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MSR Values Gain As Banks Continue Sell Off - Christo EVP Prestwick MG

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Banks are scaling back from a 10 trillion market in mortgage servicing rights amid looming Basel III and CFPB regulations.  Private equity firms crowd the space driving prices upward.

George Christo, EVP of Prestwick Mortgage Group discusses recent MSR trading trends.

Transcript

0:07 S?

The 5 Star Radio presents mortgage markets today where industry experts discuss capital markets, trading, real estate, lending in the mortgage servicing industry. For more information on guests of 5 Star Radio mortgage markets today and podcasts of previous episodes, visit us at the 5starradio.com. 5 Star Radio is brought to you by Iserv company. Now your host to 5 Star Radio Mortgage Markets Today, Louis Amaya.

0:38 Louis Amaya

Welcome to Mortgage Markets Today, my name is Louis Amaya. Today is December 9, 2013. The industry has been witnessed to the exit or retrenching of several large and mid-sized banks with substantial servicing portfolios. Think of America as currently in a process of unwinding its large MSR position and by their actions alone, it's creating a major shift in the market. The trend seems to be a transfer of MSRs from regulated depository institutions to nonbanks. The new nondepository institution and entering the mortgage servicing industry are attracted by the tremendous opportunity participation in this business presents. Currently, MSRs are changing hands at higher levels seen in past years and the trend is only increasing. Financial institutions have different reasons for either investing or divesting out of the mortgage servicing business. Basel III implication is a driving concern for many center banks and other institutions that rules may impact. The issue at hand with Basel III is the extent to which regulated institutions will have to retain capital against MSRs. Some institutions have made the strategic decision that mortgage servicing is no longer a part of their organization's long term strategy. For others, there is a concern about the cost and the scrutiny associated with increased regulation. Private equity firms are lining up to beat on deals coming out of the money center banks and pricing is on the increase once again. Joining me today to discuss MSR trends is George Christo, Executive Vice President at the Prestwick Mortgage Group. The Prestwick Mortgage Group has not been involved into the marketing and in evaluation of over a trillion dollars of mortgage servicing rights and 50 billion of whole loans within the last 10 years. Mortgage Servicing Rights up next on Mortgage Markets today...

2:19 S?

5 Star Radio is brought to you by the 5 Star Institute and next to join us for the fifth annual 5 Star Government Forum this March in Washington D.C. Leaders in the housing market, top voices in servicing and the themes government officials will gather at the same museum to discuss the issues facing the housing sector. Join us in the capital and your voice will play a critical role as we define the road ahead. Mark your calendars for March 25, 2014.

2:52 Louis Amaya

George, welcome back to the broadcast.

2:59 George Christo

Good day. How are you Louis?

3:01 Louis Amaya

Good. I apologize I didn't bring you off hold. (laughs)

3:05 George Christo

No worries.

3:06 Louis Amaya

Welcome back.

3:07 George Christo

Thank you.

3:08 Louis Amaya

You were on the broadcast several months ago and the mortgage servicing rights business was a completely different market back then it seems. So in the past year, how has it changed since we last spoke?

3:23 George Christo

Well, when I was on about this time last year. The servicing market was very much a -- it was very much marked by the Nationstar when Green Tree types kind of feeding at the countrywide corps which you described in your intro as Bank of America divesting itself of a lot of MSRs, and other than that type of transaction, there were very few transactions going on that were not marked by one of two things either a liquidation type of action where you've got somebody who just have to get out no matter what. Regardless of the prize or a co-issue buyer meaning a buyer who is purchasing servicing only as opposed to a whole loan essentially on an as originated basis. The co-issue market about a year ago and for the approximately 3 years prior to that with only liquid and a place where reps and warranties were bifurcated meaning that reps and warranties on the origination stayed with the seller meaning that Fannie Mae or Freddie Mac would look at the seller and servicing reps and warranties would go over to the buyer which is different than the Daisy chain of a traditional co-issue transaction where Fannie Mae or Freddie Mac looks at the servicer as the only counterparty and then the servicer has to turn around and look at the originator or seller. Those are the only two kinds of transactions that were going on about this time last year.

