The Big Shift

Over the last few years, the contours of the mortgage industry have been reshaped as non-banks have tripled their share of originations while the largest banks have scaled back.

 

Mortgage Banking

July 2015

By Robert Stowe England

 

The tectonic plates beneath the mortgage business landscape have been steadily shifting for years, reconfiguring and reordering the lineup of players and delivering a seismic shift for the entire industry. Just as large banks have scaled back their outsized role as paramount providers of mortgage credit, non-bank mortgage banking companies have been moving to fill the void.

 

As a result of the shift, the non-bank share of all origination volume has tripled, from 13.8 percent in 2012 to 43.3 percent in the first quarter of 2015, according to Inside Mortgage Finance.

 

This recent restructuring of the market follows years (2009 to 2012) when a handful of large banks dominated the mortgage industry. That dominance resulted in large part because several prior non-bank mortgage players went under during the housing bust.

 

Long after the mortgage meltdown of 2007 and the financial crisis of 2008, the top banks in the mortgage business are still dealing with problem loans made during the housing bubble and the aftermath of defaults, foreclosures, buybacks and settlements with government agencies and investors.

 

There continues to be, for the largest banks in particular, a fair amount of headline and reputational concern that has led them to reduce their exposure to the mortgage business, according to industry observers. "They have reduced their presence in the mortgage business, shrinking their servicing exposure, particularly their exposure to higher cost servicing and borrowers with lower cross-sell potential” according to Stanford Kurland, chief executive officer of PennyMac, based in Moorpark, California.

 

PennyMac, founded in 2008, is the eighth-largest mortgage originator, producing $8.82 billion in volume in the first quarter of 2015, according to Inside Mortgage Finance. Last year the company ranked 14th with $28.8 billion in originations.

 

Lawsuits, higher capital standards and other regulatory changes are part of “the big squeeze” that is reducing the share of mortgage business originated by big banks, according to Bob Walters, chief economist at Quicken Loans Inc., Detroit.

 

Due to the “pounding” big banks have endured from lawsuits and fines and penalties, “they have been chastened and are pulling back and being very careful about the lending they are doing,” says Walters.

 

A more risk-averse approach to the business has dried up the pipeline of originations coming from mortgage brokers, according to Walters.

 

“Prior to the financial crash of 2007 and 2008, about 30 [percent] to 35 percent of mortgage origination were done by mortgage brokers,” says Walters. These were small shops of two to 10 loan officers, but together they made up a vast army of originators.

 

“Tens of thousands of brokers would originate loans and they would end up being brokered to Bank of America, Wells Fargo, GMAC, Citi and Chase--all the large entities,” says Walters. “These brokers made the big banks the dominant part of the market,” he adds.

 

Now mortgage brokers represent only 8 percent to 10 percent of originations, Walters says. This is mostly as a result of regulation, especially the Secure and Fair Enforcement for Mortgage Licensing Act (SAFE Act), which required brokers and all originators to be licensed. In addition, the big banks have largely stopped doing business with brokers.

 

“Wells Fargo got out. Bank of America got out. Chase got out,” says Walters. “That share of the market has been picked up by other entities.”

 

Penalty juggernaut

 

One of the reasons big banks have been reducing exposure is because they have been penalized severely for how they have handled bad loans during foreclosures and for investor losses on loans and related securities issued before 2008. Federal and state governments have forced huge settlements after bringing a raft of lawsuits. The toll in settlement costs is staggering.

 

According to New York-based Keefe, Bruyette and Woods Inc. (KBW), banks had paid $187 billion in settlements and fines between 2009 and March 2015, mostly to the Department of Justice and state attorneys general.

 

Bank of America has taken the biggest hit, with a total payout of $76.6 billion or an astonishing 41 percent of the overall legal costs for all banks. Three more of the largest U.S. banks have also been hit hard. JPMorgan Chase has shelled out settlements and fines of $38 billion; Citigroup, $16 billion; and Wells Fargo, $10 billion.

 

To some, the penalties seem draconian and perhaps not entirely justified, given they are based on loans made and securities issued by companies that were acquired during the financial crisis at the urging of federal authorities.

