Evolution of the Mortgage Servicing Market since 1998

The evolution of the market for MSAs has been shaped by a variety of factors. Over the time period considered in this section--1998 to 2015--these factors include

• changes in interest rates, as well as an extended period of historically low interest rates;
• the sharp rise and fall in house prices, and the corresponding changes in mortgage debt and surge in nonperforming loans;
• changes in firms' interest in serving as aggregators by purchasing the servicing rights and originations of other firms;
• shifts in the incentives to securitizing mortgages versus holding them in portfolio; and
• regulatory, tax, and accounting changes related to mortgage servicing.

As reflected in figure 5, total bank MSA valuations increased from roughly $20 billion in 1998 to nearly $78 billion at the end of the third quarter of 2008.⁵⁰ MSA values dropped 33 percent in the fourth quarter of 2008 at the height of the crisis, fell significantly further in 2011 and 2012 and have since hovered between $30 billion and $40 billion.⁵¹ This measure includes only the MSA holdings of banks, and does not include savings associations.⁵² Savings associations were excluded because they were primarily supervised by the former Office of Thrift Supervision (OTS) prior to July 2011, and therefore filed Thrift Financial Reports (TFRs) rather than the Call Reports filed by banks.⁵³ The TFR data did not align sufficiently well with the Call Report data to create a consistent time series that combined both types of institutions. Although savings associations began filing Call Reports in 2012 after their supervision was transferred from the OTS to the OCC or FDIC, depending on an institution's charter, savings associations were excluded from the analysis for the entire time period for consistency. The assets of savings associations that failed and were acquired by banks will, however, appear in the Call Report data. The implications of this consistency issue are discussed later in this report.

Factors Determining Fluctuations of MSA Values Held by Banks

The fluctuations in banks' MSA holdings reflect several factors. To set the stage, 1996 was the first full year in which GAAP permitted the recognition of an MSA associated with loans a bank originated and sold, but for which it retained the servicing. This accounting development may have given banks an incentive to conduct business in a way that gave rise to MSAs. From the second quarter of 1998, the beginning of the time series data considered in this report, to the third quarter of 2008, banks' MSA holdings rose because of an increase in mortgage debt outstanding, as well as an increase in the share of mortgages that were securitized. During the financial crisis, banks' MSA holdings increased further as nonbank servicers withdrew from the market in response to funding and liquidity pressures. Post-crisis, banks have decreased their MSA holdings, reflecting a contraction in mortgage debt outstanding, a decline in MSA valuations due to the fall in interest rates, and an increase in nonbank market share. The increase in nonbank market share appears most directly attributable to a number of significant nonbank acquisitions of crisis-era legacy servicing portfolios of large banking institutions, as well as an increase in the nonbank market share in the mortgage origination market, and more indirectly from several regulatory changes and policy actions.

Mechanically, MSA holdings are equal to the price (or "multiple") the firm is willing to pay to service one dollar of UPB, times the servicing fee, times the UPB of the mortgages that a firm is servicing for others. In other words:

MSA holdings = multiple*servicing fee*UPB.

The following sections describe the factors that have affected two of these components--the multiple and the UPB--of bank MSA holdings during the past years.

Changes in MSA Multiple

Firms determine how much they are willing to pay to service a given portfolio of loans based on their valuation models, which, as described earlier, forecast the value of servicing based on assumptions about interest rates, default probabilities, and other factors. A firm might decide, for example, that it is willing to pay $2,000 to service a $200,000 mortgage that comes with a 0.25 percentage point servicing fee. The multiple--which is 4 in this example--is backed out of the overall $2,000 valuation as follows:

4 = $2,000 / ($200,000*0.25%)

The MSA multiple thus serves as a shorthand metric for firms to compare the value of MSAs across portfolios and over time. A rise in the multiple, therefore, means that a firm is willing to pay more to service a given portfolio, or alternatively, that servicing those loans is perceived as being more valuable.

