Basel regulations are dampening growth of banks’ mortgage servicing business, allowing nonbank entities to swoop in and become major sources of mortgage servicing rights funding, said John Britti, an executive vice president at Ocwen Financial Corp. (OCN)

Britti said banks want to exit the servicing business, but will continue to be big buyers of servicing rights because they still have a fundamental cost advantage in funding.

“Even if they decide they want to be in it, Basel III restricts their ability to grow, so I think banks will have to pull on servicing,” he told an audience of mortgage servicing professionals Wednesday at SourceMedia’s annual mortgage servicing conference in Irving, Texas.

Basel III sets higher levels for capital requirements and is designed to ensure systemically significant banks possess enough capital to cover future risks. The Basel accords offer guidance to banks on sound banking procedures and place limits on capital and liquidity to avoid excessive risk-taking. The rules do not apply to financial firms that are not banks.

The regulations also put a cap on the amount of servicing banks can hold on their balance sheet. As it stands now, servicing rights can account for 100% of equity. Basel III limits that amount to 10%.

“Those regulations will dampen (banks) ability to grow their portfolios, so it will, in effect, deconsolidate that market,” Britti said. “You won’t see a handful of banks concentrating all on servicing anymore; instead you’ll (see) a larger number of banks holding servicing.”

You’ll also see many more nonbank servicers, he said.

Ocwen’s Home Loan Servicing Solutions is a precursor to a rise in nonbank players innovatively funding and running efficient servicing operations, Britti said.

Home Loan Servicing Solutions, based in the Cayman Islands, is a foreign investment firm designed to buy mortgage servicing rights from Ocwen. It went public in February and agreed to buy rights to servicing fees on roughly $16 billion in subprime loans. Britti said Home Loan transactions are priced with a 25% return-on-equity and cost of capital of 8.5%.

“That leverages up our ROE and makes us more competitive when we bid for new servicing,” Britti said. “It’s a similar concept to Castlerock, which is the entity that Nationstar uses. I think it’s the future for nonbank funding of MSRs."