Mortgage Servicing Assets and Selected Market Developments

Mortgage Servicing Assets and Selected Market Developments

June 29, 2022
Mortgage Servicing Assets and Selected Market Developments
A mortgage servicer receives a fee to perform various
to a mortgage portfolio, prospective servicing firms
administrative tasks that include collecting and remitting
typically place bids on them at auctions. After settling on a
the principal and interest payments made by a borrower to
price, a servicer may need to borrow funds to purchase the
the owner (e.g., lender, investor) of the mortgage asset;
MSAs. One option may be to obtain a cash advance loan
managing the borrower’s escrow account; processing the
that uses anticipated ESFs as collateral. If a rising timing
loan title once paid in full; and administering loss
risk causes an MSA’s cash flow (and value) to decline, then
mitigation (e.g., forbearance plans) or foreclosure
the servicer would likely receive a margin call, which
resolution on behalf of the lender if full payment is not
would require either more collateral to be pledged or the
received. Mortgage servicing assets (MSAs), also referred
cash advance to be repaid in full. Macroeconomic events
to as mortgage servicing rights, generate fees reportedly
(e.g., interest rate movements, rising unemployment) may
averaging 25 basis points (0.25%, or $250 per $100,000 of
trigger large amounts of unanticipated prepayments or
an outstanding mortgage balance) per month. This InFocus
defaults of mortgages, resulting in no ESF payments and
describes the market for MSAs, recent developments, and
possibly material financial losses for servicers.
issues pertaining to cash flow volatility.
Selected Regulatory Developments
Background
Several regulatory developments following the 2007-2009
Just as a mortgage is an asset for the owner, the right to
Great Recession had MSA market ramifications.
earn income for servicing a mortgage is an asset for a
servicer. MSAs have properties similar to other assets.
Bank Capital Requirements and Implications. According
MSAs are traded (bought and sold) in a separate market
to the Federal Reserve, nonbank servicers purchased a
from the original underlying mortgages. MSA values are
significant share of MSAs beginning in 2011 following
based upon the discounted sum of expected future cash
bulk sales by large banks in anticipation of the 2013
flows, calculated based upon the expected cash flows
revisions to banks’ capital requirements that increased the
generated by the underlying mortgage itself. An MSA is
cost to hold MSAs. Specifically, if a bank’s MSA holdings
conceptually similar to a financial derivative in that its
were valued at less than 10% of its common equity value, a
value is linked to the performance of an underlying asset.
risk weight of 100% would be applied to that amount. The
An MSA’s cash flows are linked to the cash flows of an
risk-weighted amount would then be used to calculate how
underlying mortgage, which typically faces two key timing
much additional capital must be held to absorb any
risks:
potential credit losses. However, a bank’s total capital
reserves would be reduced by the value of MSA holdings
1. Mortgages have prepayment risk—the
exceeding the 10% threshold. On July 22, 2019, the federal
risk that a borrower repays the mortgage
banking agencies reduced the costs to hold MSAs for non-
early or ahead of schedule, causing the
advanced approaches (non-AA) banks (i.e., defined as
asset to generate a lower yield (return)
having less than $250 billion in total consolidated assets or
than initially expected. Declining interest
less than $10 billion in foreign on-balance sheet exposure).
rates increase a mortgage’s prepayment
Specifically, a non-AA bank’s MRS holdings may exceed
risk, causing the value of the linked MSA
25% of its common equity before having to reduce its
to decline in anticipation of terminated
capital reserves. However, the risk weight for MSAs below
future cash payments.
the threshold increases from 100% to 250%. After the
2. Mortgages have credit (default) risk—the
revisions to banks’ capital requirements, the Bank Policy
risk that a borrower pays late or fails to
Institute announced that non-AA banks increased their
repay the principal and interest
MSA holdings relative to the large AA banks by a
obligations. Default risk reduces the cash
statistically significant amount.
flows for a mortgage and its linked MSA.
Furthermore, the costs to service a
Consumer Protection Revisions and Implications.
defaulted mortgage rise substantially.
Servicers must comply with multiple sets of servicing rules
Servicers’
that are designed to establish policies and procedures for
potential profits, known as the excess servicing
borrower disclosures, notifications, and various other
fees (ESFs), are the difference between the fees charged and
protections. The Consumer Financial Protection Bureau
servicing costs when borrowers repay mortgages as
(CFPB) found that information about borrowers’
scheduled without any prepayment or default actions.
circumstances was lost during transfers of delinquent and
defaulted mortgages from current servicers to specialty
Servicers purchase the MSAs upfront for the right to
servicers, which specialize in servicing such loans, thus
receive future cash flows. Because the unpredictability of
resulting in delayed loss mitigation applications and
timing risks increases the difficulty to value MSAs linked
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Mortgage Servicing Assets and Selected Market Developments
resolutions. Hence, the CFPB—as well as other federal and
liquidity pressures because (1) they had to continue
federally related entities that promulgate their own
forwarding payments to investors holding federally
servicing rules—addressed borrower protection issues
guaranteed MBSs, and (2) they faced margin calls
during these MSA transfers. In 2014, the CFBP specifically
following the decline in their MSA values.
revised servicing rules for distressed mortgages and
Ginnie Mae and the Federal Housing Financing Agency
transfers that would not be guaranteed by a federal or
(FHFA)—the primary regulator for the GSEs, including the