Historically, MSA multiples have increased when interest rates rise, and, conversely, have declined when interest rates fall. This relationship holds because an increase in interest rates typically equates to a decrease in prepayment, which means that the firm will be receiving the servicing fee on the mortgage for a longer period of time. To illustrate this point,
figure 6 displays two measures of MSA multiples for the 2007 to 2015 period for 30-year, fixed-rate mortgages eligible for a GSE guarantee. One measure is an estimated multiple for a hypothetical servicing portfolio of newly originated mortgages with a 25 basis point servicing strip.⁵⁴ The other measure is the average of the multiples that a group of banks and savings associations used to value their existing books of mortgages serviced for others. These banks and savings associations in total serviced loans with between $2.9 trillion and $5.4 trillion in unpaid balances over this period.⁵⁵

The changes in these multiples are compared with the change in the average rate charged on a 30-year conventional fixed-rate mortgage, which is the interest rate most pertinent to mortgage prepayment for existing books of mortgage servicing.⁵⁶ As reflected in figure 6, the MSA multiple has generally changed in tandem with the mortgage interest rate, with both the MSA multiple and the interest rate moving lower on net since 2007.

In the years preceding the financial crisis, large banking institution aggregators significantly increased their purchases of MSAs. During and after the financial crisis, large-banking institution aggregators revisited this business model in the wake of their large losses on loans originated through these channels, and instead focused on loans originated through their retail channel, as shown in figure 7. The decline of purchase activity on the part of large banking institution aggregators reduced the demand for MSAs, and put downward pressure on the multiple during the financial crisis.

In addition to the decline in aggregator purchase activity, the other housing-market related events during the crisis, such as the sharp fall in house prices and significant increase in borrower defaults, put downward pressure on the multiple. One way to see this fact is to note that reported book values of MSAs held by banks decreased by 33 percent in the fourth quarter of 2008 alone, from about $76 billion to about $51 billion.⁵⁷ Since the volume of one- to four-family residential mortgages serviced for others by these institutions increased during that quarter, in aggregate, all of the reduction in MSA value during the fourth quarter of 2008 appears to be attributable to value decreases and none appears to be attributable to a reduction in the volume of serviced mortgages.

Other factors have also affected the trends in the MSA multiple over time, including, as discussed later in this report, tighter servicing regulations, significant legal settlements involving large banking institutions, and increases in the cost of servicing. That said, the MSA multiple currently exceeds the lows reached in 2012, and generally moved sideways in the range of 3 to 4 during 2014 and 2015.

Changes in Outstanding Unpaid Principal Balance on Mortgages Serviced for Others

The fluctuations in the UPB component of bank MSA holdings stem from four main factors: mortgage debt outstanding, bank acquisitions of the assets of failed savings associations, the bank's decision whether to hold the loan in portfolio and retain the servicing, and the shift in servicing market share between banks and nonbanks. In turn, the market shares of banks and nonbanks have been affected by an assortment of regulatory changes.

Mortgage Debt Outstanding

House prices rose sharply from 1998 to 2006, then contracted substantially through 2011 (see CoreLogic HPI in figure 8). During the build up in housing prices until 2006, mortgage debt rose in part because borrowers needed larger loans in order to purchase more expensive homes, and in part because borrowers extracted equity from their homes in order to finance other purchases (see Mortgage Debt Outstanding in figure 8). Mortgage debt started decreasing in 2008, as new mortgage originations contracted because of a lack of credit supply and demand, while an unprecedented increase in foreclosures led to an extinguishment of mortgage debt.⁵⁸

Bank Acquisitions of the Assets of Failed Savings Associations

Savings associations were generally heavily invested in mortgage-related assets because the qualified thrift lender test required these institutions to have qualifying investments (including mortgage-related assets) equal to at least 65 percent of their portfolio assets.⁵⁹ Savings associations that followed the "originate-to-distribute" model typically had particularly large concentrations in MSAs. Countrywide Bank, FSB and Washington Mutual Bank, FSB were two such savings associations that had large MSA holdings and were acquired by banks at the peak of the crisis. Effinity Financial Corporation (parent to Countrywide Bank, FSB) reported $18.4 billion in MSAs as of June 30, 2008, on its last TFR before acquisition. Similarly, Washington Mutual Inc. (parent to Washington Mutual Bank, FSB) reported $6.2 billion in MSAs as of June 30, 2008, on its last TFR before acquisition. Although some of these MSAs were sold or written off prior to acquisition, a meaningful amount of these assets were assumed by the acquiring bank and were reported in the acquiring banks' subsequent Call Reports. These acquisitions thus contributed to a spike in MSAs reported by banks between the second and third quarter of 2008.

