Servicer Compensation Proposals Ready for Public Comment

The Federal Housing Finance Agency (FHFA) is requesting public comment on twornalternative mortgage servicing compensation structures.  The proposed structures are the result of workrndone under a Joint Initiative involving Freddie Mac and Fannie Mae (the GSEs),rnFHFA, HUD, FHA, and Ginnie Mae. </p

FHFA’srnstated intention in issuing a directive to the GSEs last January to participaternin such planning was to improve service for borrowers, reduce servicers’ risk,rnand provide flexibility for guarantors to better manage non-performing loansrn(NPLs) while promoting continued liquidity in the To Be Announced (TBA)rnmortgage securities market. The Joint Initiative also seeks to develop optionsrnfor compensating servicers that will enhance competition and can be replicatedrnin any future housing finance structures that emerge under GSE reform.  </p

Servicerrncompensation (Mortgage Servicing Right or MSR) is currently decided by thernoriginator setting the mortgage rate offered to borrowers in terms of thernspread above the par TBA price net of the guarantee fee that, when combinedrnwith the other income derived from origination and servicing (late fees,rninterest on escrow and payment floats) provides the servicer with an acceptablernrisk adjusted return on capital.  Thernspread charged in the mortgage rate for origination and servicing is based onrncompetition, expected costs, and the expected returns of originator andrnservicer and should cover the expected costs of servicing including servicingrnNPLs.  When a loan is sold into thernsecondary market for Enterprise, FHA, or VA loans, the servicer is generallyrnrequired to retain a Minimum Servicing Fee (MFS) of 25 basis points for thernGSEs and 44 basis points for Ginnie Mae.</p

Thernservicer collects its servicing fee from the interest portion of the mortgagernpayment before passing it on to the investor. rnWhen a loan fails to perform there is no payment and the servicer receivesrnno servicing fee cash flow but is still expected to perform to the terms of itsrncontract obligations.</p

FHFArnsaid that, in order to understand the proposed context for determiningrnalternative compensation structures, it is important to frame the followingrnfundamental aspects of the current compensation framework: </p<ul class="unIndentedList"<liThe servicers' right to receive MSR cash flow is dependentrnupon its continued performance under the contract guidelines and these rightsrnare typically reflected as an asset on the servicer's balance sheet.</li<liThe minimum 25 basis points that servicers are required tornretain serves as collateral for the GSEs and sets a minimum level of ongoingrncash flow compensation under Servicing Guidelines. As a result, changing the MSF does not creaternor eliminate revenue to the servicer; instead it changes the timing of when thernrevenue is received in cash, and the corresponding tax treatment. </li<liThe originator prices into the note rate expectations aboutrnfuture default rates and related servicing costs. Any changes that raise expenses result in thernservicer realizing lower returns than expected.</li<liThe MSR is a capitalized asset by definition and, even in therncurrent credit cycle with its higher costs, the compensation framework stillrnresults in the MSR being an asset for most servicers.</li</ul<ul class="unIndentedList"<liThe current financial crisis has revealed a number of issuesrnin the current servicing model such as a failure of the servicers to investrnsome of their historically large spreads in technology, systems, andrninfrastructure because it would have increased their costs and might have ledrnto a write down of the MSR asset. Thusrnthey were unprepared for the significant increase in delinquencies andrndefault. This led to some practices thatrndid not comport with professional standards or even applicable laws. </li</ul

Arnform of the first proposed change in the compensation structure was proposed bothrnby the Mortgage Bankers Association and the Clearing House Association andrninvolves a modest change to the current Enterprise Servicing CompensationrnModel.  Because of the similarity of the proposals,rnFHFA is presenting for public comment this concept.  </p<ul class="unIndentedList"<liServicers would retain a reduced MSF strip of 12.5 to 20rnbasis points with an additional reserve account (ranging from three to fivernbasis points) to cover non-performing loan servicing costs. </li</ul<ul class="unIndentedList"<liThe reserve account would "kick-in" after pre-determinedrnthresholds are met. If reserves are notrnneeded, servicers could reclaim all or part based on triggers such asrngeography-based market conditions, time periods, or performance measures. Eachrnservicer would have its own reserve account related to its loans; there wouldrnbe no cross-collateralization among servicers' reserve accounts.</li</ul<ul class="unIndentedList"