This year has seen mortgage lending and home sales volumes hit new lows, even as home prices in states like California are at the highest level since the subprime crisis. The cleanup from the subprime crisis is nearing an end, but regulators are growing more aggressive with each passing day, delaying the resolution of millions of distressed mortgages.
What do these decidedly mixed signals mean for the mortgage servicing industry?
The rate of home price appreciation shown in widely followed indexes such as Case-Shiller has been decelerating for months. More granular measures suggest prices are falling in the Northeast and other areas with extended timelines for resolution of defaulted loans. The prospect of softening home prices has significant implications for asset management strategies as well as default resolution outcomes.
An issue related to softening home prices is the mortgage lending sector. From a peak of $3 trillion in originations in 2006, mortgage lending volumes now are running at about $1.2 trillion annually based on $300 billion in Q4 2013. The Mortgage Bankers Association projects 2014 mortgage originations to be $1.1 trillion, increasing to $1.2 trillion in 2015.
Looking at the public disclosures of the commercial banks, it is pretty clear that depository institutions are fleeing mortgage lending and servicing. JPMorganChase, for example, has cut thousands of front and back office staff in mortgages over the past year. But it is important to state that half of all purchase mortgage business is done by non-banks.
Is the exodus of banks from mortgage lending an opportunity for non-banks? Or to put it another way, do we need to increase the lending and servicing capacity of the non-banks to hit the mortgage loan origination projections from the MBA for 2015? The answer to both questions clearly is yes. This is an opportunity for non-bank seller/servicers.
A third area of challenge and opportunity for mortgage servicers is the fact that the proverbial ice cube is melting. Since 2008 peak of $11.3 trillion in unpaid principal balances outstanding, overall mortgage debt outstanding has dropped $1.1 trillion, two thirds of which came from charge-offs. Current levels of new 1-4 family mortgage originations are not sufficient to prevent net runoff of the aggregate servicing portfolio.
Bank 1-4 portfolios are running off at a 3.5% annualized rate and bank sales into securitizations are down about 5% in the past year, according to the FDIC. Non-bank mortgage portfolios are growing, albeit slowly and from a low base. The opportunity again is for non-bank seller/servicers to step up and meet the needs of consumers for mortgage credit. Can and will the industry respond to this challenge?
The fourth area of opportunity for the servicing industry is resolving the remaining distressed assets in the U.S. economy. Even today, roughly 1 in 5 homes with a mortgage are significantly under water. There is still about $180 billion in distressed assets on the books of US banks and hundreds of billions more held by agencies and in RMBS. More than 6% of all first lien mortgages held by commercial banks are non-current. Buying and servicing distressed assets remain among the most attractive investment strategies in the housing sector.
One of the more challenging aspects of the distressed asset trade is the issue of hot money. Thanks to the Federal Open Market Committee, a lot of investors with little experience in mortgage assets have put tens of billions of dollars behind strategies such as REO to rent. With REO discounts long gone and home prices starting to soften, the investment opportunity in REO to rent clearly has diminished. But there is still a lot of institutional money chasing strategies such as mortgage servicing rights (MSRs) and distressed assets.
The supply of MSRs and distressed assets is finite as are the special servicing resources needed to manage these strategies effectively. But prices for both MSRs and distressed loans have been pushed up significantly over the past year by what can only be described as dumb money. For rational investors and prudent servicers, the irrational players in these markets pose an ethical as well as practical dilemma.
The final challenge facing loan servicers comes from regulators. Last week, National Mortgage News reported that Ginnie Mae halted the transfer of mortgage servicing rights by Bank of America because of missing loan documents. Of note, the agency is asking all of the top servicers for an inventory of loans with missing documents.
Regulators such as the CFPB, FHFA, FHA, Fed, OCC and FDIC are all involved in overseeing the AG settlement and approving distressed loan and MSR transfers. Actions against Ocwen (OCN) and Nationstar (NSM) by New York State have put the entire MSR transfer market “on hold,” according to OCN Chairman William Erbey.
While meeting the requirements of regulators will obviously be a challenge in the near term, by addressing concerns about how distressed loans are resolved, banks and non-banks alike can make a virtue out of necessity and regain the trust of policy makers and the public. That, at the end of the day, is the biggest opportunity facing mortgage servicers in 2014 and beyond.
Christopher Whalen is a Senior Managing Director at Kroll Bond Rating Agency in New York. This post is adapted from his keynote address to be given Thursday at SourceMedia’s Mortgage Servicing Conference in Dallas.