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The ownership of mortgage servicing rights (MSRs) has been a popular trade and a growing trend in today’s market conditions. We have seen a strong uptick in activity and marketing of servicing rights. The decision to hold or purchase servicing may seem simple, given the historic low rates and overall quality of the loans produced over the last mortgage origination cycle. As a result of these factors, there have been a number of new entrants holding or buying MSRs.

The holding of servicing rights is the classic countercyclical play in mortgage banking. When originations are down, the servicing income acts as a natural hedge and will typically move in the opposite direction of origination cycles. When rates are low, refinance activity is high, and the servicing value decreases, with the opposite occurring when rates move up again.

Independent mortgage originators that have traditionally sold servicing rights are now holding onto assets; over the last year, new firms have been specifically formed to aggregate and hold servicing rights. In addition, some of the largest servicers have been consolidating and buying servicing with significant purchases of both relatively newly minted MSRs, as well as purchases of significant legacy assets.

It also appears as if the overall price for these assets has increased close to 40% to 50% over the last year, as we came out of a period where the multiples paid for servicing rights seemed artificially low.

The economic decision to own servicing might seem simple, but only on the surface. It is actually a cash-flow analysis based upon the gross fees earned less costs (either internal or third-party) with an assumed prepay speed, default rate and discount rate applied. Obviously, the value can fluctuate greatly based upon the assumptions, costs and actual performance of the pools. There may also be significant risks and great upside to holding these assets.

As the decision is made to purchase and/or hold servicing rights, the owner must consider the options for servicing. Though it may seem to be just a comparison of cost, the reality is that the environment is more complex and there are most likely additional or hidden costs and risks associated with either option. In other words, in today’s environment, it may not be as simple as hiring a subservicer and accounting for the spread between the gross servicing fee and the subservicing expense or internal costs.

The investors and regulators are adding a significant cost in compliance and performance management. Requirements by the government-sponsored enterprises (GSEs) and the consequences for minor and major mistakes can be material. While individual states continue to augment and change regulation (which adds expense to the process), the Consumer Financial Protection Bureau (CFPB) is an unprecedented entity in the mortgage compliance landscape and is likely here to stay. There are more complexities in today’s regulatory environment for a servicer than ever before.

So how does a company that wants to own servicing compare the expense and alternatives between in-house and outsourcing servicing? Servicing loans in-house may be a viable option at a certain account level and perhaps may be only a captive solution. An originator may have a geographic concentration or single investor outlet that limits the compliance and investor risk and management burden.

Third-party servicing requires an entirely different level of operational complexity and expertise that a simple, true in-house operation may not need. In addition, a third-party servicer generally has additional resources and unique functions that may not be found - or even required - in an in-house solution. For example, best-in-class, third-party subservicing has robust client management resources and sophisticated reporting and data integration capabilities that a captive servicer does not need.

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There also might be a size or loan count where it could make sense to service in-house. For a smaller portfolio or originator, it may be possible to leverage existing resources and have certain personnel fill multiple roles. Of course, there is risk to this approach, and it may be challenging to find people who have expertise across multiple operational domains. And if the staff is too small, there may be a coverage issue. We have seen success with this approach when an institution such as a small bank or credit union has other asset types it is servicing and can easily leverage similar department functions such as collections or payment processing across the mortgage operation.

So why would a company want to service loans in-house, and under what scenarios does it make sense? There may be a customer relationship or specific requirements an originator has that cannot be replicated by a third-party servicer. There may also be cost differential appearing to favor in-house; however, in today’s environment, third-party subservicing fees can be quite reasonable.

Outsourcing to a true third-party subservicer is not as simple as it has been historically. The oversight and governance model that is required for an owner of servicing rights is unprecedented. It is not as easy as sending your loans to a subservicer and collecting the net servicing fee every month. Best practices include an appropriate level of oversight and involvement in the subservicer’s operations. This may require engaging a third party to perform surveillance, or hiring servicing expertise in-house. These are some of the hidden costs that may be overlooked and not included in a quick cost comparison analysis.

A subservicer should fully embrace the idea that an owner of servicing rights be engaged with its operations. Transparency around all activities and every function a subservicer does may be critical for MSR owners.

A third-party subservicer today should be a partner - and an extension - of the servicing rights owner. But true partnering requires a whole new way of operating.

First and foremost, each client and asset type needs to be treated differently, resulting in a unique solution - and there are not many subservicers that can accommodate flexible, customer-specific solutions. Of course, the complexity of the relationship is most likely impacted by the fact that the loans are probably owned by Freddie, Fannie or Ginnie. So, even though the subservicer has a unique solution in place for the MSR owner, the servicing practices and guidelines may be dictated ultimately by the investor.

So what should an owner of MSRs consider when engaging a third-party subservicer in today’s market? First, selecting a servicer that is the right fit is critical. The factors to consider start with the types of loans being serviced, and expertise needed to properly manage the underlying assets.

Another consideration is how the subservicer will engage with the owner and accommodate the owner’s needs. Some owners may want to approve certain transactions, speak to their servicer daily, and exchange data back and forth, while others may only want to receive reports and meet monthly. To be efficient in oversight, the owner may consider the need to hire expertise or outsource the oversight function to a qualified, independent third party. In addition, the owner may also need a method to monitor regulation and investor changes and create a process to ensure the servicer has an adequate change management methodology.

Transparency is not just reporting and the receipt of after-the-fact information. To have the right level of insight into a third-party subservicer, an MSR owner should consider the following:

The challenges for an MSR owner include finding the right servicer that provides the appropriate level of transparency and having the ability to manage the vendor with the same level of expertise. Vendor management is a hot topic and is becoming more critical from a regulator point of view. The regulators and GSEs have all published additional guidance and rules regarding vendor management/oversight in working with third parties.

The Office of the Comptroller of the Currency (OCC) has recently updated its guidance on third-party risks and appears to be setting the standards for vendor management requirements. Overarching concerns around the overall quality of third-party oversight and the complexity of the relationships are leading the charge.

The new guidance focuses on a lifecycle of vendor oversight and risk and includes not only the selection process but also the ongoing monitoring and termination. Even if an owner of MSRs is not subject to oversight by a bank regulator, it may make sense to follow the model being built by these agencies to minimize risk.

A couple of interesting components of the new guidance include requirements such as these:

So there is more involved than just looking at the subservicing fee. An MSR owner must also consider what expense and expertise will be needed to appropriately manage the subservicer. The asset owner has to also have processes established to monitor and understand the regulations and investor requirements - it shouldn’t be in a position where it has to rely on a third-party vendor to provide all the guidance.

The idea of internally servicing assets does pose other challenges and risks - and the true cost may not be easily calculated. Compliance risk, adhering to CFPB requirements and just plain old-fashioned customer service are a few of the costs that may not be included in a simplified cost analysis. In addition, it may be just a lack of focus or expertise that creates the biggest issues long term.

Both options of in-house or outsourcing to a subservicer have definite pros and cons - and it is certainly not as simple as comparing a subservicing fee against internal direct labor costs. The best option may be different for each scenario or situation - but fully understanding the complete costs and true requirements for either solution is a great start.s

 

Dave Vida is president of LenderLive Lending and Loan Servicing. He can be reached at dave.vida@lenderlive.com

Subservicing

Mortgage Servicing Rights: Today’s Owner Dilemma

By Dave Vida

Lenders are increasingly bringing their servicing rights back in-house - but what factors predicate the use of a subservicer?

 

 

 

 

 

 

 

 

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