Christopher Whalen: So what is today's nonbank business model?
Regulatory pressures amount to legalized extortion
So far 2014 is turning into a mixed bag for nonbank financial firms focused on the mortgage sector. And it's not likely to change given the current regulatory attitude that amounts to nothing short of the legalized extortion of the mortgage business.
The Consumer Financial Protection Bureau and other federal regulators put the brakes on bulk loan transfers from the largest banks. The New York State regulator halted the transfer of about $39 billion in unpaid balance of mortgage loans rights to Ocwen Financial (OCN) from Wells Fargo (WFC).
Since last summer, federal regulators have quietly put in place a review process for loan transfers that requires both the seller and buyer of loans and mortgage servicing rights to gain approval.
Most recently, the State of New York has said it has concerns about Ocwen Financial and Nationstar (NSM), two of the nation’s largest mortgage servicing companies. Echoing the disinformation of the consumer protection community, Benjamin M. Lawsky, supervisor of the state’s Department of Financial Services, said his office had found a “number of potential conflicts of interest” between Ocwen and other public companies with which it has relationships. He said that these relationships could “harm borrowers and push homeowners unduly in foreclosure.”
What is happening with the nonbank financial firms at the state level is a continuation of the pro-consumer effort by various liberal groups and elected officials that has been underway since the start of the subprime crisis.
As I told a housing panel at American Enterprise Institute in Washington, D.C. earlier this month, the cause of the subprime crisis was securities fraud – not the violation of consumer rights.
Yet looking at the Dodd-Frank law, the state AG settlement and the regulations promulgated by the CFPB, you’d believe that the problems with consumers were the sole cause of the 2008 financial crisis.
“One of the factors causing the foreclosure crisis to sludge along and even to large degree run-in-place, is the amount of misinformation that has been allowed to proliferate throughout the country,” notes Martin Andelman, host of the “Mandelman Matters” program and a keen observer of the industry.
“As time passed and the crisis worsened, absent any factual communications to the contrary, the problems of correlation and causation started to multiply. Georgetown Law professor Adam Levitin and Tara Twoomy, in an effort to explain what was happening to homeowners, published a paper in 2010 titled Mortgage Servicing, that became the gospel for consumer attorneys and then homeowners across the country... and it remains so today. The problem is the paper's conclusions were wrong.”
The basic thrust of the Levitan Twoomy paper is that mortgage lenders and servicers want to push home owners into foreclosure, gain control over the homes and thereby profit. This fundamental error -- that it is good business to push a homeowner into foreclosure – is repeated constantly in the Big Media and by regulators like the CFPB and the State of New York.
Anybody with even the slightest idea about the world of distressed servicing knows that the law now requires that loan modification is the first order of business when a borrower gets into trouble. But apparently the folks at the CFPB and the State of New York, where it can take a creditor up to three years to foreclose on a house, have not gotten the memo.
If you actually know the world of distressed servicing, there are three golden rules when it comes to a non-performing loan.
First is keep the owner in the house.
Second is protect the asset and make sure that maintenance, taxes and insurance are current. And third is to preserve the cash flow of the loan via loan modification, if possible.
Keeping the family in the house and protecting the asset and cash flow, even with a substantial modification, is always better for the note holder, whether that is Uncle Sam or a private investor.
The conflicting regulatory guidance coming from the CFPB and other regulators makes the job of the nonbank mortgage companies and the large banks problematic. This lack of visibility in terms of costs and business processes makes it very difficult for investors and research analysts to assess the operations of the nonbanks and make informed decisions as to whether or not to recommend these stocks to investors.
For example, in the most recent conference call held by Nationstar regarding its 2013 financial results, Paul Miller from FBR Capital Markets asked CEO Jay Bray repeatedly how the bank is going to go from the current 6bp of profit on its servicing operations to the 11bp target that Nationstar has targeted for investors in its official guidance.
Miller noted that the various “extraordinary” expenses and restructuring costs had reduced the profitability of Nationstar below 6bp. At one point, Bray and Nationstar CFO David C. Hisey contradicted each other, suggesting that they really don’t know whether the “extraordinary” expenses that have occurred in the past few quarters won’t continue in the future.
