinquent, the costs far outweigh the revenue, Lee and Carnes said. The two analysts said small servicers will witness a "significant reduction" in revenue from a reduced fee structure, given that they do not have the performance issues many large servicers encounter. "Given their higher servicing cost structure, higher market yield requirements, and higher capital costs, the smaller servicer may find that reduced MSRs no longer cover the risk in owning mortgage servicing rights," Lee and Carnes said. A reduced fee structure will lead to greater consolidation in the servicing sector and fewer market competitors, they claim. Larger servicer will experience more positive aspects than negative from this structure. "On the assumption that large servicers have lower cost for capital, lower servicing costs due to economies of scale, and in general lower yield requirements, these large servicers should still be able to make a profit on the performing MSRs, (albeit at a reduced service fee revenue projection)," MIAC said. "However, late fee income, float income, and ancillary income resulting in fewer cross-selling opportunities will be disadvantage the smaller servicer." Instead of changing the servicer fee structure, they suggested using a risk-tiered credit structure as a solution to managing the mortgage market and producing higher quality mortgages across the board. This foundational structure adequately assesses borrower credit risk and provides investors with a reserve bank to cover first losses, they said. "The ranking of these credit and risk profiles will require standard guidelines to ensure that consumers receive mortgage market rates that accurately reflect borrower risk," Lee and Carnes wrote. Under the proposed risk-tiered structure, higher risk and nonqualified mortgages will incur higher guarantor fees with the borrower sharing at least some of the cost in the form of above market mortgage rates, the authors said. Investors will feel a positive impact from this structure in that a "risk-based guarantor insurance premium," derived from borrower interest rate, will act as a loss reserve escrow account, the MIAC analysts said. Investors can draw from this account to cover losses. The premium would be reflective of the projected loss exposure over the lifetime of a loan. "For instance, a 750 Fico, 75 LTV, at market rate conforming loan may incur a lower cumulative default and be considered low risk, thereby incorporating the smallest risk based guarantor insurance premium, 12.5 basis points in our example," Lee and Carnes said. "As the tables suggest, the accumulated risk-based guarantor fees will aid the investor, classified as the GSEs or the private label originator as they will accumulate more credit reserves to offset future collateral losses," they said. The risk-tiered guarantor structure also benefits investors by adequately representing borrower credit risk. Higher note rates, reflective of credit will dictate higher reserves. "Overall impact to the servicing market of a reduced service fee and the use of a risk-based tiered guarantor fee may promote higher quality originations." Write to Christine Ricciardi. Follow her on Twitter @HWnewbieCR.

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