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Why the government pushes servicers to avoid foreclosure

Brent Nyitray, CFA, MBA

Overview: CoreLogic Foreclosure Report June 2014 (Part 2 of 3)

(Continued from Part 1)

Government encourages servicers to avoid foreclosure

The federal government has taken numerous steps to reduce foreclosures, starting with loan modification programs and also encouraging servicers to pursue other means of dealing with a delinquent borrower. The loan servicer handles the day-to-day management of the loan pool for the ultimate investor. They’re responsible for collecting mortgage payments, forwarding the interest and principal to mortgage-backed securities (or MBS) holders, and handling delinquent borrowers.

The most common alternative is the short sale, where the homeowner sells the property for less than the outstanding mortgage and the remaining debt is forgiven. The other type of disposition is called “deed in lieu,” where the lender offers the borrower money in exchange for the keys. Foreclosures aren’t cheap. The lender would like to skip the foreclosure process if at all possible.

As you can see from the previous chart, foreclosures as a percent of all mortgages outstanding have been declining rapidly.

Non-bank servicers are under pressure from the government

We’ve seen the Consumer Financial Protection Bureau ramp up scrutiny of the non-bank servicers. This has added to the cost of servicing portfolios. Servicing is a difficult business even in the best of times. However, the added regulatory scrutiny has made things even more difficult.

It’s interesting to see that the stock prices of the non-bank servicers like Ocwen (OCN) and Nationstar (NSM) have been clocked over the past year while the value of their mortgage servicing portfolios have increased dramatically. A year ago, newly originated Fannie Mae MSRs were trading at three times the servicing fee. As hedge funds have anticipated an increase in interest rates, newly originated Fannie MSRs are trading between four and five times. The stock prices of the non-bank servicers don’t reflect the increase in the value of their portfolios.

It’s important to keep in mind that the banks with large servicing portfolios, like Wells Fargo (WFC), will experience the same thing, as well as non-agency real estate investment trusts (or REITs) that retain servicing from their origination arms, like PennyMac (PMT). Investors who are interested in taking direction bets on interest rates should look at the 20-year bond ETF (TLT).

Continue to Part 3

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