5:19 George Christo

Starting around this time last year and for about the 6 months prior, all the private equity money and hedge fund money that you were describing in the interim was setting itself up for getting into the mortgage servicing business that all of that money was researching for the prior two to three years. They positioned themselves to get in at that time and starting around the middle of February this year as interest rates started to creep up, that money started to find its way into the marketplace in much more traditional ways. In traditional bulk sales, in traditional co-issue sales and the market essentially sprouted up to the point where it became a recognizable and healthy market and it has been pretty much for the year. With that change, pricing has increased quite dramatically for a handful of very rational reasons for people who are used to looking at the servicing asset. As interests go up prepayment speed expectation go down, therefore the duration of the asset is perceived to be much longer and therefore much more valuable. Delinquencies have gone down and are not expected to be coming in the same way that they did in the aftermath of the financial crisis and repurchase risk was generally being regarded not necessarily as going away completely but is getting back to a normal type of risk as opposed to the risk of where it is coming from next because of what is coming out of places that nobody was even dreaming that repurchases would come out of for several years.

7:21 George Christo

Pile on top of that of that, a new reps and warranties regime that started in January of this year were ultimately newly originated, newly secondary marketed loans starting in 2013 would not be subject to repurchase if the borrower on an individual loan made its payment for 36 straight months. The possibility of repurchase on that loan would go away under the new reps and warrants regime. Through all of that...

8:00 Louis Amaya

Just to interrupt you for 1 second.

8:01 George Christo

Sorry?

8:03 Louis Amaya

I'm just gonna interrupt you for 1 minute. So loans originated in 2014 did you say?

8:08 George Christo

In 2013, starting in January of 2013.

8:16 Louis Amaya

The likelihood of a repurchase almost diminishes regardless if there was inaccurate data or whatever the possibilities maybe if the borrower makes payments 36 months in a row.

8:30 George Christo

The Reader's Digest version is that that is correct. I have not read the exact memo of the exact legal lease but the thing that we are sticking in the industries craw in the aftermath of the financial crisis was getting repurchase requests for loans that were originated in 2000 and '99, '01 on loans that were performing for years and suddenly the guys lost his job, property went up side down and lo and behold there was something back there that Fannie or Freddie was expecting the servicer to repurchase the loan but he had performed just fine during in an extended period and I believe it was the FHFA that directed Fannie and Freddie to come up with a new paradigm for how repurchases would be handled in the future. So you've got all of the legacy loans prior to 2013 and then a legacy loans connotes prior to '08 but in this instance 2012 and prior originations where the possibility of repurchase is under the old regime, but 2013 and later originations are under a new repurchase regime as it relates to Fannie and Freddie coming back.

10:07 Louis Amaya

So you had mentioned bulk and co-issue, what's more active currently in the current market?

10:18 George Christo

I would say that in general they are both very active and compared to the conditions at this time last year and prior for about four to five years. Just about anything would be much more active. Co-issue and bulk are both quite active. I would say that co-issue is probably a little bit more active for a couple of reasons. 1. In terms of being able to get a sizeable enough co-issue flow, there are lots of guys who do not have a Fannie Mae or Freddie Mac servicing portfolio or even a Ginnie Mae servicing portfolio that they could put out in bulk but they do have the window to be able to sell to Fannie, Freddie or Ginnie directly and from a pricing perspective and exclusion perspective would generally like to have the outlet to be able to sell naked servicing rights and there is simply a lot more seller options on the co-issue side with a good number of buyer options on the buyer side of co-issue deals. On the bulk side, that market is very active and there was a period over the summer, where I would have answered the question in reverse. There were a lot of bulky loans that got out there in late July through middle of September, maybe middle of October, there was a really fast deal flow at that point in the bulk market. Nonetheless in 2013, the market has been extremely active in both of those side.

12:14 Louis Amaya

You know on the co-issue side, it really allows, it is benefit to the smaller originators who may not as you mentioned have a Ginnie Mae or Fannie or Freddie seller service or number because, from what I understand what the benefit to the originator is that the co-issue are actually passed along -- you know Fannie-Freddie pricing direct with no increase or a kind of vague on the rate in exchange to acquire the mortgage servicing right. So that's a two-way benefit for both organizations, I would imagine.

12:39 George Christo

Certainly, but the co-issue mechanism is one that requires the seller to have the direct window to Fannie, Freddie or Ginnie. It is possible to do an assignment of trade which is much more like the mechanism that you just described where the originator creates the pool, creates the security, assigns the trade to the buyer and the seller gets the window execution from the agency. On co-issue, the seller actually does the delivery to Fannie, Freddy or Ginnie and then flips naked servicing out so the benefit is you are exactly right on the benefit. The benefit is that the seller gets the screen pricing and is able to get all of the benefits on float. All of the benefits of straight out flood pricing. No junk fees straight out tax service pricing. No junk fees. Really, it is a direct transaction where it is creating the asset that ultimately is going to be created anyway and is getting paid for that asset and gets all the benefits on the whole loan side, and is able to maximise this benefit on the sale of servicing side.

