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Report to the Congress on the Effect of Capital Rules on Mortgage Servicing Assets

Potential Impact of the Revised Capital Rule on Nonbanks

This section describes how the mortgage servicing market might change if the revised capital rule were also applied to nonbank firms. The analysis is a hypothetical exercise based on estimates from public filings. The federal banking agencies only have the authority to set capital requirements for nonbanks that are subject to the supervision of one of the agencies, such as nonbank financial companies that the FSOC has determined shall be supervised by the Board.103 Other agencies have some ability to set financial requirements for nonbank servicers. Under its conservatorship authority, FHFA has the ability to set financial strength requirements for the GSEs' servicer counterparties. Ginnie Mae can also set criteria for its servicer counterparties. Ginnie Mae and FHFA recently enacted increases in these requirements, which took effect January 1, 2015, 104 and December 31, 2015, 105 respectively. State regulators have also proposed prudential standards that would apply to nonbank servicers.106

Capital requirements for insured depository institutions must be strong enough to limit the moral hazard associated with government-provided deposit insurance, which also tends to reduce the incentive for private market participants to monitor the risk-taking behavior of regulated banks. However, nonbank firms, including nonbank servicers, do not have access to deposit insurance and thus are more closely monitored by a range of counterparties and stakeholders. This difference implies that the capital requirements that apply to banking institutions would not necessarily be appropriate for nonbank servicers.

If the revised capital rule were applied to nonbank firms, the MSA treatment would likely affect nonbank activity in the mortgage servicing market. However, the deduction of MSAs from regulatory capital would prove far more consequential for nonbank servicers than the 250 percent risk weight for MSAs that are not deducted. The discussion in this section, therefore, focuses on the potential effect of the MSA deduction approach.

The effect of this approach on nonbank servicers depends on the structure of the nonbank servicer's balance sheet, which in turn depends on the servicer's corporate structure and business model. Broadly speaking, nonbank servicers fall into three groups, although most servicers are some combination of these models. The first group consists of servicers that have a REIT structure. The portfolios of REITs, in order to meet REIT tax requirements, are heavily weighted towards passive real-estate investments such as MBS and whole loans held for investment. The second group consists of firms that primarily specialize in servicing and that grow their portfolios by purchasing MSAs in bulk. These firms have balance sheets weighted heavily towards servicing advances and MSAs. The third group consists of firms that primarily originate mortgages, sell them into the secondary market, and retain the servicing rights. These firms typically have portfolios of loans held for sale in addition to MSAs and servicing advances.

Currently, aggregate holdings of MSAs by REITs are small. REITs serviced 6 percent, measured by the UPB, of mortgages serviced by nonbanks in 2015.107 However, direct REIT investments in MSAs increased significantly in the wake of the 2013 IRS PLR referenced earlier in this report. In particular, REIT holdings of MSAs increased from $5 million in 2012 to nearly $1 billion in 2015, while total assets of these REITs contracted over this period from $48 billion to $37 billion.108

The effect of REITs on nonbank servicers, though, is larger than this tabulation suggests. Many nonbank servicers have a relationship or affiliation with a REIT. Such nonbank servicers typically finance part of their balance sheet by selling their excess servicing as an interest-only strip associated with the MSAs to a third-party REIT. Nonbanks have been increasing their use of this financing structure. Two REITs that buy these excess servicing strips, for example, increased their holdings of these assets from $250 million in 2012 to $2.5 billion in 2015, at a time when their overall assets increased from $48 billion to $52 billion.109 REITs have also provided nonbank servicers with funding for servicing advances.

Table 4 shows selected components of the balance sheets of nine large publicly traded nonbank servicers.110 This balance sheet information was used to estimate a proxy of each firm's ratio of MSAs to CET1 capital.111 The analysis focuses only on publicly traded firms--which hold about 60 percent of the UPB of loans serviced for others by nonbanks--because data are not available on privately held firms.112 The analysis does not include several large privately held nonbank servicers, including Quicken Loans Inc. (Quicken), Caliber Home Loans, Inc., Lakeview Loan Servicing, LLC, and Freedom Mortgage Corporation, and may overweigh firms that elect REIT tax treatment because these firms are more likely to be publicly traded.

Table 4. Balance sheet components and selected capital ratios for selected large nonbank mortgage servicers
Thousands of dollars, except as noted
Entity MSAs, fair value Servicing advances Residential mortgages Real estate securities Total assets CET1 proxy MSAs at FV/total assets MSAs at FV/CET1 proxy
Two Harbors 493,688 37,499 3,985,158 7,825,320 14,575,772 3,576,561 3% 14%
Hatteras 269,926 0 361,307 14,302,230 16,137,526 1,865,105 2% 14%
Redwood Trust 191,976 1,000 3,928,803 1,233,256 6,231,027 1,146,265 3% 17%
PHH 880,000 691,000 743,000 0 3,652,000 1,318,000 24% 67%
Stonegate Mortgage 199,637 19,374 645,696 0 1,280,626 261,628 16% 76%
Ocwen 1,222,745 2,151,066 2,902,299 7,985 7,404,809 851,562 17% 144%
Nationstar Mortgage 3,358,327 2,223,083 9,117,664 0 16,654,070 1,758,114 20% 191%
Walter Investment 1,810,416 1,595,911 13,214,845 0 18,591,501 804,676 10% 225%
PennyMac 1,426,592 299,354 1,101,204 0 3,505,294 270,826 41% 527%

Source: Staff calculations based on SEC Form 10-K data.

