Mortgage servicers plan more MSR risk-transfer bonds

Fri Feb 28, 2014 3:51pm EST

NEW YORK, Feb 28 (IFR) - Embattled mortgage servicer Ocwen Financial and at least one other US servicer are actively working on new types of mortgage servicing rights (MSR) securitizations, known as direct-debt prepayment-risk deals or MSR IO (interest-only) trades.

The purpose of the deals is not to raise money - it is purely to reduce earnings volatility by shedding prepayment risk linked to MSRs associated with the GSEs. The non-bank servicers want to continue to acquire agency servicing, but they want to transfer the prepayment risk to private investors.

Several industry participants compared the transactions to the recent risk-sharing trades from Fannie Mae and Freddie Mac.

Ocwen completed the first such deal, known as OASIS 2014-1 (Ocwen Asset Servicing Income Series) on February 25, and plans US$1bn worth of deals this year. Another servicer - market rumour is that its NationStar, but the company declined to confirm - liked the execution of the Ocwen deal and is seeking to mimic it. Ocwen did not return phone calls inquiring about the new securitization program.

Ocwen and other servicers have been in the crosshairs of US regulators in recent weeks as the government cracks down on non-bank servicers that have bought up billions of dollars of MSRs from traditional banks, who are shedding the MSRs because of onerous Basel III requirements.

This week, New York's banking regulator said that executives at Ocwen have ties to related mortgage companies that may give them an incentive to push borrowers into foreclosure, according to Reuters.

And in early February, the same regulator halted Ocwen's purchase from Wells Fargo of the servicing rights on 184,000 home loans with a total principal balance of US$39bn. The office was concerned with Ocwen's ability to take on the additional servicing load, Reuters said.

This recent headline risk - as well as the fact that the deal was the first of its kind - led to diminished proceeds for the OASIS trade (a final amount of US$123m versus the US$136m that was intended), and wider yields. The fact that the deal coincided with a negative news cycle was coincidental, however; sources say Ocwen had been working on the transaction for more than year.

Despite the bumpy pricing, hedge funds and REITs want more of the product, as it "gives them a bit of a hedge against interest rates rising," one investor told IFR. "If you're long mortgage assets, these are good assets for the REITs."

These trades transfer earnings volatility on the excess interest-only (IO) strip to third-party investors - protecting the servicer from the possibility of the value of the IO decreasing. The investor said that this is actually preferable to Ocwen taking out another secured term loan to cover their prepayment-related costs, which they would have to pay back.

On balance sheet risk

The bond was on balance sheet and was an obligation of Ocwen, meaning that investors had to take on Ocwen credit risk - yet another reason that there was a steep new issue concession.

This differs from the strategy employed by PHH Mortage Corp, another non-bank servicer, which in November sold up to 50% of its newly originated MSRs to Matrix Financial Services. That off-balance-sheet sale also increased PHH's liquidity and reduced its earnings volatilty, but unlike the Ocwen deal, it was not syndicated to investors, and therefore does not have as much scalability, according to observers.

The Ocwen transaction offered investors a 21bp IO strip - a direct debt obligation of Ocwen - and was originally intended to be sold at a 5.5 multiple. The 21bp figure is the servicing value on the mortgages. And the multiple is what Ocwen views the present value to be of the future servicing income attached to the loans. Investors, however, were less optmistic and settled on a multiple of five, which meant lower proceeds for Ocwen.

Even so, this was higher than the 3.1 multiple that Ocwen actually has them marked at on its books. At the end of 14 years, Ocwen will pay back investors the initial purchase price times the unpaid balance.

The 17 accounts that took down the Ocwen bonds were dominated by hedge funds (three quarters of the investors) that had in the past or currently invested in Ocwen's other debt, according to people familiar with the transaction.

Specifically, the hedge funds that already had a view on how Ocwen's US$1.5bn outstanding term loan trades in the markets were the ones most interested in the securitization.

One hedge fund investor said that it had one desk analysing and trading IO strips, and another that had expertise in analysing Ocwen credit risk - making it particularly well suited to invest in the deal.

Servicers such as Ocwen must hedge against the runoff from their servicing portfolio due to prepayments; this can equal about 15% of the servicing portfolio per annum, according to Moody's. Origination volume, on the other hand, is not sufficient to replenish that runoff; hence these MSR IO trades must be completed to address the prepayment risk, Moody's analysts told IFR.

From a regulatory accounting standpoint, traditional banks who want to get their MSRs off balance sheet due to impending capital constraints may pursue similar plans as the non-bank lenders, according to Warren Kornfeld, a senior vice president at Moody's.

However, banks would be more likely to pursue the PHH sale template rather than the structured-note template used by Ocwen, Kornfeld said.

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