 

For Bank of America, for the most part the penalties are for the misconduct at two companies that occurred before the bank acquired them: former market leader Countrywide Home Loans and Merrill Lynch. According to the Department of Justice, the settlement included a statement of facts, in which the bank has acknowledged that it sold billions of dollars of RMBS without disclosing to investors key facts about the quality of the securitized loans. The DOJ also claimed the bank conceded that it originated risky mortgage loans and made misrepresentations about the quality of those loans to Fannie Mae, Freddie Mac and the Federal Housing Administration (FHA).

 

For JPMorgan Chase, the greatest share of the penalties has been paid for misconduct at Bear Stearns and Washington Mutual before the bank acquired them. While the Department of Justice claimed at the time of the settlement in December 2013 that JPMorgan had admitted making "serious misrepresentations" to investors in mortgage-backed securities, bank executives have insisted they had not admitted to any specific violations of the law.

 

The severity of punishment has left an indelible mark. “It has had a very chilling effect on the banking industry,” says John Robbins, CMB, founder and board member of The Mortgage Collaborative, a San Diego-based independent lending cooperative serving small and midsized mortgage lenders.

 

The enforcement response has forced a rethinking that has led to a de-emphasis of the mortgage business. That reorientation has been made not only because of the losses the banks incurred from bad loans and securities, but also from the troubled foreclosure process that followed.

 

Big banks have scaled back mortgage exposure in varying degrees across their business, from origination to servicing. “Legacy portfolios and mortgage servicing rights have been sold and larger banks, to one degree or another, have narrowed their channels for originations by ending correspondent lending and restricting retail lending to the bank’s own customers,” according to PennyMac’s Kurland.

 

Fallout from Basel III

 

New capital rules that apply to banks and not their non-bank competitors are another engine driving the shift in lending from banks to non-banks. Chief among these rules is the Basel III rule that limits servicing rights to 10 percent of Tier 1 common equity. The rule is often cited as prompting an onslaught of MSR transfers from banks to non-banks beginning in 2010 and accelerating after 2012.

 

The Basel III challenge for large banks is that the mortgage servicing assets they already had on their balance sheet as common equity Tier 1 capital were greater than 10 percent of Tier 1 capital, which is maximum allowable under the new capital standards, according to David Fleig, president and chief executive officer of MorVest Capital LLC, a Houston company that has been active in arranging financing of MSR purchases, working with Customers Bank, headquartered in Phoenixville, Pennsylvania.

 

“The bid the big aggregators were putting out in the marketplace with their wholesale and correspondent units to acquire mortgages from third parties just really became a lot less competitive,” explains Fleig.

 

The low bid for MSRs, in turn, gave independent mortgage banking companies an opportunity the industry had not seen in a long time.

 

“For the first time in a couple decades, independent mortgage bankers could say, ‘If we retain the servicing, then we’re going to have better economics than if we sell it servicing-released. It’s worth more to us to keep it than to sell it,’” says Fleig.

 

Beginning around 2010 an increasing number of independent mortgage bankers, many of them having started as new businesses after the financial crisis, began selling whole loans directly to Fannie Mae and Freddie Mac and retaining the servicing.

 

“A whole new generation of mortgage bankers had to rediscover mortgage banking” and learn or relearn the servicing business, usually beginning by hiring a subservicer, says Fleig. Then in the intervening years, the trickle of MSRs moving to non-banks or being retained by non-banks turned into a river.

 

“In the last three or four years, there has been an enormous shift generally in the industry toward servicing volume going to big mortgage bankers, whether they are retail, wholesale, correspondent or some combination,” says Fleig.

 

Ocwen Financial Corporation, Atlanta, for example, grew to become the nation’s largest non-bank servicer by buying up MSRs from banks trimming down their exposures. However, since last year, after running into problems with managing customers in its servicing portfolio, Ocwen has been selling off its portfolio of agency MSRs representing $89 billion in loans and is reinventing itself as a non-agency mortgage servicer.

 

In a surprise move JPMorgan Chase bought Ocwen’s servicing rights for 266,000 prime Fannie Mae loans with an unpaid principal balance of $45 billion --more than half Ocwen’s agency servicing rights.

