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Consumer Financial Protection Bureau rose cost of loan servicing

Brent Nyitray, CFA

Mortgage REIT 101: What is a mortgage servicing right? (Part 5 of 5)

(Continued from Part 4)

Regulatory risks

One of the other big risks for holders of mortgage servicing rights (MSRs) is the Consumer Financial Protection Bureau (CFPB). While the servicer’s job is to look out for the bondholders, the regulators are tasked with looking after the borrower.

First, one of a servicer’s jobs is dealing with the borrower once a loan becomes delinquent. The CFPB has all sorts of regulations regarding how the servicer should contact the borrower, and the servicer must adhere to all the debt-collection regulations.

Second, the servicer has the job of trying to help the borrower become current. This means modifying loans to lower the payment. The government has been very aggressive in strong-arming servicers to modify problem loans. While the servicer’s first duty is to the bondholder, it’s subject to influence by the government. This pressure can create a conflict of interest between the servicer and the bondholder. While modifications are often in the best interest of the bondholder, if the borrower re-defaults, the modifications do not benefit the bondholder. In this case, the foreclosure timeline extends, and in a declining real estate market, that’s bad for the bondholder.

The CFPB stopped permitting dual tracking, through which a servicer could simultaneously pursue foreclosure and loan modification. The practice was largely followed because many modifications simply didn’t work. The mortgage rate would reduce, and the borrower would make a payment or two and then stop. Under dual-tracking, if the borrower subsequently re-defaulted, the foreclosure timeline would shorten because the foreclosure process would already have initiated. So the CFPB has ended this practice.

The CFPB has also curtailed force-placed insurance, through which the servicer could take out homeowner insurance on the home (and send the bill to the borrower) if they believed the borrower had let the policy lapse. The CFPB also implemented timelines for reaching out to delinquent borrowers, response time limits to modifications, and other new regulations.

The net effect of these changes has been to increase the cost of servicing a loan, which should decrease the value of MSRs at the margin.

  • Part 1 - Mortgage servicing rights increase in value as interest rates rise
  • Part 2 - Why mortgage servicing rights can hedge interest rate risk
  • Part 3 - Why mortgage servicing rights imply risks for servicers