Banks' Decision to Hold Loans in Portfolio

As shown in figure 9, the share of all loan originations that were securitized (as calculated by Inside Mortgage Finance) rose from 61 percent in 2006 to 89 percent in 2009. The first part of the rise (in 2006 and early 2007) was due to a substantial increase in activity in the private-label MBS market. After the housing bubble burst in 2007 and the private-label MBS market froze, mortgage securitizations guaranteed by the GSEs or Ginnie Mae rose, facilitated in part by an increase in the conforming loan limit, which is the maximum loan size eligible for FHA and GSE credit guarantees.⁶⁰ Under the assumption that loans originated by banking institutions are securitized at a roughly similar rate as mortgage originations overall, the increase in securitization share from 2005 to 2009 likely contributed to the increase in MSAs recorded on banking institutions' books during that period.

After the crisis, private capital began to re-enter the mortgage market, the conforming loan limit was lowered (in October 2011), ⁶¹ and the securitization rate gradually decreased. In 2014 and 2015, the securitization rate dropped to around 70 percent, in part because of ongoing growth in banks' originations of loans larger than the conforming loan limit, which banks largely held in portfolio. The lower securitization rate in 2014 and 2015 may have dampened MSA holdings by banks. That is, as banks hold a greater share of the mortgages they originate on their balance sheet, their holdings of MSAs may diminish.

Shift in Servicing Market Share between Banks and Nonbanks

The dollar volume of mortgages serviced by banking institutions rose until 2008 (the left panel of figure 10), reflecting the fact that mortgage debt overall peaked in 2008 and the fact that the banking institution market share of mortgage servicing increased from 2006 to 2008 (the right panel of figure 10).⁶² During the financial crisis, many nonbank lenders and servicers experienced significant funding strains and either scaled back their origination and servicing operations or left the business entirely. As the strains of the financial crisis eased, nonbank mortgage originators and servicers regained and then built upon their market share in both mortgage originations and mortgage servicing. Data collected under the Home Mortgage Disclosure Act (HMDA), for example, indicate that the share of home-purchase mortgages originated by independent mortgage companies rose from 23 percent in 2007 to 47 percent in 2014.⁶³

Nonbanks also boosted their mortgage servicing market share through bulk purchases of MSAs. Many of these purchases were composed of portfolios related to nonperforming loans originally held by banking institutions, ⁶⁴ most notably in 2013, when nonbank servicers purchased from banks in bulk sales the MSAs corresponding to more than $500 billion in mortgages.⁶⁵ These sales included a $215 billion sale from Bank of America Corporation to Nationstar Mortgage LLC (Nationstar), a $93 billion sale from Bank of America Corporation to Walter Investment Management Corp. (Walter), an $87 billion sale from Ally Financial Inc. to Ocwen Financial Corp. (Ocwen), a $78 billion sale from OneWest Bank to Ocwen, a $40 billion sale from Flagstar Bank to Two Harbors Investment Corp., and a $9 billion sale from EverBank Financial Corp. to Walter.⁶⁶ By 2015, roughly one-third of MSAs were held by nonbanks, whereas before the financial crisis, the nonbank share was around 15 percent.

Role that the challenges of servicing nonperforming loans had on the shift. As suggested by these bulk sales, banks' difficulties managing their portfolios of nonperforming loans appear to have played a key role in the growth of the nonbank servicer sector. Before the financial crisis, the mortgage servicing business was generally dominated by banking institutions and their affiliates, and was oriented toward handling large volumes of performing loans.⁶⁷ This model began to show its weaknesses as the housing market deteriorated and the number of delinquent loans rose. Through the supervisory process and other means, the federal banking agencies had begun to identify widespread problems throughout the mortgage servicing market, such as accounts of poor communication with borrowers, lost information, improper or no documentation, and inadequate staffing. The increase in mortgage delinquencies and foreclosures that occurred during the financial crisis further highlighted servicing deficiencies. These weaknesses resulted in findings of unsafe and unsound practices, violations of applicable federal and state law and requirements, and widespread consequences for the national housing market and borrowers.⁶⁸

In 2011, the Federal Reserve and OCC mandated improvements to servicing practices through enforcement actions against 10 banks.⁶⁹ In 2012, further improvements were mandated through a legal settlement among the U.S. Department of Justice (DOJ), the U.S. Department of Housing and Urban Development, 49 state attorneys general, and 5 large bank mortgage servicers (DOJ settlement).⁷⁰ These actions and settlements involved large civil penalties, including more than $25 billion in penalties and consumer relief under the terms of the DOJ settlement.

