Gauging The Mortgage Migration

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Most big mortgage lenders seem to have gotten the same memo: Your bedside manner stinks.

For that and other reasons, the biggest banks continue to sell off the portions of their portfolios requiring them to service mortgage loans, especially loans for which the borrowers are under stress.

On the receiving end are independent mortgage servicers, specialists in dealing with mortgage customers — and with problem loans in particular.

Bank of America (BAC) early this month agreed to sell servicer Nationstar Mortgage Holdings (NSM) some $215 billion in residential mortgage servicing rights. More than half are private-label securitizations that tend to be the most troubled and toughest to service.

Nationstar will shell out $1.3 billion for the portfolio. That will bring the total servicing rights it has taken over from banks in the last two years to nearly $400 billion, measured in unpaid principal balances of the loans.

Nationstar shares surged 14% the week the deal was announced.

In October, the bankrupt Residential Capital auctioned off $374 billion in mortgage servicing assets. The winning bidders: Ocwen Financial (OCN) and Walter Investment Management (WAC).

Ocwen and Walter barely registered on stock screens before last year. Nationstar went public in March, backed by co-investors Newcastle Investment (NCT) and majority owner Fortress Investments.

The three have since glowed on heat maps as they've scooped up hundreds of billions in loans shed by restructuring banks and become the top-three nonbank mortgage servicers in the industry.

"These companies are some of the best servicers of distressed loans," said analyst Kevin Barker of Compass Point. "Banks are not very good at servicing distressed and credit-sensitive loans. The special servicers have been doing this for decades.

The trio have been the driving force behind IBD's mortgage and real estate services industry group, which has held a top five ranking among 197 industries tracked by IBD since June.

Another driver, CoreLogic (CLGX), is a real estate and mortgage data and analytics firm that separated from title insurer First American Financial (FAF) in 2010. Its shares rose 86% in the 12 months through Thursday.

In the ResCap deal, Ocwen will gobble up all but the $50.4 billion Fannie Mae (FNMA) portion of ResCap's portfolio. That smaller portion was awarded to Walter, which also landed origination and capital markets platforms in the deal.

Nationstar lost out on ResCap, but prevailed in the Bank of America deal. Banks aren't done downsizing portfolios yet, analysts say. In addition, the federal regulator overseeing government service agencies such as Fannie Mae and Freddie Mac (FMCC) is encouraging them to transfer mortgage servicing from banks to special servicers, Barker says.

"(Banks) are looking for partners like us to help them," said Nationstar Chief Executive Jay Bray. He says Nationstar, Ocwen and Walter will be prime beneficiaries since they've been at it longer than most.

"The size and level of servicing that has been moving in the last 12 months has been the largest it's been historically," Bray said.

Critical Mass Mortgage servicers get paid a fee for the loans they service. A standard servicing fee is 25 cents per $100 of unpaid loan balance, or $250 a year on a $100,000 outstanding loan. Fees are higher on loans that require more work, such as adjustable rate mortgages. Distressed loans can bring added servicing fees, and incentive and modification fees can add another 5 cents per $100.

The key is to balance yield and risk across the portfolio.

"Servicing is a business that works better if you have a substantially large number of loans to spread costs over," said Fitch Ratings managing director Diane Pendley.

This is where efficiencies of scale kick into effect. By applying account technology, systems and experience, servicers can work "just as cheaply on 1 million loans as they can on 1,000 loans," Pendley said.

Ocwen, Nationstar and Walter are growing in giant steps. Not only are they snapping up servicing rights offloaded by banks, they are acquiring smaller servicers.

The cost and hassle of complying with increased regulations has hit smaller servicers hard.

"We're seeing a lot of consolidation of servicers because their prior owners wanted to get out of the business," Pendley said.

In September 2011, Ocwen acquired Litton Loan Servicing from Goldman Sachs, which came with a $38.6 billion portfolio. It later bought Saxon Mortgage Services from Morgan Stanley.

Added Borrower Protection "Robo" signings on foreclosure papers and other sloppy mortgage-servicing practices used by banks during the housing crisis led to two multibillion-dollar bank settlements over abusive servicing and foreclosure practices.

First came a $25 billion Department of Justice settlement in February. This month, an $8.5 billion deal replaced a criticized earlier version. A foreclosure review was cut in favor of a program that distributes aid more quickly to eligible borrowers.

Major banks involved in both settlements — Bank of America, Citigroup (NYSE:C), JPMorgan Chase (JPM) and Wells Fargo (WFC) — were required to make extensive fixes to mortgage servicing and foreclosure processes.

Banks continue to face rising protections for borrowers. The most recent rules from the Consumer Financial Protection Bureau apply to nonbank servicers as well.

The new CFPB rules requires mortgage servicers of all kinds to work harder to prevent foreclosures, and to offer more information on insurance and loan-modification options. They can't, for example, push borrowers through the foreclosure process while they are seeking loan modifications.

"The CFPB rules are positive for specialized servicers in that they may result in banks offloading more products to them," Pendley said.

It also increases pressure on smaller servicers, driving the industry toward further consolidation.

"Smaller servicers are being challenged to make the economics work with the regulatory burden," said Bray.

Margins And Rules Major banks also are gearing up for higher capital requirements effective in 2014 under Basel III regulatory reforms.

Nonbank servicers aren't affected by the new liquidity rules, but more rules could spring from government service enterprises such as Fannie and Freddie, who have set base lines for a lot of the practices in the industry, Pendley says.

"And there are always individual state laws," she added, not to mention states' attorneys general clamoring for tighter regulations and cities setting their own requirements.

"Servicing is a constantly evolving business," she said. "It takes large companies years to retool all their procedures, retrain employees and get the technology down. And changes keep coming.

If priced correctly, however, mortgage servicing can still be a profitable business despite all the regulations, Pendley says. But it's "becoming less profitable because of the costs to meet all the requirements.

"Most of the servicers taking on additional product have seen the writing on the wall and they've had some time to prepare for these new changes and regulations," she said.

Outlook Bray expects servicing rights on $300 billion to $400 billion in unpaid principal balances to transfer to specialty nonbank servicers over the next 12 months.

Bank of America is likely to sell more of its portfolio, analysts say. Even giant mortgage origination and servicer Wells Fargo is said to be considering selling more of its servicing rights.

Nationstar estimates the mortgage servicing flow from banks to nonbanks over the next few years could run as high as $2 trillion. The total servicing market currently is around $10 trillion.

Servicing platforms could become more valuable if interest rates go up because borrowers won't be as inclined to refinance out of a loan, Bray says. "So the servicing will stay with us longer, which makes it a more valuable asset," he said.

Servicing costs are rising, although higher volumes help leverage those costs. Ocwen's earnings are expected to soar more than 250% from 2012 to 2014, according to Thomson Reuters. Nationstar's and Walter's are each seen rising more than 140% over that time.

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