Private-equity firms and hedge funds are increasing their control of the rights to collect America’s monthly mortgage payments, an almost $10 trillion market that banks are retreating from amid looming regulations.
Servicing rights, or MSRs, on at least $1 trillion of mortgages will trade in the next two years, said Jay Bray, chief executive officer of Nationstar Mortgage Holdings Inc. (NSM:US), a servicer majority owned by Fortress Investment Group LLC. (FIG:US) The private equity firm said in July it raised a new $1.1 billion fund to buy the contracts. GSO Capital Partners LP, the credit arm of Blackstone Group LP, announced last week it helped form a company targeting the assets after Two Harbors Investment Corp. (TWO:US), a real estate investment trust, started buying the contracts in the second quarter.
“Now’s a good opportunity for banks to scale back,” said David Stephens, chief operating officer of United Capital Markets Inc., a broker-dealer that helps investors manage the risk of owning the contracts. “Buyers have come into the market from private equity, hedge funds and REITs.”
The value of servicing rights has jumped to about 1.25 percent of the loan principal from 0.75 percent a year ago, according to Stephens. In addition to a widening pool of buyers, rising mortgage rates have also boosted their appeal since higher costs discourage borrowers from refinancing. This prolongs the length of the servicing contract. A reduction in new mortgages also constricts the supply of new rights.
“The ice cube melts slower,” Stephens said.
The balance on mortgages handled by servicers declined to $9.81 trillion in the second quarter from a high of $11.2 trillion in the first quarter of 2008, as more Americans paid down debt or lost property to foreclosure, according to data compiled by Bloomberg from Inside Mortgage Finance.
Origination is also slowing. Since mortgage rates rose from near record lows in May when the Federal Reserve signaled it was preparing to reduce stimulus efforts, refinancing has dropped more than 70 percent and applications for purchase loans dropped 17 percent, data from the Mortgage Bankers Association show.
A slowdown in mortgage activity and rising demand for MSRs is encouraging more banks to weigh sales. Wells Fargo & Co. (WFC:US), the largest mortgage servicer with $1.85 trillion in collection rights, is putting rights on $41 billion of government-backed home loans on the market, according to two people briefed on the process.
Home-loan servicing has prompted customer complaints and regulatory probes of poor treatment by banks overwhelmed with record-high foreclosures. Federal and state investigations of foreclosure practices led to new regulations that drove up costs and last year the five largest bank-servicers -- Wells Fargo, JPMorgan Chase & Co. (JPM:US), Bank of America Corp. (BAC:US), Citigroup Inc. (C:US) and Ally Financial Inc. (ALLY:US) -- paid $25 billion to settle a government probe of servicing misconduct without admitting guilt.
Banks accelerated sales last year with the bankrupt servicer Residential Capital LLC, a unit of Ally, selling a $374 billion portfolio to Ocwen Financial Corp. (OCN:US) and Walter Investment Management Corp. for a joint $3 billion bid.
Bank of America sold rights to more than $200 billion this year and OneWest Bank FSB said in June it has agreed to sell $78 billion.
“Most of the portfolios that have been transferred were due to either bankruptcy, in the case of ResCap, or due to the cost of servicing delinquent loans and the capacity of banks to handle large levels of delinquent loans,” Kevin Barker, an analyst with Compass Point Research & Trading LLC, said in a telephone interview from Washington.
Banks also are facing pending regulations as part of the international financial agreement known as Basel III, which limits the amount of capital banks can risk on servicing rights.
Wells Fargo Chief Financial Officer Tim Sloan said last week the San Francisco-based bank will sell MSRs in coming quarters as a risk-management practice. Wells Fargo generated $393 million in the second quarter from the business. The bank doesn’t have “a lot of pressure” on its capital levels, Sloan said.
The $41 billion sale is for rights to government-, or agency-backed home loans, those guaranteed by Fannie Mae, Freddie Mac and Ginnie Mae, according to one of the people, both of whom asked for anonymity because they weren’t authorized to speak publicly about the transaction.