As suggested by the discussion above, servicers that are REITs can have large portfolios of mortgages and MBS relative to their holdings of MSAs. As a result, the ratios of MSAs to a CET1 capital proxy would be relatively low for this subset of nonbank servicers (Two Harbors, Hatteras, and Redwood Trust)--around 14 to 17 percent. Although complying with the revised capital rule would increase some of these firms' incentives to increase capital and might induce them to shed some servicing rights or otherwise rebalance their portfolios, their fundamental business model likely would remain viable.

Because MSAs constitute a larger share of the total assets of other nonbank servicers compared with those structured as REITs, such nonbank servicers could incur substantial capital deductions, unless they substantially increased their capital levels. Two such nonbank servicers--PHH Corporation and Stonegate Mortgage Corporation--would have MSAs to CET1 capital proxy ratios in the range of 65 to 75 percent. Three of the nonbank servicers--Ocwen, Nationstar, and Walter--would have MSAs to CET1 capital proxy ratios around 150 to 225 percent and PennyMac, as a result of its corporate structure, could potentially have an MSAs to CET1 capital proxy ratio of around 525 percent. Thus, nonbank servicers without a REIT structure would face pressures to increase their capital levels or change their business models significantly, or both, if they were subject to the revised capital rule.

In the event that these nonbank servicers--other than the three publicly traded REITs--left the mortgage servicing business, the concentration of the servicing industry, based on the HHI, would double, from roughly 850 for the mortgage servicing industry in 2015 to around 1,600.113 The analysis assumes, for purposes of this exercise, that no new servicers enter the market, and the portfolios of the nonbanks that exit the market are spread across the remaining servicers in proportion to their current servicing share. Although the increase in concentration is significant under this scenario, it is generally consistent with the HHI values in 2009 and 2010--the last time period when nonbank servicers significantly reduced their market share. Importantly, this higher value does not appear to be problematic from a competition perspective, as DOJ guidelines consider markets with HHIs between 1,500 and 2,500 to be moderately concentrated. Under these conditions, mortgage servicers would likely still have limited market power.

The assumptions underlying this exercise may not be true in practice. For example, banking institution servicers may be reluctant to increase their market share. In some cases, this reluctance may stem from concerns about breaching the 10 percent deduction threshold, particularly in a scenario where a banking institution is considering acquiring the servicing portfolio of a large nonbank. For example, as of the fourth quarter of 2015, four banking institution servicers that had a significant presence in the servicing market would have been able to take on the entire servicing portfolio of the two biggest nonbank servicers (Nationstar and Walter) without the acquiring banking institution breaching the deduction threshold in the revised capital rule; six banking institution servicers would have been able to take on the entire servicing portfolio of any of the five largest nonbank servicers (Nationstar, Walter, PennyMac, Quicken, and Ocwen) without breaching the threshold.114 In other cases, a banking institution's reluctance to increase its servicing portfolio might stem from the higher costs of servicing loans and the banking institution's experiences with nonperforming loans during and after the crisis. Offsetting this consideration to some extent is the fact that the compensation for servicing loans might increase after the nonbank firms left the market. This increased compensation might offset any increases in capital costs and might also induce new servicers to enter the market.


103. See 12 USC 5365. Return to text

104. "Eligibility Requirements," Ginnie Mae, to text

105. Federal Housing Finance Agency, "Fannie Mae and Freddie Mac Issue New Eligibility Requirements for Seller/Servicers," news release, May 20, 2015, to text

106. Conference of State Bank Supervisors and American Association of Residential Mortgage Regulators, "State Regulators Propose Prudential Regulatory Standards for Non-Bank Mortgage Servicers," news release, March 25, 2015,  Leaving the BoardReturn to text

107. Tabulation based on Inside Mortgage Finance data of the top 50 holders of MSAs in 2015. Return to text

108. Tabulation based on the public filings of Redwood Trust, Inc. (Redwood), Hatteras Financial Corp. (Hatteras), and Two Harbors Investment Corp (Two Harbors). Return to text

109. Tabulation based on the public filings of New Residential Investment Corporation and PennyMac Investment Trust (PennyMac). Return to text

110. Estimates are based on the public 2015 10-K filings of these firms, available at to text

111. The proxy CET1 is the sum of common stock, additional paid-in capital, retained earnings, accumulated other comprehensive income net of distributions, and treasury shares. Return to text

112. The estimate of the market share of the nine banks in the sample is based on data from Inside Mortgage Finance. Return to text

113. This estimate is based on Inside Mortgage Finance data on the top 50 servicers. The HHI presented earlier in the report was based on the top 30 servicers in order to maintain comparability across time. The HHI estimate in this section is lower than this earlier estimate because it is based on a larger number of servicers. Return to text

114. We consider a servicer to have a significant presence in the servicing market if it is listed in the Inside Mortgage Finance 2015 list of the top 50 servicers. Quicken's MSA holdings are not publicly available because Quicken is a privately held company. For purposes of this calculation, Quicken's MSA holdings are imputed from its mortgage servicing book as reported in Inside Mortgage Finance data, and from the relationship that holds for other nonbank servicers between their MSA holdings and their servicing book. For this calculation only, the estimate of DTLs associated with MSAs is based on data from public financial reports for several large banking institutions and the estimate adjusted the ratios of MSAs to CET1 accordingly. Return to text

Last update: August 12, 2016

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