 

Banks curtail FHA exposure

 

Nowhere has the shift from banks to non-banks been more pronounced than it has for loans insured by the Federal Housing Administration (FHA).

 

Ginnie Mae, the government agency that insures securities backed by pools of FHA-insured loans, has found itself in a front-row seat monitoring the shift to non-bank lenders. In 2011, about 18 percent of securities guaranteed by Ginnie Mae were issued by non-banks, according to Ted Tozer, president of Ginnie Mae. (See “Q&A with Ted Tozer,” also in this issue of Mortgage Banking at this link.

 

“Now around 65 percent of securities we’re guaranteeing are for non-banks--so it’s a pretty dramatic change,” Tozer says.

 

FHA represents about 20 percent of the residential mortgage market and to the extent banks are getting out of FHA lending, it represents an opportunity for non-banks that want to expanding their lending volume, according to Kurland at PennyMac

 

A draconian penalty involving treble damages of $614 million on $200 million of FHA-insured loans levied against JPMorgan Chase last summer put an added spotlight on the risks that come with originating loans insured by FHA.

 

It may have inadvertently turned an orderly reduction in FHA lending by big banks into a stampede for the exit.

 

“The real question to me is, should we be in the FHA business at all,” JPMorgan Chase’s chairman and chief executive officer, Jamie Dimon, told investors last summer during an earnings conference call.

 

JPMorgan Chase has since slashed its FHA lending. For all of 2014, it reduced FHA lending by 74 percent, according to Inside Mortgage Finance, while the mortgage industry overall shrank its FHA-insured business by 37 percent. In the first quarter of 2015, JPMorgan Chase’s FHA lending was down 86 percent from a year earlier while overall origination activity rose 40 percent.

 

As a result, the bank’s ranking among FHA lenders fell from sixth for all of 2014 to 68th in the first quarter of 2015, according to Inside Mortgage Finance.

 

The Mortgage Bankers Association (MBA) has taken issue with the triple damages being charged lenders over FHA-insured loans for what are seen as tiny, inadvertent mistakes. Mortgage lenders have been pressing the Department of Housing and Urban Development (HUD) to spell out more precisely what types of mistakes are going to subject them to triple damages. In May the FHA released for comment proposed guidelines to clarify what certifications lenders must make for FHA-backed loans.

 

Heavy claims paid out on FHA insurance-backed home loans made during the housing bubble required a $1.7 billion infusion from the Treasury to the insurance fund backing the FHA program to restore the required capitalization level to the fund. That was the first time the FHA insurance fund required such a draw on the Treasury after years of earning profits and being in the black.

 

The Mortgage Collaborative’s Robbins also faults new servicing rules imposed by the Consumer Financial Protection Bureau (CFPB) for pushing a lot of the mortgage servicing business out of the banks.

 

“Servicing regulations have become even more difficult, and impose a lot of new standards that make servicing more expensive,” says Robbins.

 

This, in turn, makes servicing less profitable for all but the highest-credit-quality loans that do not require a lot of extra work for the bank. This makes the banks “shy away from lower FICO® score lending,” such as at FHA, and stick with conforming loans that can be sold to Fannie Mae and Freddie Mac, says Robbins.

 

Not surprisingly, banks continue to keep in place many of the credit overlays above and beyond the underwriting requirements of Fannie Mae and Freddie Mac, as they also limit new loans almost entirely to plain-vanilla Qualified Mortgages (QM) as defined by new federal rules from the Consumer Financial Protection Bureau.

 

By pursuing this strategy, large banks are giving up market share to focus more on loan performance and safety, according to Guy Cecala, chief executive officer and publisher of Inside Mortgage Finance.

 

Non-bank advantages

 

The void left by banks pulling back on FHA lending, correspondent lending and even retail lending gave non-banks an open field to win new customers.

 

“To me, it’s somewhat natural that some of the non-bank mortgage banks would start to increase market share based upon the conservative lending of banks,” says Robbins.

 

As the founder of several independent mortgage companies, Robbins has a record of identifying where the opportunities lie for independent mortgage bankers. He founded American Residential Mortgage, which he sold in 1994 to Chase Manhattan Bank (now JPMorgan Chase) and founded American Mortgage Network, which was sold in 2005 to Wachovia (now Wells Fargo & Co.).