Banks' difficulties in servicing their nonperforming loans, in conjunction with these enforcement actions and settlements, appear to have motivated banks to sell MSAs to nonbanks. Nonbank servicers were willing to pick up much of this servicing, in part because of their cost advantage relative to bank servicers in handling nonperforming loans. That cost advantage stemmed from both their specialization in this type of servicing ⁷¹ and from their ability to harness technological innovations in order to reduce costs.⁷² The specialty servicers also got a boost from Fannie Mae's "High Touch Servicing Program," which was designed to facilitate the transfer of nonperforming loans from banks to specialty servicers.⁷³

In January 2014, new servicing standards and requirements mandated by the Consumer Financial Protection Bureau (CFPB) became effective.⁷⁴ These requirements applied to both banking institution and nonbank servicers, as the Dodd-Frank Act provided the CFPB with the authority to supervise banking institutions with assets over $10 billion and nonbank mortgage servicers, and to issue rules that addressed consumer protection issues in mortgage servicing.⁷⁵ Under its authority under the Truth in Lending Act, as implemented by Regulation Z, and the Real Estate Settlement Procedures Act, as implemented by Regulation X, the CFPB issued rules that require changes in the notices and statements provided to borrowers, the way in which payments are credited, and servicer recordkeeping. The new rules also establish minimum standards that servicers must follow when handling delinquent mortgages or engaging in loss mitigation.

Although servicing conducted by banking institutions was the primary focus of regulatory scrutiny between 2011 and 2013, more recently servicing provided by nonbank servicers has been the subject of review by the CFPB, the Federal Trade Commission, and state regulators.⁷⁶ The Financial Stability Oversight Council (FSOC), the Government Accountability Office, and Federal Housing Finance Agency's (FHFA) inspector general have also highlighted possible risks posed by nonbank servicers.⁷⁷

Role of changes in the REIT tax treatment of excess MSAs. In 2013, the Internal Revenue Service (IRS) issued a private letter ruling (PLR) that provides an incentive for REITs ⁷⁸ to invest in certain cash flows associated with MSAs.⁷⁹ Servicers have the option of splitting their servicing revenue into two pieces: the "base servicing," representing the servicer's compensation for carrying out its servicing duties, and the "excess servicing," representing the revenue beyond the servicer's costs. The PLR established that the excess servicing spread portion of an MSA is a qualifying asset for a REIT and that the excess servicing strip is more similar to an interest-only mortgage strip than compensation for performing servicing.⁸⁰ This clarification in tax treatment appears to correspond to an increased appetite on the part of REITs for investing in MSAs.

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Trends in Banks' MSA Values Relative to Assets and to Capital

MSAs represent a very small share in the aggregate of total bank assets and CET1 capital. As illustrated in figure 11, the amount of MSAs relative to total assets during the 1998 to 2015 period ranged from nearly zero to 0.7 percent, and stood at 0.25 percent in 2015. Meanwhile, the amount of MSAs in relation to CET1 capital (or tier 1 capital less preferred stock and related surplus, prior to January 1, 2015) ranged from 2 percent to 9 percent during the 1998 to 2015 period, and was 2.8 percent in 2015.⁸¹

The time-series pattern of MSAs relative to total assets and to CET1 capital shown in figure 11 shares many of the same peaks and troughs as the time series of MSAs alone in figure 5. However, the MSAs to assets and to CET1 capital series have declined more sharply since 2008 than the MSA valuations alone. This fact suggests that the capital and the assets of banks have risen by more than MSA holdings since the financial crisis.

Although MSAs have become a smaller share of banking sector assets in the aggregate, the number of banks that held MSAs increased considerably during the period, from 513 in the second quarter of 1998 to 913 in the fourth quarter of 2015, as shown in figure 12. Figure 12 also shows that the share of banks with MSAs rose even more during this period--from 6 percent in 1998 to 16 percent in 2015--in part because the overall number of banks contracted significantly. The increase in the number and share of banks holding MSAs appears to have started accelerating around 2009.

