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Risks, Rewards for Fast Growing Servicers

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Residential loan servicers are seeing improved performance in all facets of their operations. Three rapidly growing servicers have more to gain in the short run as the environment improves. But longer term, pressure to originate nonprime mortgages, as well as other factors, could pose a risk for the trio.

Metrics for collections on jumbo and Alt-A loans were better in the third quarter for all mortgage servicers except GMAC, which has seen its performance trend fluctuate as it been in the process of being acquired by Ocwen.

Re-modification rates on all product types were higher at Bank of America, N.A., and Wells Fargo Bank, N.A. Even GMAC’s re-modification rate moved higher once its operations were acquired by Ocwen.

The findings were discussed in the Servicer Dashboard Third Quarter 2013 from Moody’s Investors Service.

At the same time BofA’s re-modification levels rose, its re-default rates increased. Chase, on the other hand, outperformed its peers with its re-default rates.

Foreclosure timelines have lengthened for all servicers, though Moody’s sees improvement this year as foreclosure pipelines clear and judicial state court backlogs diminish.

Moody’s noted that Nationstar Mortgage LLC, Ocwen Financial Corp. and Walter Investment Management Corp. have been transitioning from servicing performing nonprime mortgages to providing full-service mortgage banking. Their originations now include agency mortgages, while their servicing portfolios include a full spectrum of loans — from distressed mortgages to “super prime.”

The three companies derive the majority of their revenues from special servicing, and special servicers have the most to gain from an improving housing market and economy since it costs 10 times more to service delinquent loans than performing loans. Each 1 percent decline in delinquency lowers servicing costs by 1 to 2 basis points, and the impact on mortgage servicing rights valuation is 10 times that.

Moody’s considers expanded origination capacity to be a much-needed source of organic growth. It sees the trio as poised to become the next generation of nonprime loan originators.

But escalation of nonprime originations could add risk to their credit profiles.

Moody’s noted that rapid growth fueled largely by bulk acquisitions of credit-impaired residential mortgage servicing portfolios at the three firms poses significant operational risks such as operational deficiencies, volatile financial performance and even failure.

Although it’s been easier for non-bank servicers to profitably expand over the past couple of years, Moody’s said competition will increase as banks work through their legacy mortgage issues and clarity increases on the capital challenges of Basel III.

Moody’s also noted that servicers do better focusing on either prime or nonprime loans, and it is difficult to manage both businesses under one roof.

Moody’s said that as all three companies transition from acquisition-based growth to organic growth, their cash flows will improve. Their ability to sustain success will depend on how they deploy the additional cash flow.

“As the housing market continues to improve, the companies will benefit from increasing profitability, a credit positive,” the ratings agency said. “Nevertheless, the companies’ high growth rates will challenge their ability to service loans, a credit negative.”

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