 

Mortgage bankers can offer a wider range of products than most banks offer, Robbins says. Because of that, he contends, they can better match the best products to the borrower’s needs. Robbins further argues that mortgage bankers typically offer better service and do a better job of shortening the time it takes to close a loan. This ability derives from a long tradition of mortgage bankers having ties to real estate agents, “who demand a high degree of service,” Robbins says.

 

On the negative side, independent mortgage bankers today are being held back by persistent weakness in the private-label residential mortgage-backed securities (RMBS) market. Mortgage bankers typically have preferred originating jumbo loans and selling them into the secondary market, according to Robbins. This means that jumbo loan products, which can be as much as 20 percent of the market, according to Inside Mortgage Finance, are largely a portfolio lending product today for banks--both large and small.

 

Non-banks, along with smaller banks and community banks, have improved their competitive position in the all-important prime market for conventional Fannie Mae and Freddie Mac loans, thanks to the fact the Federal Housing Finance Agency (FHFA) has directed the government-sponsored enterprises (GSEs) to raise their guarantee fees (g-fees) for larger lenders and bring them in line with what they charge smaller lenders.

 

“In the past, the lower g-fees for the largest lenders created an uneven playing field for the banks because banks already have a natural advantage over non-banks with their low cost of funds,” says Robbins.

 

The combination of a lower cost of funds and lower g-fees “made it extremely difficult for mortgage bankers to compete against them,” he says. “The move to flatten GSE fees and make them more transparent has been a real boon to the industry,” he adds.

 

Servicer to originator

 

A number of today’s big originators got into the mortgage business first by acquiring mortgage servicing rights and then becoming originators of new loans from servicing customers who refinanced.

 

“When the servicing portfolios moved, obviously the client base of those servicers moved with them. And this was all around the time when the Home Affordable Refinance Program [HARP] was put into place in all its glory,” says Kevin Wall, president of First American Mortgage Solutions, a division of First American Title Company based in Santa Ana, California.

 

The sale of servicing rights created some of the largest servicing companies, including Ocwen Financial Corporation, which still ranked fifth in the first quarter of 2015 with $373 billion, even after selling off part of its servicing last year.

 

Nationstar Mortgage LLC, Dallas, passed Ocwen to become the largest non-bank servicer in the first quarter with a $390 billion portfolio. Then there’s Green Tree Servicing LLC a St. Paul, Minnesota-based company acquired by Walter Investment Management Company in 2011, which is ranked eighth with $236 billion in servicing in the first quarter.

 

In fact, five of the top-10 residential servicers in the first quarter of 2015 are non-banks, according to nside Mortgage Finance. In addition to Nationstar, Ocwen and Green Tree, there’s also PHH Mortgage, Mt. Laurel, New Jersey, ranking ninth with $224 billion in servicing, and Quicken Loans Inc., Detroit, ranked 10th with $167 billion in servicing.

 

The introduction of HARP transformed these same companies into some of the largest originators, according to Wall. “They had a captive portfolio of customers to market to, and with HARP, [they had] the lowest barrier-to-entry product,” Wall adds.

 

Refis are less-costly products to originate because they do not require a lot of expensive documents and there are fewer issues around appraisals, according to Wall.

 

The non-banks got a second refi wave after the FHA lowered its annual premiums by 50 basis points in January 2015.

 

“A lot of [FHA] loans that were not necessarily that old since origination now had another lower-cost structure even though interest rates didn’t move very much,” says Wall. This gave the large non-bank servicers another opportunity to create refinance origination volume, he explains.

 

Nationstar’s core competency is acquiring servicing and onboarding it--and the company is working to strengthen its marketing efforts aimed at its portfolio customers so it can “recapture” them when they refinance or move and need a new mortgage, according to Chad Patton, executive vice president of loan origination and business development at Nationstar.

 

“The vast majority of the origination volume we do and the vast majority of earnings we have is from our recapture effort,” Patton says. Nationstar ranked 20th in the first quarter of 2015 with $3.4 billion in originations, slipping from its 13th-place ranking for 2014 with $16.9 billion, according to Inside Mortgage Finance.