The contracts relate to borrowers Wells Fargo identifies as “non-core” because they have few other products from the bank, the other person said. Tom Goyda, a company spokesman, declined to comment on specific deals.
The transfer of rights for large-scale, non-distressed portfolios of agency-backed mortgages “would be a wholesale change to the transfer of mortgage servicing rights that have occurred over the last three years,” Compass Point’s Barker said.
Demand from non-bank buyers has increased the value of servicing rights on bank balance sheets. The value of Wells Wells Fargo’s servicing rights jumped to 81 basis points at the end of June from 67 basis points at the end of last year, according to Barker.
Blackstone’s GSO, which manages about $62 billion of assets, is one of the latest entrants seeking to capitalize on the regulatory changes. Along with EJF Capital LLC and Arbor Commercial Mortgage LLC, the New York-based debt investor formed Seneca Mortgage Investments LP to buy servicing rights.
Seneca will target “opportunities arising from the comprehensive changes across the residential mortgage business,” according to a Sept. 12 statement. Erica Mileo, a spokeswoman for Seneca, declined to comment.
Fortress closed its MSR Opportunities Fund II to new investors in July after reaching $1.1 billion, according to a statement last month. The fund is a successor to a $600 million fund that closed in August of last year, said Gordon Runte, a Fortress managing director.
The firm is already deeply embedded in the mortgage market. It owns Nationstar, a loan originator and servicer that has rights to collect on $318 billion in residential loans as of June 30, triple its portfolio at the end of 2011, according to John Hoffmann, a spokesman.
New Residential Investment Corp., a spinoff of New York-based Fortress’s Newcastle Investment Corp., spent $180 million on rights for a $23 billion portfolio of agency pools for the quarter ending June 30, according to a statement.
Two Harbors, a Minnesota, Minnesota-based mortgage REIT managed by hedge fund Pine River Capital Management LP, began investing in rights to agency-backed mortgages in the second quarter and closed “two small bulk transactions in July,” CEO Thomas Siering said during an Sept. 10 investors conference in New York.
Two Harbors is buying rights to generate interest-only revenue as a hedge against other mortgage-market investments rather than to make money servicing the loans, Siering said.
“It’s not our desire to be in the origination business or to actually service the MSRs, but rather be a capital partner to those who do originate and do service,” he said.
Partners like Two Harbors open opportunities for banks to sell the rights while continuing to service the mortgages, a “work around” for Basel III, according to Rick Sharga, executive vice president of Auction.com. Banks can add liquidity by unloading servicing rights, eliminate some risk and then, if they get a subservicing contract, get paid to continue to do the same work, he said.
“That’s not a bad deal if you can pull it off,” Sharga said in a telephone interview. “It’s probably something we wouldn’t have seen absent Basel III requirements. But in an odd way, it has a certain logic to it.”
While banks sold off portfolios with high delinquency rates, they also sought to retain or acquire pools with high-quality borrowers who provide steady payments at little cost.
“As part of our strategy to strengthen and grow our servicing business, we continually look at opportunities to buy and sell mortgage servicing rights,” Amy Bonitatibus, a spokeswoman for JPMorgan, the second-largest servicer with $1.06 trillion in collection rights, said in an e-mail. She declined to answer specific questions on the bank’s plans for the unit, which generated $133 million in pre-tax revenue for the quarter ending June 30, according to a filing.
Private equity firms are buying because they can earn as much as 9 percent, more than many other mortgage assets, said Dan Thomas, managing director of MIAC Analytics, a broker in New York.
“It’s a much stronger market than it was a year ago because of the private equity guys,” said Thomas. “It took them awhile to get their ducks in a row. This isn’t the same as buying a security. You have to have the infrastructure in place to take on the operation or a sub-servicer lined up to do it for you.”
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