14:07 Louis Amaya

When we talked about -- you had mentioned interest rate as a key driver of value increase in MSRs because of the decline and prepay in the extent of the duration and also some more favorable repurchase rules that are being implemented for 2013. Is there anything else or is it primarily just interest rate? What else could be driving value?

14:36 George Christo

When we talked about -- you had mentioned interest rate as a key driver of value increase in MSRs because of the decline and prepay in the extent of the duration and also some more favorable repurchase rules that are being implemented for 2013. Is there anything else or is it primarily just interest rate? What else could be driving value?

15:40 Louis Amaya

That makes complete sense so when you talk about new market participants, what should a new participant be paying attention to in this market as far as risks. You know pricing is going up but it makes sense because the duration is longer. We know regulation is a benefit to some in extent that its foreseen MSRs transfers are out of the moneys in our banks and it is a detriment to others but all in all what should new participants should be looking out for?

16:13 George Christo

Well, I think from an operational point of view, I know enough to be dangerous but from an operational point of view, all of the regulations that if have come out of Dodd Frank, that have come out of CFPB, it is a much more voluminous set of regulations that servicers have to deal with now and -- you know when you get into the nuts and bolts of what exactly does that mean, I honestly do not know how to describe it other than there is a lot more than people have to deal with. From the perspective of the CFPB, you are going into shops. I've had a couple of client that they've had to deal with CFPB auditors coming through and it is a similar experience but a much more nerve racking experience than having other auditors coming through simply because there is a lot of unknown. When you get down to why is it that a lot new servicers on new entrance to the servicing market who may have been servicers years and years ago are utilizing subservicers. Well, a lot of it does have to do with the new regulations and subservicers having enough girth to deal with all of the compliances issues that the regulations have voiced in on our industry. So I can't stress enough how much regulatory risk should drive new entrance servicing practices. The other risks that new entrance should be looking at really wind up.

18:07 George Christo

I have described them before with delinquency risk which is really pretty low unless you are talking about our pre-2008 portfolio where there is probably a whole lot in there and you already know that it is there. In the repurchase risk, it is a much different animal right now. That is not to say that repurchase risk is gone, but in terms of being able to quantify and sort of know that there is something going on with repurchases potentially -- you know, you practically want to keep your eye on the ball if you are a new servicer and need to know that that is a possibility out there. Most contracts would call for repurchases to go back to the seller if you are a purchasing servicer but going back to '06,'07,'08, there were a lot of guys who had those contracts that ultimately work contracts with companies that went out of business. I am not saying that that is going to happen, but you know what is gonna happen 3, 4, 5 years from now. What's gonna happen 3 to 6 months from now? It s a shoulder shrug.

19:21 Louis Amaya

Is there an optimum size of a deal or optimum product type that is right now getting the best pricing in the market place? I mean is there a difference between Ginnie Mae, oh I am sure there is, Ginnie Mae Fannie, Freddie -- you know interest rates, origination dates -- I mean what's the best deal all around that is giving the highest execution?

19:48 George Christo

Best deal all around, it's almost like there are so many corners of the servicing market room where the market is good and has a lot of potential buyers that have a lot of guys who have expressed an interest in XYZ and you know, you can almost plug the descriptors into each XYZ and have a whole bunch of guys who have described an interest in that. From the point of view of legacy servicing, you are talking girth, legacy servicing meaning 2008 and prior originations. If you are dealing with a portfolio that is less than a billion on that stuff, you're gonna have a hard time in general. It does not mean that it's impossible, but if you are above a billion and you may even need to make it above 5 or 10 billion to get interest that would be that type of deal. If you are talking about a 2011 and later origination, Ginnie Mae deal. You probably have to have something on the order of 250 to 500 million to catch interest in bulk and your optimum interest is probably a billion plus in terms of the unpaid principal balance underlying the servicing. For Fannie Mae and Freddie Mac post-2011 and I simply used 2011 as a -- you know relatively recent yet still populating a lot of servicing portfolios type of date. If you are 250 million plus, you're getting a lot of interest. If you're at 200 million plus, some of that interests starts to peel away but gets replaced by some other interest on the other side with guys who can't deal with 500 or a billion. The market is just starting to get tested with some regularity on sub-200 million dollar deals and from what I have been able to see so far, the interest has been pretty good. What I have been telling my clients is, if you're able to assemble 250 million, that's going to give you optimum interest and then if the question winds up being priced, we all know what the most valuable servicing is it's generally the 30-year fixed rates to Fannie and Freddie's that are between 3% and 4%. Those are the types of loans that you can generally see a five multiple on a sort of a starting spot and then depending on how low the rate is within that range. That will be this positive as to whether or not you actually see a 5. If you see a lot of... Okay go ahead.