Shifts between Small Bank and Large Bank Holdings of MSAs

That MSA balances have been decreasing while the number of banks holding MSAs has been increasing is due to the fact that large banks--which hold the majority of MSAs--are decreasing their holdings, whereas small banks--which make up the majority of banks that hold any amounts of MSAs--are increasing their holdings. On this point, figure 13 shows the MSAs to CET1 capital ratio for banks of four different asset sizes: less than $10 billion, between $10 billion and $50 billion, between $50 billion and $250 billion, and more than $250 billion. Of the four groups, banks with less than $10 billion in assets have, by far, the lowest MSAs to CET1 capital ratio. However, the aggregate MSAs to CET1 capital ratio for these banks has increased from less than 0.4 percent in 2009 to about 0.9 percent in 2015. Likewise, the share of total MSAs held by banks with less than $10 billion in assets also rose over that period, from less than 2 percent in 2009 to 8 percent in 2015. In contrast, banks with assets greater than $250 billion have seen a steady decline in MSA holdings since the third quarter of 2008, when they had an MSAs to CET1 capital ratio of 19 percent, compared with 4.4 percent at the end of 2015.

The increase in the MSAs to CET1 capital ratio for small banks and the decrease in the same ratio for all other banks could reflect differences between these two groups in either the multiple or the UPB of loans serviced for others. Data are not publicly available on MSA valuation multiple by bank size. However, data on the UPB of mortgages serviced by others seems to explain the differences in the MSAs to CET1 capital ratio. As shown in table 2, from 2010 to 2015, for example, the UPB of mortgages serviced for others declined by roughly $2 trillion, or about 40 percent, for banks with more than $250 billion in total assets. It increased by around $70 billion, or 44 percent, for banks with less than $10 billion in total assets.

Table 2. Changes in unpaid balances of loans serviced for others by banks
Billions of dollars, except as noted

Asset size category	Total 1-4 family mortgages serviced for others reported by banks
	Year-end 2010	Year-end 2015	Percent change	Number of banks in 2015
Greater than $250 billion	$4,819	$2,928	-39%	6
$50 to $250 billion	$545	$418	-23%	26
$10 to $50 billion	$213	$163	-24%	48
Less than $10 billion	$159	$230	44%	5,258
Total	$5,736	$3,739	-35%	5,338

Source: Staff calculations from Call Report data.

Distribution of Banks by MSAs to CET1 Ratios

Most banks--83 percent--hold no MSAs.⁸² The number of banks with no MSAs has decreased significantly since 1998, but that decline almost entirely reflects the contraction in the number of banks overall during this period. Of banks with MSAs, the vast majority--646 in 2015--held relatively small quantities, less than 3 percent of CET1 capital. As shown in figure 14, 120 banks have MSAs to CET1 capital ratios of 3 to 5 percent and 67 have MSAs to CET1 capital ratios of 5 to 8 percent. Finally, 19 banks have MSAs to CET1 capital ratios of 8 to 10 percent and 61 have ratios in excess of 10 percent. The number of banks in each of these categories has, on net, increased since 1998.

The increase in the number of banks with higher MSAs to CET1 capital ratios, however, masks a significant difference in the trends for small and large banks.Figure 15 shows the share of banks by asset size with MSAs that are more than 10 percent of their CET1 capital. The number of banks that have less than $10 billion in assets and MSAs to CET1 capital ratios in excess of 10 percent rose from 20 at the recent low point in the fourth quarter of 2008 to 58 in the fourth quarter of 2015. To put this rise in context, these 58 banks represent only about 1 percent of the 5,258 U.S. banks with assets less than $10 billion. In contrast, the number of banks with MSAs to CET1 capital ratios in excess of 10 percent has decreased significantly for banks with more than $10 billion in assets. In total, only 3 such banks currently have ratios of MSAs to CET1 capital in excess of 10 percent, compared with 11 at the recent high point in 2009. These banks represent about 4 percent of banks with assets greater than $10 billion.

