Mortgage servicers flourished during the financial crisis and have exponentially grown their businesses, largely through acquisitions of credit-impaired residential mortgage servicing portfolios. But all of this is about to change, according to a recent report from Moody’s Investors Corp. (MCO).
"The mortgage servicers covered in the report have grown dramatically following the financial crisis. As the housing market continues to improve, the companies will benefit from increasing profitability, a credit positive," Moody's Senior Vice President Warren Kornfeld said. "But high growth and rapid transformation continue to present significant operational risks that constrain their ratings."
Special servicers saw exponential growth in 2013, with Nationstar Mortgage Holdings (NSM), Ocwen Financial (OCN), and Walter Investment (WAC) launching onto the list of top ten residential mortgage servicers in the U.S. by market share. While as recently as early 2012, none of the companies made it into the top 20, Moody's said.
But with such rapid growth comes a hefty risk.
Kornfeld explained that some people believe that a wealth of opportunities still exist, but at some point in time, the opportunities will slow down.
"At that point in time, they will have to sacrifice profitability or they will have to get smaller. At some point in time, we are going to play out through the cycle," Kornfeld added.
As the companies growth rates slowdown, their free cash flow will increase, in particular as they realize the benefits of significant investments in their servicing businesses.
How the companies choose to deploy this excess cash flow will be pivotal in sustaining their success, the report said.
"A potential credit negative would be if the companies sacrifice profitability or increase operating risks to continue their rapid growth, let alone defend their current servicing market share. Given our outlook of the size of the non-prime mortgage banking market, along with the companies’ expertise in that market, we believe the companies will have to choose between lower profitability, lower market share, or expand into other lines of business," the report said.
On the positive side: the recovering housing market will lower delinquency and default rates, which will lower servicing costs.
Additionally, as economic growth picks up, interest rates will rise, resulting in fewer mortgage prepayments. As a result, it increases the duration of the companies’ servicing portfolios, in turn increasing the valuations of their MSRs.