Fannie & Freddie Overhaul Impact on Banks Who Service Mortgages

Freddie Mac’s chief operating officer, Bruce Witherell, quit yesterday. This comes a day after Wells Fargo’s CFO resigned/retired “for personal reasons,” and before tomorrow’s official release of the Treasury’s proposals to overhaul Fannie & Freddie.

The Fannie & Freddie plans have been well leaked to the press at this point, although anything that is decided upon will takes years to implement. Of great interest to many investors, and especially those servicing loans, is what will happen to the value of servicing under the plan, and how this will impact street pricing for originators. (And let’s not forget Basel III bank capital controls simmering out there.) Minds much smarter than mine suggest that existing servicing will be “grandfathered in to the current process/values. Going forward, at some point, however, the minimum servicing fee for newly securitized loans would be reduced from 25bps to 5bps. Concurrent with this lower minimum fee, servicers will only be required to process loans that are less than 89 days delinquent. For the current loans, the Servicer will be allowed to earn the float, late fees and ancillary income; however, it will be obligated to make advances as needed while the loans are less than 89 days delinquent. Loans that are 90+ days delinquent will be transferred to a “Special Servicer” who will be paid on a “cost plus” basis from a pre-negotiated schedule. This Special Servicer can be another party or a different department within the original Servicer. So writes a trader at BofA/Merrill Lynch.

The suggested outcome goes on. The GSE (or other “wrapping entity”) may raise the minimum guarantee fee to something in the 40 to 65 basis point range. So perhaps for most servicers, a drop in the servicing fee, combined with an increase in the g-fee, may be somewhat close to a “wash” price-wise. Or perhaps not – it may depend to some extent on how much of the delinquency burden the GSE takes versus the servicer. The Merrill piece suggests that “it make perfect sense to give the economic risk of the entire delinquent mortgage function to the experts who can then charge the correct price versus paying a known DM fee schedule.” Also, since the large bulk servicers are banks that will fall under the new Basel III rules, reducing the capitalized MBSR from 25bps to 5bps will mostly solve the proposed capital restriction issues.

Market Update
At least we had a little rebound Wednesday in the bond markets, which helped out rates. As one trader from Jefferies put it, “While the performance of mortgages over the past few sessions has been incredibly disappointing we continue to expect that over time adding into these pockets of weakness will pay dividends. Supply will remain nearly non-existent at these rate levels and once the market establishes a new trading range investors will be in search of ways to enhance returns, particularly ones which offer the liquidity of MBS.”

We saw some of that yesterday, and it was paired with a decent $24 billion 10-yr auction. And let’s not forget Ben Bernanke’s testimony, and that fact that the bond markets were “oversold” and therefore one would expect a bounce at some point. When the proverbial dust had settled, mortgage security prices were about .375 better than Tuesday’s close. Hopefully you don’t mind (too much) rates where they are, as many analysts feel that in the immediate future rates may chop around at these levels for a while.

This morning we’ve had our usual weekly Jobless Claims, which dropped by 36,000 to 383,000, and the 4-week moving average fell 15,000 to 431,500. (Many prefer focusing on the 4-week moving average since it irons out some of the weekly volatility.) Regardless, this puts the jobless claims number at its lowest level since the summer of 2008. After the news we find the 10-yr yielding about 3.69% and MBS prices slightly worse. We still have a $16 billion 30-yr auction to muddle through.