22:50 Louis Amaya

Oh no! I was gonna mention that -- I mean we see Fannie Mae actually just recently coming to market with a deal. I've seen her like they're testing the market. What is the implication if Fannie and Freddie become regular sellers of their own MSRs?

23:06 George Christo

Well, Fannie and Freddy are generally sellers of their own MSRs because if they wind up with seized portfolios, they are out there selling stuff, pretty regularly. I am unaware of them going out with their own MSRs in terms of new originations outside of a couple of very specific service released programs where they are purchasing from sellers and then telling those sellers where to move those loans to within a month or two. The mechanism on that as I understand it, is that Fannie and Freddie are only taking positions for a very short amount of time and if they are selling bulks. That is something that I quite honestly can't speak to.

24:03 Louis Amaya

So we are wrapping up on time, but I did want to ask you one last question -- that is long term prospects and implications of market involvement so interest rates are rising which is creating problems on one end of the spectrum but is creating opportunities on the other side of the spectrum is that the sign of you know market normalcy? I mean are we on our way to becoming -- you know a normalized market again and at what point in time do we get up to pre-crash levels on pricing, how quickly has it increased and is the pricing gonna increase continue.

24:48 George Christo

Well if the pricing increased just on thumbnails, it is basically gone from about 3-1/2 multiple to somewhere between a 4-1/2 and a 4-3/4 multiple for very generic stuff. If by pre-crisis levels you mean 30-year fixed rates catching six multiples, generally speaking value increases as a result of duration extension it pretty much gotten baked in the keg. Value increases as a result of other cash flow or where the next like up in value are gonna be able to come from and by that, I mean, if short term rates go up as growth flowed all of a sudden has value, suddenly there is more value to be rung out of the servicing asset. Until you wind up seeing a fed funds rate or a libor rate that starts getting meaning a short term libor rate that starts getting into a two handle or three handle. You are probably looking at values that are pretty close to reaching their top on those three to four 30-year interest rate segments. In terms of how else could you get a higher value ultimately, you would have to have cost go down and I do not know that anybody is really able to see a whole lot more cost saving coming out than we borrowed even able to get technologically or with buyers accepting a lower yield for this asset. Is that possible? Yeah, that is possible. But a six multiple I think is gonna take a little while to common. It think it winds up being very much swayed to fed policy rather than something that is market driven.

26:55 Louis Amaya

So if you have a larger deal and a small deal and they are going to different buyers right cause you had mentioned -- you know if you have Fannie Mae generic product, you know -- you'll get interest of 250 million plus and then if its smaller, you'll still get interest but from different small investors, is there a pricing difference between the smaller and larger deal, or the small investor having to pay up any as a result that the deal is smaller?

27:25 George Christo

Generally speaking, the pricing difference is probably in the three to six territory in basis points and that is very generally speaking.

27:30 Louis Amaya

In the long term prospects for this business, obviously it is looking better than it was a year ago. What are your thoughts for the next year and a half?

27:49 George Christo

Well, I think in terms of long term prospects in the MSRs space, the servicing that is being created ultimately is what I have termed for a while the luggage. Stuffs you are gonna be carrying around for quite awhile. Servicing for the last 15 years leading into the crisis wind up going three cycle of ah okay we've reached our bottom and then we find out no we haven't reached our bottom in terms of interest rates and wind up getting ourselves back into our pre-payment cycle three years later. With this last cycle, that started in the summer of 2012 and ended beginning of this year. We probably have found our luggage and from that perspective we have gotten that ourselves, I believe in doing much more normal spot into a place where the servicing asset is going to be much more stable for the foreseeable future short of something that we can foresee or at least we will know as coming via some sort of recession, some short of major shock to the economy that puts all of those elements back into the economy. Short of that type of scenario. I think the next year to 4 years for servicing is going to be pretty good and pretty stable.

29:20 Louis Amaya

Excellent! Well, that is great news. Thanks so much George for coming back on and I'll ping you again in a few months and have you on again and get another update. I appreciated the time.

29:31 George Christo

Looking forward to it. Thanks a lot Louis.

29:37 Louis Amaya

Issues attendant to the 5 Star government form is more critical than ever before on March 25, 2014. Leaders in the house in the mortgage servicing industry will engage with government officials and regulators and meaningful discussions on housing and mortgage policy, state of the housing economy, pending legislation and compliance of regulatory issues. You can register at the 5Star.com. Mortgage Markets Today is on the web via LinkedIn and Twitter. Also please subscribe to the broadcast via ITunes for quick and easy download and listening. Today's show is sponsored by Iserv Companies. We'll talk to you next time.

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