Hilltop’s View on the FHFA Financial Requirements Changes for GSE Servicers
Nigel Brazier and Stephen M. McGurl
The Federal Housing Finance Agency (FHFA) announced that the proposed requirements set forth this past January regarding new minimum financial eligibility requirements for Fannie Mae and Freddie Mac sellers and servicers has been finalized. The FHFA stated that the new operational requirements will become effective no later than Sep. 1, 2015 and the financial requirements will become effective Dec. 31, 2015.
“In response to changes taking place in the servicing industry, FHFA directed Fannie Mae and Freddie Mac, as part of their 2014 and 2015 Conservatorship Scorecards, to update their counterparty standards for mortgage servicers,” the FHFA said in a statement“. http://www.fhfa.gov/Media/PublicAffairs/Pages/New-Eligibility-Requirements-for-SellerServicers.aspx)
Banks that are seller/servicers to the GSEs must maintain minimum Net Worth of $2.5 million plus a dollar amount equivalent to 25 basis points times the unpaid principal balance of all residential mortgages that are serviced by the Bank.
In addition to the minimum amount of Net Worth, Non-bank servicers must also have a tangible Net Worth Capital Ratio equal to at least 6% (calculated as tangible Net Worth divided by Total Assets) to meet the minimum capital requirement. Tangible Net Worth represents the amount of Tangible Assets (example is property, plant and equipment would be a tangible asset and goodwill is not a tangible asset) less Total Liabilities. For liquidity, the non-bank servicers must retain 3.5 basis points times the total Agency (Fannie, Freddie and Ginnie) unpaid principal balances being serviced. Nonbank servicers also have to hold cash and/or other defined liquid assets equal to 2% of the unpaid principal balances of nonperforming loans that exceed 6% of the servicer’s total serviced Agency portfolio.
The new liquidity rules apply only to the primary servicer of the GSE’s loans and not to any subservicers that may be utilized by the owner of the underlying Mortgage Servicing Rights. However, all subservicers must be approved GSE servicers and must meet the above minimum Net Worth and tangible Capital Ratio requirements.
Servicers will need to closely monitor the performance of their Ginnie Mae portfolios (as driven primarily by FHA loans), in that non-performing FHA loans have been at or near 7% of total outstandings for recent periods. The Ginnie Mae market has grown significantly over the past five years and the underlying FHA loans have yet to reach their “expected loss peaks”. Given the liquidity requirement noted above, a medium to large Ginnie Mae servicer could potentially trigger the 200 basis point addition for the minimum liquidity calculation.
Meeting the new Net Worth and liquidity requirements will be critical for non-banks that regularly buy servicing. All transfers are subject to review and approval by the GSEs. Such review will assess whether both the transferor and the transferee servicers meet these new minimum Net Worth and liquidity requirements as a result of the transaction.
While most banks will meet these new requirements, non-banks and MSR investors will need to factor these new requirements into their cost of doing business. Hilltop’s view is that it is likely that these new financial requirements could have some impact on both current and new non-bank entrants given possible lower returns on investment (due to higher capital requirements). MSR investments are generally attractive to many investors given lower prepayment and credit risks in current production portfolios and therefore the new requirements should not have any material impact on the value of mortgage servicing rights (such values are at higher levels in recent years due to demand for servicing).
Operationally, all seller/servicers will have to adhere to new reporting requirements that must be implemented and executed on a quarterly basis. For instance, the new reporting criteria will require a seller/servicer’s Chief Financial Officer (CFO) to certify delinquency statistics for all GSE and Ginnie Mae portfolios to each of the GSEs. This is in addition to the monthly remittance data provided to each of the GSEs on a discrete basis that typically includes delinquency data for the discrete GSE’s loans serviced by the seller/servicer. In addition, the seller/servicer CFO must also certify to any amount of unused/available approved servicing advance lines, where applicable, as part of the allowable liquidity components used in the liquidity calculations.
Our Hilltop view is that these new financial requirements will not have a material impact on most seller/servicers either because of stronger capitalization and/or lower delinquencies on newer GSE loans. Hilltop also views the reporting requirements as being possibly problematic for some servicers that will need to enhance both their basic reporting and internal controls to ensure the CFO certifications are complete and accurate.
Given that several large banks have indicated that they are deemphasizing the mortgage servicing business, we see this as an opportunity for Non-Banks to gain market share. However, higher capital and liquidity requirements will put pressure on the seller/servicer to reduce overall operating costs, streamline processes and cycle times, reduce headcount and enhance the profitability of the mortgage business and specifically the servicing operations overall. Hilltop views this challenge as difficult but certainly not insurmountable and that targeted investor returns can be achieved if the mortgage business engages a “change agent”.