 

Nationstar, which has the largest non-bank servicing portfolio, has developed a marketing program it calls Customers for Life, which is aimed at improving its rate of recapture. The company also acquires new customers via its online and call center consumer-direct channel. Seventy percent of the company’s originations are tied to either recapture or new acquisitions via the consumer-direct channel.

 

Nationstar is also building both a correspondent channel as well as a builder channel, according to Patton.

 

Originator to servicer

 

Other non-banks have expanded as mortgage bankers by moving from a model where they originate loans and sell the MSRs to one where they originate loans and retain servicing rights.

 

“We’re a good example,” says Walters at Quicken Loans. Quicken Loans has grown into an origination powerhouse and is now third-largest originator, with $19.3 billion in origination volume in the first quarter of 2015 after producing $59 billion in loans for all of 2014.

 

By comparison, Bank of America Home Loans, based in Calabasas, California, is ranked fourth after Quicken Loans, with $13.7 billion in the first quarter of 2015 and $54.2 billion for all of 2014.

 

Only two large banks rank higher than Quicken Loans in origination volume. Wells Fargo remains No. 1 on the list of top originators, producing the top $48.1 billion in new loans in the first quarter and $180.2 billion for all of 2014. The second-largest originator is Chase Home Finance LLC, Edison, New Jersey, which generated $26.6 billion in new loans in the first quarter of 2015 and $87 billion for 2014.

 

Quicken Loans decided to get into the servicing business in 2010 and by the first quarter of 2015 had become the 10th-largest, making Quicken Loans the largest non-bank mortgage company.

 

In early May, Quicken Loans, which is closely held, did its first-ever bond offering, raising $1.25 billion. Investors snapped up the 10-year securities with a coupon rate of 5.75 percent, even though all but $250 million flowed back to the parent company, Rock Holdings Inc., which is 70 percent owned by Dan Gilbert, the founder and chairman of Quicken Loans.

 

Originator to securitizer

 

PennyMac’s overall business model goes back to 2008, when the company was founded as a new enterprise to participate in the mortgage industry. The company’s initial focus was on acquiring distressed loans and legacy loans but, from the beginning it planned to be in the mortgage origination and servicing markets.

 

PennyMac Financial Services, Inc. originates through the consumer direct channel via online and call centers in Moorpark, Pasadena, and Fort Worth Texas. The company also participates in the the correspondent aggregation business in partnership with PennyMac Mortgage Investment Trust (PMT), a publicly traded REIT that PennyMac Financial manages.

 

The company has a network of over 350 approved lenders. “We buy the loans through a set of guidelines and standards we’ve approved,” says Kurland.

 

PennyMac then pools and securitizes the loans, predominantly as Fannie Mae, Freddie Mac or Ginne Mae securitizations.  The company also aggregates prime non-Agency jumbo loans, although it is a relatively small part of the business, the company expects to grow its jumbo volumes. Finally, PennyMac services the loans it originates and has a $115 billion servicing portfolio, making it the 14th-largest, according to Inside Mortgage Finance.

 

PennyMac does not have retail branches. Its loan officers and fulfillment staff work at the call center hubs. Corporate marketing drives leads and opportunities to the call centers.

 

Importantly, our call center model drives leads to our account executives, providing greater efficiency and cost savings,” says Kurland.  PennyMac has 2,000 employees.

 

The advantages that have favored the growth of the non-banking sector may be abating, according to Kurland . Non-banks face a considerable amount of regulatory oversight from the CFPB, state regulators, the GSEs, HUD, VA, the rating agencies and their financing banks, in addition to increasing capital standards. “This regulatory oversight creates high barriers to entry, particularly if you want to operate a full-scale mortgage business on a national basis,” says Kurland.

 

“The costs of these regulatory and capital standard burdens will favor economies of scale and companies with access to capital,” Kurland says.

 

“For PennyMac, the ability to grow the servicing portfolios through our own production activities, PMT’s ability to co-invest with PennyMac Financial in the acquisition of MSR portfolios and access to the capital markets are all important competitive advantages,” Kurland says.