Reason for MSA Decreases among Large Banking Institutions

As discussed earlier in this report, much of the servicing contraction in large banking institutions appears related to banking institutions' desires to rid themselves of the servicing on nonperforming loans. The MSA treatment under the revised capital rule is unlikely to be a motive for the banking institution bulk sales of nonperforming loans because the MSA valuations for nonperforming loans tend to be low, and so selling the servicing on these loans may not be an effective way to reduce the MSAs to CET1 capital ratio.⁸³ Some of the contraction also results from large banking institutions scaling back somewhat their mortgage origination activity more generally during the post-crisis period. For example, data reported by Inside Mortgage Finance indicate that the large banking institution ⁸⁴ share of mortgages originated to purchase homes fell from 53 percent in 2008 to 28 percent in 2015.⁸⁵ The overall amount of mortgages directly or indirectly financed by large banking institutions is more difficult to determine. Large banking institutions provide significant funding to some nonbank mortgage companies, and under some business models banking institutions source some of the mortgage loans that nonbank lenders originate.

Large reductions in servicing portfolios by large banking institutions were widespread after the crisis for the reasons described in this report, both for institutions whose MSA concentrations fell far short of the 10 percent deduction threshold and for those that exceeded it. Nonetheless, the decline in the number of large banks with MSAs to CET1 capital ratios in excess of 10 percent is partially explained by increases in capital levels at these firms during the last few years and suggests that large banks' economic incentive to avoid regulatory capital deductions resulting from MSAs above the 10 percent threshold is one of the factors that is influencing the amount and distribution of MSAs.

Reason for Increase in MSAs among Small Banks

As noted earlier, the number of banks with less than $10 billion in assets and MSAs to CET1 capital ratios higher than 10 percent has risen considerably since 2010. This increase appears to stem, in part, from at least two factors. First, unlike the trend for large banks, banks with less than $10 billion in assets have increased their mortgage origination market share from 13 percent in 2008 to 19 percent in 2014.⁸⁶ Second, small banks appear to have switched their MSA business models after the financial crisis. During the housing bubble, some of the larger firms typically served as aggregators by purchasing loans and their accompanying servicing rights from smaller banks. The aggregator business was profitable, in part, because the GSEs charged lower guarantee fees ⁸⁷ to firms that brought them larger quantities of loans.⁸⁸ Aggregators, in turn, shared some of these cost savings with the smaller banks from whom they purchased loans.

During and after the financial crisis, aggregators pulled back sharply on their purchases of loans from smaller banks. This pullback reflected several factors. First, the guarantee fee pricing became less favorable to aggregators.⁸⁹ Second, the GSEs began increasing their demands that banks repurchase loans that had performed poorly since being sold to the GSEs.⁹⁰ Aggregators' losses on these repurchases were disproportionately concentrated among loans that they had purchased from other firms.⁹¹ Third, the revised capital rule, stricter mortgage servicing regulations, and the litigation experience of some banks may have dampened aggregators' interest in amassing large portfolios of MSAs.⁹²

With the withdrawal of the aggregators from the market, smaller banks found it advantageous to sell their loans directly to the GSEs through the cash window.⁹³ However, the GSEs, unlike the aggregators, do not purchase the servicing rights along with the underlying loans. Some of these smaller banks now appear to be retaining the servicing rights after selling the loans that they originate to the GSEs, and thereby recording an MSA, when they likely would not have done so with a sale to an aggregator.

To illustrate the shift in business strategy on the part of small banks, figure 16 shows the number and share of small banks that sold any loans to the GSEs in a given year. This calculation is based on data reported by lenders under HMDA.⁹⁴ Between 2011 and 2012, the number of small banks that sold loans to the GSEs rose from 765 to 927, and remained around this level through 2014.⁹⁵ This 150-bank increase in the number of small banks selling loans to the GSEs is roughly comparable to the increase in the number of banks recording an MSA during the same period.

The HMDA data do not include information on whether any of these small banks retained the servicing rights after selling the loan to the GSEs. However, separate data from Freddie Mac suggest that the selling bank typically has retained the servicing, particularly in recent years. An important caveat is that these results are based on sellers and servicers with market shares greater than 1 percent, as the identity of smaller sellers and servicers is masked in the Freddie Mac data. Thus, these results may not reflect fully the behavior of small banks. That said, as shown in figure 17, the share of loans securitized by Freddie Mac in which the selling bank retained the servicing rose from around 65 percent in 2007 to nearly 100 percent by 2011, and has held steady around that level since.

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