The U.S. economic recovery continues to wane, owing in part to the persistently weak housing market. To revitalize the housing sector and the overall economy, we must fix structural problems with the mortgage market.
One place to start is with the inappropriately high minimum servicing fees on conforming and private label loans. These fees have resulted in inefficient capital investment requirements for mortgage servicing rights. This in turn has concentrated loan servicing at a handful of large financial enterprises with the stockpiles of capital required to carry volatile mortgage service rights.
Today, these megabank servicers are under siege, with servicing capabilities and standards not designed to handle the record volumes of distressed mortgages. Not to mention they are on a capital collision course with Basel III that will likely reduce their investment in and management of servicing rights in the future.
Concurrently, the industry faces impending reductions to the maximum loan amount eligible for delivery to the government-sponsored enterprises Fannie Mae and Freddie Mac. These factors underscore the need to restart the private label mortgage securitization markets. But both the GSE and private label mortgage markets need structural reform.
Beginning with GSE servicing, the industry should accept the simplest, most efficient and expedient change: to reduce the minimum service fee from 25 to 12.5 basis points, which was one of the proposals put forth by the Federal Housing Finance Agency. This fee includes the costs associated with normal anticipated levels of default management.
Additional servicer compensation in a stress scenario should be paid for by the GSEs and provided for in their guarantee fee calculation. The seller-servicer agreement can address the mechanics of how and when servicing is moved to a replacement/specialty servicer.
This efficient solution would work within the existing architecture of the market and meet current accounting standards. It would enable more servicers to enter the market by eliminating the capital inefficiency of investing in an oversized mortgage servicing right asset. And it would thereby reduce the overconcentration of mortgage origination and servicing activities in a handful of large institutions.
Another critical structural change to diversify the market is to bring parity to the guarantee fees paid by seller-servicers. The unintended consequence of preferential guarantee fees has been the unhealthy consolidation of the mortgage industry. The guarantee-fee structure should be consistent with the desire to diversify the industry.
The solution for private label markets is similar. First the market needs a minimum servicing fee that is appropriate and profitable in normal conditions.
Next, there must be clear conditions for transferring servicing to a specialty servicer under certain loan-level distress conditions and higher economic stress environments. Similar to the GSE model, additional compensation for higher stress conditions should align the interests of investors, the regular servicer and the replacement servicer.
The conditions and terms for transferring loans to a replacement specialty servicer need to align the interests of both servicers with the interests of the security holders as well as address consumer protection issues.
Clear, transparent and actionable terms can be built into the agreement governing the relationship between the securitization trust and the servicer to ensure incentives are fully aligned:
1) The original servicer should pay the initial increase in cost associated with bringing in a replacement specialty servicer. This will give the first servicer an incentive to try to resolve troubled loans and not automatically push them off to the replacement servicer to reduce costs.
2) Under levels of extreme stress not caused by the servicer’s performance, the cost of a replacement servicer should be borne by the security holder in a predetermined waterfall. For the securitization to begin paying the higher specialty fees, two tests would have to be met: the initial servicer must have paid in excess of a cumulative ceiling of special servicing cost; and the cumulative default levels must exceed the normal anticipated level by at least 25%. This condition holds the servicer responsible for a limited level of added costs, but assigns the bulk of the risk of distress from an unforeseen credit event to the security holders.
3) A replacement servicer should only be invoked when the pool-level default characteristics exceed the normally anticipated level of default, the speed of default is accelerating at an unanticipated pace, or the servicer is underperforming on an agreed upon standard inclusive of a reasonable cure period.
4) The initial servicer should be permitted to recapture re-performing loans if: the initial servicer paid all excess fees; the re-performing loan has six months of stable payment; the initial servicer paid a success fee to the special servicer; and the consumer does not object to returning to the original servicer. The ongoing servicing compensation of a re-performing loan should never exceed the initial minimum service fee provided in the securitization. This policy rewards good special servicers with a minimum of six months of fees plus an incentive fee.
The home mortgage market must be prepared to support a revitalized private label mortgage-backed securities market. This will not occur without a rational, efficient and appropriately agreed upon structure.
While more considerable analyses are needed to determine the exact fees and triggers, these basic structural revisions are actionable and efficient.
Stanford L. Kurland is the founder, chairman and chief executive of Private National Mortgage Acceptance Company LLC, or PennyMac, in Calabasas, Calif. He is a former president of Countrywide Financial Corp., which he left in 2006.