 

Regulating the non-banks

 

The surge in MSR acquisitions by companies that have now grown quite large has begun to slow down because of “regulatory friction,” explains Nationstar’s Patton. The GSEs and the CFPB are concerned because much of the servicing has moved away from institutions that were highly regulated to companies where regulation is not nearly as developed, he explains.

 

“Now you see a little bit different regulatory environment where people woke up and said, ‘Wait a minute, all these guys are very big--who’s regulating these guys and how?,’” says Patton.

 

The Federal Housing Finance Agency Inspector General’s Audit Report, “Recent Trends in the Enterprises’ Purchases of Mortgages from Smaller Landers and Nonbank Mortgage Companies, July 17, 2014, raised alarms about the rapid growth of non-bank servicers after non-bank servicing assets tripled in value between 2012 and 2014.

 

Earlier, the Financial Stability Oversight Council also registered concern when MSR holdings doubled from $806 billion to $1.7 trillion between 2012 and 2013, with acquisitions often financed by short-term funding.

 

Last summer, Ginnie Mae President Ted Tozer said that his agency was considering ramping up the capital requirements for Ginnie Mae servicers above the current requirements for a minimum net worth of $2.5 million and capital equal to 0.2 percent of loan balances in the servicing portfolio.

 

In May, the FHFA finalized new minimum financial eligibility requirements for net worth, capital ratio and liquidity criteria for Fannie Mae and Freddie Mac sellers and servicers. These requirements are expected to slow down the pace of transfers to non-banks.

 

The steps taken by regulators to ensure that non-bank originators have sufficient capital add a new wrinkle to the business. “Historically you didn’t have to be well capitalized to be a mortgage originator,” says Inside Mortgage Finance’s Cecala.

 

Significant capital was not required because the originator was selling all the loans it originated in an originate-to-distribute business model. In the new world order, where counterparty risk and repurchase capability have become a major focus, non-bank mortgage companies are facing the challenge that comes from holding on to MSRs and not selling them.

 

The bigger a servicing portfolio becomes the greater the capital requirement to make sure non-banks are not too thinly capitalized and vulnerable to market forces in a downturn.

 

“The easiest way for non-banks to build up capital is to use profits from servicing fees,” says Cecala. Most of the top-25 nonbanks are building up their capital this way, he adds.

 

“Mortgage bankers hold on to their MSRs, if for no other reason than it’s a good way to maximize the pricing of loans,” says Cecala. “You don’t have to sell them on a flow basis. You can hold them for several months and then sell them. Mortgages with any sort of seasoning--three months or so--get a better price than current production,” he says. “That’s because the borrower has already made several payments.”

 

The fact that a transfer of MSRs has fueled vertical integration in the mortgage industry is “a little ironic,” according to Mark Fleming, chief economist at First American Financial Corporation.

 

“There’s an element of back to the future,” he says.

 

Before the housing bust, there was a lot of vertical integration orchestrated by Wall Street firms like Lehman Brothers and Bear Stearns that securitized private-label securities. They bought up servicers and originators “to vertically integrate the process of creating private mortgages,” Fleming says. “I think there’s an element of that in place today,” he adds.

 

Instead of having big Wall Street firms vertically integrating by acquiring originators and servicers, Fleming says, the specialty servicers are vertically integrating to better manage the servicing of their own portfolios. Some, like PennyMac and Quicken Loans, are also becoming securitizers.

 

Fleming contends that the transfer of MSRs to non-banks has made it possible for “a lot of private capital to find its way into the mortgage marketplace and earn leveraged returns.” By comparison, in the era before 2008, private capital came into the mortgage market via investors in RMBS, he notes.

 

“This explains why there are a lot of bids for MSRs from hedge funds and private-equity funds,” Fleming says.

 

Wall agrees. “I think the MSR is the former RMBS,” he says.

 

It provides a place for investors to apply leverage to an asset pool, he explains. “Instead of doing that in bond tranches of [RMBS] securities, they’re levering on the MSR side.”

 

Focus on the footprint

 

The shift in mortgage origination market share away from large banks is not just to non-banks. It is also shifting to regional and smaller banks, according to Quicken Loans’ Walters.