Part of the reason that nonbank servicers such as Nationstar, Ocwen and Walter Investment (WAC) are not able to describe the “steady state” earnings and revenue of their businesses accurately for investors is that regulators like the CFPB and the State of New York are prescribing conflicting and often nonsensical regulations.
For example, the Consumer Financial Protection Bureau is probing "zombie" foreclosures, a phenomenon first revealed by a report by Reuters last year:
Zombie foreclosures result when banks begin a foreclosure — even going so far as to send the homeowners a foreclosure notice — but then abandon it, failing to alert the homeowners, who have often moved out, that they are still responsible for their vacant properties.
Borrowers, who don't realize they still own their homes, are then left responsible for mortgage debt, taxes and upkeep.
Technically, when a lender or servicer makes a decision to abandon a home, they are supposed to release the lien and notify the debtor. But if the debtor has already abandoned the property, what is the lender/servicer supposed to do?
This situation is complicated by another CFPB rule, which states that lender/servicers may not foreclose on delinquent borrowers until they exhaust the possibility of modification or other alternatives short for foreclosure. The CFPB and many states also have “cooling off” rules that essentially prohibit the lender/servicer from contacting a borrower in default for as much as a year. In effect, these rules make it possible for a home owner in default on a mortgage with a fully perfected lien to live in the house for free for years depending on the location.
The CFPB’s final regulations regarding mortgages, which became effective Jan. 10, 2014, prohibit mortgage servicers from beginning foreclosure proceedings until a mortgage loan is 120 days delinquent. During this period, the borrower may apply for a loan modification or other option and the servicer cannot begin foreclosure until the application has been addressed.
What this means is that a home owner can default on their mortgage and basically live in the house for free for at least half a year before the bank can even contact the debtor. In states like Massachusetts, the home of Democratic Senator Elizabeth Warren, there is an additional cooling-off period set by state law that starts after the federal cooling-off period is done.
Bottom line is that a Massachusetts resident can default on their mortgage and live in the house for free for a year before the lender/servicer is allowed to contact them.
So now you know why the large banks don’t want to touch a new borrower with less than a mid-700 FICO score.
Because of the pro-consumer legal regime in states like MA, home sales volumes are a fraction of pre-crisis levels. For this reason, secondary market prices for non-performing loans in states like MA, CT, NY and NJ are typically among the lowest in the nation.
The examples above illustrate why the largest banks are intent upon transferring servicing on many legacy loans to nonbank servicers with “high touch” capabilities necessary to deal with delinquent mortgages. But the obvious question is whether or not the special servicers can make money dealing with distressed loans given the interference and conflicting laws and regulations coming from the CFPB. Indeed, even if servicers do everything right, it still may not be possible to satisfy the doctrinaire liberals that populate the CFPB and state regulatory agencies.
Ocwen CEO William Erbey noted in the company’s most recent earnings conference call:
"I'd like to address various comments I've seen in news reports regarding data on Ocwen's ability to serve distressed borrowers… Ocwen has completed more HAMP modifications than any other servicer, including Wells Fargo, Bank of America, Citibank and JPMorgan Chase, according to data from the U.S. Treasury. Indeed, we have done 20% of the total for all HAMP modification and 36 more -- 36% more HAMP modifications than the next highest servicer. Our performance on HAMP principal modifications relative to other servicers is even more impressive. We've accounted for about 39% of all HAMP principal modifications and exceed the number of the next highest servicer by a ratio of 2:1."
Unfortunately, when you speak to federal and state regulators, they seem to believe that firms such as Ocwen are in business to exploit and abuse American consumers. The fact that keeping families in their homes clearly is the optimal business strategy for servicers does not seem to impress hardened political climbers such as CFPB chief Richard Cordray and his lieutenants.
Indeed, at the end of the day, it appears that career politicians like Richard Cordray are not interested in fixing the mortgage market, but instead seem only interested in extracting settlements and payments from banks and nonbank firms alike.
This legalized extortion is done in the name of “protecting consumers,” but the true objective of the exercise is clearly political.
Until the attitude of regulators changes, it will be very hard for nonbank firms to be able to stabilize their businesses and describe them accurately for investors.