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Fortress Gains in Servicing Market as BofA Retreats: Mortgages

Fortress Investment Group LLC (FIG) took its Nationstar Mortgage Holdings Inc. (NSM) public last week in the second offering of a loan servicer in a month as upstart firms grab market share from banks inundated with troubled borrowers.

Banks are retreating from the approximately $10 trillion mortgage servicing market, once a cash cow that generated monthly revenue of 0.25 percent to 0.4 percent of loan balances. Federal and state probes of foreclosure practices led to new regulations that are driving up costs, and a pending change in bank capital requirements also made the business less desirable.

“Smaller servicers have an opportunity to pick up market share because they aren’t facing the same regulatory issues and the same capital issues as banks,” said Diane Swonk, chief economist at Mesirow Financial Inc. in Chicago. “We’re in big trouble if they don’t -- banks are so completely overwhelmed with defaults and regulatory issues, some of them can’t even handle a refinance request.”

Bank of America Corp. (BAC) and JPMorgan Chase & Co. (JPM) last year reduced by about half the value of their mortgage servicing rights, or MSRs, that estimate future cash flows against costs. For Wells Fargo & Co. (WFC) in San Francisco, the drop was 13 percent.

Nationstar and Ocwen Financial Corp. (OCN), which spun off Home Loan Servicing Solutions Ltd. in a public offering last month, are betting their expertise in handling defaulted or seriously delinquent loans will help them grow. About $1 trillion of mortgage servicing rights currently are for sale by banks, according to Jay Bray, chief executive officer of Lewisville, Texas-based Nationstar, who declined to name the companies because his firm intends to compete for some of the assets.

New Model

In the next three to five years, as much as $4 trillion of servicing assets could be moved off bank books and bought by companies like Nationstar, Bray said.

The company fell 42 cents, or 3 percent, to $13.77 as of 3:44 p.m. in New York. Nationstar priced 16.7 million shares at $14 in the March 7 initial public offering, according to data compiled by Bloomberg. That was less than the $17 to $19 estimated by underwriters. Home Loan Servicing (HLSS) has declined 40 cents to $13.60 since its IPO.

“The new model of servicing is going to be flow servicing, where these types of loans will be automatically moved to non- bank companies,” Bray said. “There will be a continued need for the high-touch model like ours that focuses on borrowers who need extra loving care.”

Fannie Mae Buys

Revenue at Nationstar rose 44 percent in 2011 as it bought servicing rights from Charlotte, North Carolina-based Bank of America and sub-contracted with other institutions to handle their most troubled loans. In May, the company will purchase $67 billion of servicing assets from Aurora Bank FSB, a unit of defunct Lehman Brothers Holdings Inc., Bray said.

Banks including Goldman Sachs Group Inc. have sold the servicing rights of more than $160 billion of mortgages since mid-2011. Bank of America sold $73 billion of its portfolio to Fannie Mae in August and $18 billion to Nationstar in December, falling to the No. 2 ranking. Wells Fargo is now the largest servicer.

JPMorgan, based in New York, in November agreed to sell mortgage servicing rights for $15 billion of its portfolio to Ocwen. The West Palm Beach, Florida-based servicer in October bought Morgan Stanley’s Saxon Mortgage Services Inc., with servicing rights on $26.6 billion of mortgages. In June, it purchased Goldman Sachs’s Litton Loan Servicing, with about $41.2 billion of mortgages.

‘Under Stress’

“The big guys are all under stress, trying to handle the volume of loans while they deal with regulatory issues,” said William Fricke, senior credit officer at Moody’s Investors Service in New York. “They’re offloading some of their servicing to relieve the pressure.”

Thomas Kelly, a JPMorgan spokesman, Ancel Martinez of Wells Fargo, and Bank of America’s Dan Frahm declined to comment.

Homeward Residential, which until last month was known as American Home Mortgage Servicing Inc., is another small servicer seeking to grow -- both by purchasing mortgage servicing rights and contracting with the industry’s biggest servicers to handle some of their loans, said owner Wilbur Ross, the billionaire investor who’s chairman of WL Ross & Co. in New York.

“Small servicers will gain share, partly because the big banks are selling MSRs instead of buying them and partly because some of the big banks are servicing such large amounts of problem loans that they’re farming out special servicing to firms like ours that are particularly well set up to perform it,” Ross said.

Adding Assets

Ross bought Homeward in 2008 and has since added assets from Citigroup Inc. (C) and Option One Mortgage Corp., a division of H&R Block Inc. (HRB) The company, based in Coppell, Texas, went into correspondent and warehouse lending last year, financing mortgages and keeping the servicing rights when selling them, Ross said. Bank of America announced in October it was exiting the correspondent business.

Administering home loans had little oversight until allegations of fraud in late 2010 sparked federal and state investigations. In April, the Federal Reserve, U.S. Treasury and other regulators issued an enforcement action forcing the banks to hire staff, improve foreclosure performance and keep stricter controls on fees they charge borrowers and bond holders.

Bank of America, Wells Fargo, JPMorgan, Citigroup and Ally Financial Inc. agreed in February to a $25 billion settlement with state attorneys general, pledging to compensate borrowers wrongfully evicted from homes and adhere to new standards. The banks service more than half of the market.

Servicer Misconduct

Servicer misconduct included the use of fraudulent affidavits to establish claims and falsifying promissory notes that transfer the ownership of mortgages, according to Fed Governor Sarah Bloom Raskin.

“These problems have hampered the ability of the courts and the markets to work through the foreclosure inventory in an efficient manner,” she said in a January speech in Washington. It’s “one of the factors hindering a rapid recovery in the economy,” she said.

More changes are in store for the industry, said Peter Swire, a professor at Ohio State University’s Moritz College of Law in Columbus.

The new Consumer Financial Protection Bureau in Washington has said it plans to reform servicing practices. So far, all they’ve done is draft a new format for monthly mortgage bills, though Richard Cordray, head of the bureau, has said there’s more to come.

Changing Fee Model

In addition, the Federal Housing Finance Agency has proposed changing the current flat-fee compensation model to a system that rewards performance.

While regulatory crackdowns and burgeoning costs are currently driving the fragmentation of the servicing industry, banks also are mindful of the changes in capital rules that in 2014 will begin to be implemented, Swire said.

Mortgage servicing rights that now help banks to meet capital requirements will shrink in value as new standards set by Basel III, an international banking agreement, phase out their use. Companies like Nationstar and Home Loan Servicing won’t be affected because they’re not banks.

“The big players are already thinking about the new capital rules kicking in, and that creates an incentive to shrink their market share,” Swire said.

To contact the reporter on this story: Kathleen M. Howley in Boston at kmhowley@bloomberg.net.

To contact the editor responsible for this story: Rob Urban at robprag@bloomberg.net.

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