Last week, Ginnie Mae released
Ginnie Mae has claimed in several public statements that most or all of the Ginnie Mae issuers will be "compliant" with the rule, but this statement largely sidesteps the true issue. The majority of government lenders sell their loans servicing released to larger banks or IMBs. The large owners of Ginnie Mae MSRs are really the top 20-25 issuers.
"To talk about 95% of issuers by count being compliant without recognizing that a very large number of issuers hold few MSRs is disingenuous," says an industry executive. "The real number is at least 20% by UPB of loans serviced will not be compliant. Reducing bidders by 20% will lower MSR yields, harming lenders and vulnerable low-income FHA/VA borrowers."
The FAQs state: "We are attempting to ensure that balance sheets containing large concentrations of [MSRs] are adequately capitalized" and then makes a reference to fluctuating valuations of servicing assets. Despite the opacity of pricing, Ginnie Mae MSRs in fact are fully capitalized today, either with equity or debt.
The general haircut for lenders that finance the debt portion of MSRs is 50%, so that means that most government MSRs already have a full, market based capitalization of 50 LTV. In many cases, the government MSR is entirely funded with equity, but some issuers use debt or the sale of excess servicing to partially finance servicing assets.
Of note, the suggestion made by Ginnie Mae officials that 85% leverage against a Ginnie Mae MSR is possible at market interest rates is incorrect. Only a punitive interest rate will allow such a high LTV vs the MSR and then only from a nonbank lender. A reference to an 85% advance rate for MSRs offered by Rithm Capital, the largest owner of Ginnie Mae MSRs, was included
The FAQs reveal continued confusion about the nature of the risk facing Ginnie Mae. MSRs are an important capital asset and source of liquidity for independent mortgage banks, who use the asset to leverage current income and, most importantly, enhance loan volumes in falling interest rate environments. If IMBs hold fewer MSRs and more cash, then liquidity falls and the risk to Ginnie Mae increases. Note: You cannot leverage cash.
More important, warehouse lenders view IMBs with investments in MSR as being superior credits to issuers without servicing (aka "brokers"). Although the mortgage industry did see large write-downs of MSRs in 2020, no one defaulted due to the volatility caused by the Fed's actions. Several IMBs, however, have defaulted because of non-agency loan exposures.
During 2020, most large Ginnie Mae servicers, in fact, were able to grow servicing UPB via new lending even after subtracting the large runoff of MSRs. Ginnie Mae's stated concern about the "extreme concentration" of MSRs misstates the way these assets are actually used in the markets and also ignores other risk concentrations that have actually caused defaults of IMBs.
Ginnie Mae spends a great deal of time talking about the "opaque" nature of MSRs and the lack of transparency on pricing, but again this statement misses the point. The larger holders of MSRs tend to buy and hold these assets, in part to hedge their exposure to the secondary loan market and interest rates. If you need to sell MSRs to raise cash, that means you are probably going out of business anyway.
When interest rates fall, MSRs payoff faster and valuations decline. But at the same time, lending volumes grow and new MSRs are created. The negative duration of the MSR makes it a perfect capital asset for IMBs that helps to reduce their overall market risk profile while increasing future loan volumes. Yet contrary to decades of industry practice, Ginnie Mae now sees MSRs as problem.
Ginnie Mae asserts that its version of Basel III is less onerous than the rule applicable to banks, but you cannot compare a federally insured depository to a private finance company. Banks finance the mortgage business and hold title to the collateral — ALL of the collateral, including the MSR.
If you reduce the amount of MSR held as investments by IMBs, then you necessarily must reduce operating leverage and profitability. Since debt, not equity, is the primary means of financing most IMBs, less collateral means less lending. As you reduce leverage and profits at IMBs, and of course assets, the willingness of lenders to extend credit to IMBs will also fall.
If the Ginnie Mae rule goes forward, we can expect adverse ratings actions by Moody's and the other credit agencies. This will start a spiral of downgrades and default events for some significant Ginnie Mae issuers and servicers.
Strangely, the FAQs and the Ginnie Mae proposal give relatively positive treatment to excess servicing strip transactions, even though ESS is one of the most pressing risks to issuers and Ginnie Mae during a period of rising loan delinquency. Ginnie Mae states:
"As a result of the RFI process in 2021, Ginnie Mae received comments suggesting that the sale of ESS should result in capital relief. Considering these legitimate comments, Ginnie Mae reduced the RBCR requirement to 6% from 10% and have committed to further investigation of potential future capital relief."
Frankly, this writer and many others believe that the concession by Ginnie Mae to accommodate ESS transactions was a serious mistake. The idea that a fund or REIT that buys ESS will support loss mitigation activities down the road ought to be rejected by Ginnie Mae out of hand.
When an issuer sells off part of the servicing strip for an upfront payment, the proceeds are used to buy more MSR or cover other expenses. But the future income from the ESS is gone and will not be available to fund loss mitigation activities — regardless of what the contract of sale or agreement with Ginnie Mae may state.
To encourage ESS transactions, but not allow unsecured debt to be counted towards adjusted net worth, is a serious error in credit risk methodology. A far better approach, which this writer discussed with former FHA Commissioner David Stevens in an interview in
The FAQs state: One of Ginnie Mae's statutory purposes is to "provide stability in the secondary market for residential mortgages." If, as seems likely, Ginnie Mae refuses to make substantive changes in the issuer eligibility proposal, we should expect to see large blocks of Ginnie Mae MSRs put up for sale before year-end.
In the event, MSR prices will fall, bank lenders to government issuers will step back, and the government loan market will start to implode. By then, any accommodation that Ginnie Mae is willing to make to address industry concerns will be too little too late. The damage will be done.
