5 ways mortgage companies can get the most out of their MSRs

April 1, 2022 5:00 AM

Mortgage servicing rights research tools

With rates rising and originations falling, lenders have returned their focus to mortgage servicing rights as a means of keeping their income up. In some cases, companies have started earning more pretax income from servicing than from their slowing loan-production channels.

MSRs have benefits besides the fee income — they can be sold for cash or mined for origination leads at a time when that business is slow. But only if lenders are able to manage them correctly in conjunction with their lending and hedging efforts, the latter of which address MSRs’ rate-related risks.

For banks and other institutions that offer additional financial products, they may be used to cross-sell. MSRs can also secure lines of credit for corporate expenses or other needs.

To make the most out of all those opportunities, it helps to know about some of the nuances that go into the economics of mortgage servicing rights and their valuations, and how to manage them efficiently with technology or through collaborative work with subservicers.

What follows are tips on five ways lenders who hold onto their mortgage servicing rights can get the most out of them from four experts familiar with the nuances involved in the various aspects of this segment.

These tips include information about current conditions in the markets for financing, subservicing and technology. Also discussed below are existing and proposed rules for remittances and escrows that may affect the value, and some creative recapture and marketing strategies that can be executed using mortgage servicing rights.

Ask about fees when shopping for MSR financing

While after two banner years of strong production profits lenders may not immediately need an additional line of credit secured by mortgage servicing rights for corporate expenses, it might not be a bad idea to have one for a rainy day.

However, companies should think hard not only about how financing can impact their leverage ratio, whether they meet net worth requirements or if selling might be preferable, but also consider the other ancillary costs and prerequisites that recently have varied by line provider.

“There can be a usage fee. They might have a minimum line necessary to do business,” said Mike Carnes, a managing director in the Mortgage Industry Advisory Corp.’s capital markets group. “Some of the larger players may be less enthralled about somebody needing a small line of credit, but it completely depends on who the lender is.”

Still, banks and other providers in this niche generally have been eager to lend recently, including TIAA-CREF, Western Alliance and Merchants Bank of Indiana, just to name a few.

“There’s a pretty healthy supply of firms out there,” Carnes said.

Cut conveyance costs

Although no cure-all exists for current cost pressures in the mortgage industry, one of the small changes servicers might be able to make is to work on reducing their conveyance losses.

Conveyance, which is the process of transferring a property to another party, in the context of servicing most often refers to moving title from Federal Housing Administration-insured loan collateral to the Department of Housing and Urban Development in a distressed loan workout.

If the cost-benefit numbers work out, reconditioning homes that deteriorated during the pandemic, submitting claims without conveyance of title, or retooling processes around providing information to the FHA’s insurance department efficiently could be ways to do that.

“When you have an FHA loan, you are subject to variable conveyance loss, depending on the condition of the property or how you handle the claims side,” said Michael Dubeck, president and CEO of Planet Financial Group.

Because of the many government rules involved, servicers may work with a specialist to handle this, and they may not know that the process is a nuanced one they could potentially get more information from their vendor about and possible work with to whittle down costs, he said.

“I think it's hard for people using a subservicer to have transparency as to whether that's going well or not,” said Dubeck. “So I think if they found a way to focus on that with a subservicer they might be able to pick up some value.”

Analyze retention rates by loan channel

During the refinancing boom, lenders had so much volume that they worried less about whether they lost some customers while bringing on new ones, But it is always cheaper to retain current clients and at times of tight margins, so lenders should be analyzing their servicing book to see which loan channels were the most effective at retaining customers when they sought out new purchase or refinance loans.

“You had these servicers that basically just bought books to refinance them, but when interest rates get to say 6% and a lot of people have a rate that’s around 2, 3, or maybe 4% that play goes away,” said Dan Sogorka, president and CEO at servicing technology provider Sagent.

Now that originations are ebbing due to higher financing costs, more companies may want to run that kind of analysis on the mortgage servicing rights they own and adjust their loan channel mix based not only on margin, but also recapture rates.

“Some companies don't value retention and others value it quite a bit,” said Dubeck. “We think it makes a massive difference in the valuation of our book …and the cost of servicing.”

Companies vary in how they measure and manage retention or recapture. Planet, for example, divides retained loans by mortgage payoffs and aims to maintain an average above the industry’s across channels, Dubeck said. Others use a less conservative approach, he said.

With a lot of companies needing to adjust their loan channel mix for the current market, this could prove to be a competitive differentiator. MIAC offers a recapture propensity score to help with the process, Carnes said.

“It's going to be a little bit of a musical chairs thing, where everybody's going to have to get their ducks in a row and some people aren't going to be good in this next environment,” said Sogorka.

Some companies have already pivoted with some success, said Tom Piercy, president of national enterprise business development at Incenter, in an email.

“For the recapture/refinance value, several servicers are offering borrowers the opportunity to refinance into shorter term fixed rate to save on life-of-loan interest expense. Borrowers may also look at 5/1 or 7/1 ARMs that are now coming back,” Piercy said.

One cross-selling strategy Incenter has offered involves a white-labeled private student-loan platform that mortgage servicers can use to debt-consolidation products, said Piercy.

Examine differences in escrow, remittance and markets

Regional differences and concentrations affect MSR valuations.

For example, some states like New York and California have rules requiring servicers to pay interest on escrow accounts they maintain to cover certain housing-related expenses borrowers have. Furthermore, various waivers and exceptions can apply to these and other escrow rules.

“Otherwise it might cost them more in interest that they have to pay back to the borrower than what they’re earning,” Carnes said.

Similarly, investors like government-sponsored enterprises Fannie Mae and Freddie Mac offer different remittance types that allow servicers to deliver payments at different times in ways that can affect valuations as well. Although it’s unclear whether this will affect valuations, the GSEs’ regulator is considering distinguishing some of their counterparty requirements based on remittance type as well.

Depositories are in the best position to profit from the float on escrows when allowed although it can help nonbanks as well, said Piercy, who also is managing director of his company’s capital markets trading and valuation subsidiary, Incenter Mortgage Advisors.

“Banks are the big winner in leveraging the value of short (principal and interest) and long-term (tax and insurance) escrow balances,” Piercy said.

Whether or not MSRs are associated with loans in a depository’s footprint can make a difference in their valuations as well. Banks are more likely than nonbanks to use MSRs to cross-sell multiple financial products so they may submit stronger bids.

“When we're trading MSR packages, it can be hard for anyone to out bid a bank, particularly for a portfolio in their footprint,” said Carnes.

Know how competitive subservicing and tech offerings are

While servicers may have options for MSR financing, the pool of subservicers is limited.

“There are not many options in the third-party servicing world, and they may not be very flexible at negotiating terms,” said Dubeck. “They do give you discounts for volume.”

However, competition could change things. Companies may need to work with multiple subservicers to diversify counterisk risk and that could help companies negotiate.

Servicing technology also could improve and become more competitive as this part of the mortgage business becomes more prominent, Dubeck predicted. (Planet sub-services and primarily uses vendor systems to automate.)

“More originators, particularly the larger ones, are creating proprietary servicing systems. That could be a significant cost reduction. We're also hearing that these parties may be interested in licensing out that technology,” said Dubeck.