The Federal Housing Finance Agency proposed two mortgage servicing compensation models Tuesday, prompting the market to quickly react with a list of pros and cons. Analysts Henry Coffey Jr. and Jason Weaver with Sterne Agee released a note evaluating the proposals. The first would essentially reduce the bottom-line servicing fee on government-sponsored enterprise loans to 12.5 to 20 basis points from 25 bps while creating a reserve of three to five basis points of principal balance to fund "nonperforming servicing or what (the analysts) call special servicing," the Sterne Agee analysts said. Steve Horne, CEO of Wingspan Portfolio Advisors, supports the FHFA initiative saying, "it’s a step in the right direction because there is clearly a misalignment of incentives and interests under the current compensation structure." "I applaud the fact (the regulator) is saying special servicing should be independent of primary servicers. I appreciate the intent," Horne said. Additionally, Horne said he has no problem with the idea of funding special servicing shops because they have the potential to pay for themselves through the increased value they bring to portfolios through their work. Sterne Agee analysts said the second plan would pay a fix dollar amount for each loan serviced while also separating "the reps and warranties guarantee that was made by originator/servicers from the servicing contract." As far as what's good and bad about the proposals, Sterne Agee analysts say lowering servicing fees upfront will reduce the amount of excess servicing that originators who sell mortgage servicing are required to fund, thereby enhancing the realizable cash gains that come with selling servicer retained mortgages. Deutsche Bank (DB) adds that Fannie Mae and Freddie Mac would get increased discretion to create incentives for good credit performance and impose penalties for fast prepayments. "Market participants may worry that servicers will have reduced disincentives to solicit borrowers for refinance," said housing analyst Doug Bendt. "But FHFA plans to require the GSEs to monitor servicers and give them the option to impose fees on those with prepayment speeds much faster than their peers." Furthermore, the Sterne Agee analysts said, "the creation of a reserve account or a set of special fees to pay for nonperforming servicing creates the funds to pay for the extra services and legitimizes the concept of a special servicer." This should give banks an avenue and structure to fund the services provided by special servicers "without harming the profitability of the core, payments, processing business," according to the Sterne Agee analysis. By bifurcating servicing, the analysts say regulators will unfreeze the market for servicing sales since many in the industry blame reps and warranty risks for freezing up the market. "Under Basel III, banks could be required to allocate up to 17% of capital to MSRs. By potentially reducing/eliminating excess servicing and facilitating the more ready sale of MSRs, these proposals should be a positive for banks," the Sterne Agee team concluded. "The proposals should reduce the capital commitment required to originate mortgages, a positive for smaller, non-bank originators and by implication a negative for bank originators." As far as claims that the deals will impact payment speed, the Stern Agee analysts speculated there won't be any negative impact on that front, saying the "driving force behind mortgage refinance is not servicers." Overall, Horne with Wingspan said, "I think it's a good opportunity. It's consistent with a lot of trends. Special servicers have existed for years in the commercial space." Moving this set-up more into the residential space is just a natural step and a new truth, he said. Write to Kerri Panchuk.