federally related entity. Compliance with these rules
Federal Home Loan Bank (FHLB) system—subsequently
requires greater interaction with borrowers to ensure that
announced the expansion of various programs that would
information is not lost during transfers of distressed loans.
support liquidity for mortgage servicers. On April 7, 2020,
Greater reliance on manual labor, however, arguably runs
Ginnie Mae announced a private market servicer liquidity
counter to financial industry trends to automate mortgage
facility for its servicers that borrow to finance their MSAs.
servicing functions to streamline costs. Hence, servicers
On April 21, 2020, FHFA announced that servicers for GSE
minimize the risk of incurring material costs to service non-
mortgages will have no further obligation to advance
performing loans by bidding predominantly on MSAs
scheduled payments after having advanced four months of
linked to mortgages originated for borrowers with pristine
missed payments. In addition, FHFA allowed member
credit quality.
institutions of the FHLB system to post residential
mortgages in forbearance (i.e., the consumer defers
Credit Union Participation in MSA Markets. Partly in
payments) as collateral, which would allow them to
response to the Savings and Loan crisis of the 1980s, the
continue receiving cash advances from their regional
National Credit Union Administration (NCUA), the
FHLBs. Some of the 11 FHLB institutions established
primary regulator for credit unions, limited credit unions’
additional collateral relief programs to allow member
exposure to various mortgage risks and MSA market
institutions to continue receiving wholesale funding.
participation. Specifically, a credit union could retain the
MSAs for its own loan originations, but it could not directly
Pay (Share Risk) Now or Pay Later?
purchase MSAs. Over time, credit unions have been
In sum, MSAs are highly sensitive to sudden cash flow
allowed to increase their participation in the mortgage
shifts, and nonbank servicers are unlikely to enjoy the same
market and their use of financial derivatives to hedge
access to funds as depositories (i.e., banks and credit
exposures to mortgage-related risks. On December 23,
unions). In addition, servicers finance their MSAs by
2021, the NCUA also permitted federal credit unions that
forgoing some ESFs as opposed to setting aside financial
meet the requirements to be well-capitalized to purchase
buffers for unanticipated macroeconomic events that would
MSAs from other federal credit unions. The ability to
cause a decline in MSA values. Because Agencies’ MSAs
purchase MSAs will allow those credit unions choosing to
owned by nonbank servicers now comprise the largest share
specialize in this market to bypass membership restrictions
of the MSA market, the Agencies may prefer that ESFs be
and profit from scale (higher volume) advantages.
set aside to forward investor payments and administer loss
mitigations to avoid foreclosures during adverse periods.
Recent MSA Market Resiliency Test
By April 2020, the Conference of State Bank Supervisors
Proposals for the Agencies to require their servicers to
estimated that nonbank mortgage servicers held MSAs for
accumulate higher cash buffers, likely to increase the costs
approximately 50% of the federally insured mortgage
to hold MSAs, could cause some nonbank servicers to react
market, which includes Fannie Mae and Freddie Mac—also
similarly to the large banks and limit their MSA holdings.
referred to as the government-sponsored enterprises
As previously discussed, the banking regulators and NCUA
(GSEs)—as well as Ginnie Mae, the federal agency that
recently implemented some regulatory changes that would
facilitates the creation of mortgage-backed securities
encourage greater participation by depositories in the MSA
(MBS) linked to mortgages insured by various federal
market. In addition, building cash buffers against mortgage
agencies. If a delinquency or default occurs on a securitized
timing risks and margin calls might be accomplished if
mortgage (typically held in a trust with other mortgages and
borrowers, the Agencies, or both share the costs. Although
funded with MBS issuances) by the GSEs and Ginnie Mae
increasing servicing fees, with the possibility of charging
(the Agencies), a servicer must forward timely payments to
higher basis points to higher-risk borrowers, is one option,
MBS investors until the distressed mortgage has been
various regulations discourage high-cost mortgage loan
repurchased out of the trust. Nonbank mortgage servicers,
originations. Another option may be for the Agencies to
however, lack liquidity comparable to banks either in the
hold excess capital on behalf of their servicers. Another
form of available cash, liquid assets, or access to federal
option may be to charge servicers insurance premiums, paid
backstops such as the Federal Reserve.
to an Agency or other third-party insurers, for access to a
specified amount of funds during an adverse event that
In response to the COVID-19 pandemic, the Federal
would be used for forwarding payments to investors and
Reserve lowered interest rates, increasing prepayment risks
mitigating foreclosures. Insurance may be less costly for
for existing mortgages. Although rising unemployment
many servicers compared to establishing their own capital
filings might have signaled increased mortgage credit risks,
buffers. Absent any action, stakeholders may be left to
rising home values may have had a dampening effect.
assume that the relevant federal agencies, Congress, or both
Meanwhile, the CARES Act (P.L. 116-136) still required a
will ease liquidity pressures for MSA holders in the event
foreclosure moratorium for all federally insured loans,
of market distress.
allowing borrowers to request from their servicers 180 days
forbearance relief for no additional fees and, if necessary,
Darryl E. Getter, Specialist in Financial Economics
an additional 180 days. Servicers also faced greater
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Mortgage Servicing Assets and Selected Market Developments

IF12151

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