The recent spike in mortgage rates has deal advisers hearing more chatter for transactions involving portfolios of mortgage servicing rights.
Citigroup Inc. on Jan. 30 announced its plan to exit mortgage servicing altogether with a plan to sell $97 billion unpaid principal balance of mortgage servicing rights and outsource the servicing rights on its remaining mortgages. A day after the deal announcement, New Residential Investment Corp., parent of the buyer of Citigroup's $97 billion portfolio, closed its acquisition of a different portfolio of mortgage servicing rights. New Residential's mortgage subsidiary also purchased a portfolio of $72 billion unpaid balance of mortgage servicing rights from PHH Corp. to end the year.
With the jump in mortgage rates since the November 2016 election, deal advisers said they expect more companies to take advantage of the opportunity to sell high on their mortgage servicing rights.
"I do think you'll see a lot of deal activity occurring in the market in 2017, particularly in the first couple of quarters," said Mike Carnes, managing director for Mortgage Industry Advisory Corp. Matt Maurer, managing director for MountainView Capital Holdings, agreed, predicting more deal activity in coming months as clients have expressed interest in selling.
The asset class of mortgage servicing rights has already seen significant deal activity in recent years. New regulations from the Consumer Financial Protection Bureau have increased the cost of servicing mortgages, increasing the importance of economies of scale. Further, changes in capital regulations mean a bank can be punished for having too many mortgage servicing assets. Specifically, if the value of a bank's mortgage servicing assets exceeds 10% of the bank's common equity Tier 1 capital, the bank must deduct the excess amount from its calculation of common equity Tier 1 capital, an important metric in the post-crisis regulatory regime.
As a result, many banks have been exiting the business. The nonbank market share of assets among the top 30 servicers jumped to 32% in 2015 from 7% in 2011, according to a June 2016 report from the Federal Reserve. However, with Citigroup's massive balance sheet, it was not in danger of hitting the regulatory threshold that would affect its capital position.
"I don't know if there was a specific trigger for Citi. I think it reflects ongoing efforts by the company to shrink and simplify," said Julie Solar, senior director for Fitch Ratings.
Other banks might feel more pressure. The spike in mortgage rates since the election has increased the value of their mortgage servicing assets, pushing some banks closer to the 10% threshold. Data from Mortgage Industry Advisory Corp. shows the price of general servicing assets jumped 23.6% between Sept. 30, 2016, and Dec. 30, 2016.
"For those firms that may be a little more cash-strapped than others, it certainly would put more pressure on that capital threshold," Carnes said. At the same time, the rate movement could encourage certain nonbanks to sell their servicing rights, too. The rate spike could cut refinance volume in half, which will particularly hurt origination shops heavily reliant on refinancing.
"Origination volume in the first quarter is expected to be light, and with that we will have [nonbank] sellers who will need to bring servicing to market to manage short-term cash needs," Maurer said.
Maurer and Carnes both said it could take some time for deal activity to materialize and overcome a gap between what buyers are willing to pay and seller expectations. Maurer said he is advising clients interested in selling to wait a couple months for buyers to increase their bids. The gap is largely driven by a difference between what current mortgage rates dictate for valuation and the buyers' models for how the portfolios will perform. In recent years, rates have increased only to be driven down again by economic malaise across the globe. When rates plummet, mortgage borrowers will refinance, crushing the value of a mortgage servicing portfolio as borrowers exit that pool of assets.
"There's been a lot of buyers over the last three years that were torched because prepaid speeds were so much faster than their acquisition prices contemplated," Carnes said. "Now you take one quarter where interest rates are up over 70 basis points and they're saying, 'Ok, is this true? Is this going to last?'"