 

One such bank that is expanding its share is Commerce Bank, a 195-branch bank based in St. Louis that originated $340 million in mortgages last year.

 

The bank sees an opportunity for growth by focusing on meeting the mortgage needs of its existing customers for home purchases, as well as refinancing mortgages, says Jeff Gerner, president of Commerce Mortgage Corp, Kansas City.

 

Prior to refocusing on existing customers, Commerce had been primarily concentrating on refinance mortgages it originated to hold in its portfolio. The prospect of higher interest rates more than a year ago got the bank thinking about how it would make up the lost profits from lower refinance volume. That led to a new strategy.

 

The bank decided it would find a way to do more purchase mortgage business and sell those loans into the secondary market and retain the servicing, according to Gerner.

 

The flattening of the g-fee structure has given Commerce Mortgage the opportunity to compete with big banks to do Fannie Mae and Freddie Mac conventional loans. To generate business, the bank established a direct-to-consumer call center for mortgages and also offers mortgages at selected branches of the retail bank.

 

“It’s a good opportunity to leverage customer loyalty and deepen the relationship,” Gerner says.

 

Small banks and community banks, even as they might seek to expand their mortgage business, are expected to focus more on conventional loans. “They like the quality of Fannie and Freddie loans. They prefer to compete for that business as opposed to FHA. They also have more experience in the Fannie and Freddie market,” says Cecala.

 

Challenge and opportunity

 

Non-banks that have grown large by buying and building up servicing rights are facing a cash conundrum, according to Fleig at MorVest Capital. “They are coming up against a brick wall with their balance sheets,” he says.

 

The larger independent mortgage servicers that have been acquiring MSRs for years are starting to see the MSR asset approaching the total net worth of the company, he explains. As a result, they have to figure out a way to add capital. Even though they can use retained earnings to build up capital, they no longer have the cash from a servicing-release sale and must rely instead on the cash available from the stream of fee income. That cash flow is not sufficient to allow companies that are plowing it back into capital to keep capital levels at minimal levels required by counterparties, according to Fleig.

 

Because of the cash shortfall and a thinning capital base, independent mortgage banking companies, as they expand and retain servicing, are going to need cash to continue to expand. Raising capital through new equity is not usually attractive, according to Fleig. This is due to the fact that investors who do not get a controlling interest are unlikely to pay a premium over book value. Most mortgage bankers do not want to give up control and do not want to strongly dilute the value of their holdings by selling a minority interest.

 

Fleig thinks it may be more attractive to issue mezzanine debt or preferred equity. “Eventually you’re going to get to a point where you’re going to have to do something else for the liquidity. When you start looking at MSR assets getting close to total net worth, that gets a little bit problematic,” says Fleig.

 

Independent mortgage bankers are also facing a servicing challenge as their portfolios grow ever larger and the quality of servicing starts to suffer as it begins to overwhelm subservicers’ capacity, according to Fleig.

 

“As this market evolves and independent mortgage bankers realize they are hitting critical mass, they will have to go ahead and hire people and bring servicing in-house,” he predicts.

 

In spite of the challenges, independent mortgage bankers are likely to continue to expand their share, according to Fleig, because the underlying dynamics that have been driving the shift remain in place.

 

The big bank aggregators are unlikely to increase their bid for servicing rights. Independent mortgage bankers will continue to find it more profitable to retain servicing and have origination capabilities--attractive enough to make it likely non-banks will find ways to meet their liquidity challenges and improve the management of their servicing portfolios, according to Fleig.

 

The competitive advantage now being enjoyed by non-banks, in short, will continue to remain a central reality of the mortgage banking industry. “It really has been in many ways a perfect storm for the opportunity it has created for mortgage bankers,” he says.  MB

 

 

 

Robert Stowe England is a freelance writer based in Milton, Delaware, and author of Black Box Casino: How Wall Street’s Risky Shadow Banking Crashed Global Finance, published by Praeger and available at Amazon.com. He can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it..

 

 

Robert Stowe England is an author and financial journalist who has specialized in writing about financial institutions, financial markets, retirement income issues, and the financial impact of population aging.

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