Fannie Mae is giving the mortgage servicing industry's handling of troubled government-backed loans a makeover. But it would rather do so in private.
The government-sponsored enterprise has acquired the rights to service hundreds of billions of dollars of loans and transferred responsibility for managing them to a select group of large subservicers, according to mortgage servicing insiders and analysts. It has specifically acknowledged only one such deal — the August purchase of servicing rights for a $73 billion pool of Bank of America loans — but industry participants believe more than a dozen others have already occurred.
Why the secrecy? Fannie is "under a lot of political pressure, and wants to keep everything" quiet, says Paul Miller, managing director of FBR Capital Markets.
To Fannie, yanking servicing rights from big banks has other appeal, Miller says. Fannie executives "don't like how Bank of America, or any other major servicer, is servicing the loans," he says. "The biggest servicers are totally dysfunctional and putting no resources into the process."
Even so, the secrecy of Fannie's deals has some worried that it is using government funds to further entrench itself in the mortgage market. Members of Congress from both sides of the aisle are howling about Fannie's lack of disclosure.
Longtime industry executives complain that Fannie could be cutting deals that wouldn't make economic sense in the private sector. At a time when many lawmakers are pressing to wind down Fannie and fellow GSE Freddie Mac, Fannie's servicing push is "a game plan for survival," says a former Fannie executive still in the industry.
Fannie dismisses such concerns. The recent servicing transfers are simply the best way to protect itself from losses resulting from botched loan management, says Amy Bonitatibus, a spokeswoman for the company.
"When we identify a segment of our loans where credit losses may be substantial with the existing servicer, we will facilitate a transfer to a specialty servicer that has capacity and expertise in handling high-touch loans," she says. "We currently work with four specialty servicers who have all helped us to reduce credit losses by working more closely with homeowners to prevent foreclosures."
The Federal Housing Finance Agency, which oversees Fannie and Freddie, has been as reluctant to discuss Fannie's acquisitions as Fannie has. The agency declined to reveal the terms of the Bank of America deal in September. American Banker subsequently submitted a Freedom of Information Act request seeking the documents pertaining to the contract and others like it. The FHFA's staff uncovered 4,000 pages of documents realated to the FOIA request but said not a single one was releasable, even in redacted form. American Banker has appealed the decision.
Adding to the secrecy concern is the fact that Fannie is handing its subservicing work to a small group of specialists whose top ranks include former Fannie officials.
"It's a fantastic deal for these subservicers," says David Stephens, chief financial officer of United Capital Markets, which provides consulting and hedging services to mortgage companies. "We're wondering what Fannie's motives are. Are they going to be a big competitor? All these questions are up in the air."
The subservicing industry is big and getting bigger. It currently manages portfolios containing roughly 1.1 million home loans, says Walter Investment Management, parent company of the specialty servicer Green Tree Credit Solutions. That number will grow to 3 million loans next year, it says.
Some of the specialty servicers' business will come from private investors or banks, but Fannie Mae already accounts for a significant and growing share of the volume. (The FHFA and Freddie Mac are considering getting into the specialty servicing business themselves but are yet to do so, servicing analysts and others say.)
An insight into the considerable role that Fannie and Freddie play in supplying specialty servicing business comes from Nationstar, a servicer that Fortress Investment Group built out of the home builder Centex's former affiliated mortgage operation. Of the total of $60 billion in loans that Nationstar has taken responsibility for servicing since 2008, more than 40% was sourced from a single GSE in the last two months of 2010, according to May securities filings. Nationstar has a "strategic relationship agreement" with Fannie Mae and says it believes it "will continue to benefit from our strong relationships with the GSEs" and other investors," the filings state.
The rationale for transferring the loans is the widespread view that servicing practices have exacerbated the mortgage crisis. During the boom years, servicing was consolidated among a handful of banks that were adept at processing mortgage payments in bulk.
When borrowers began to fall behind on their loans, however, the efficient system went off the rails. Major servicers were ill-equipped to handle large-scale defaults and lacked both the organizational capacity and financial incentive to develop them. The industry entered an ugly period in which Fannie lost money, servicers were fined for mishandling mortgages and borrowers missed chances to save their homes.
Specialty servicing offers a potentially better alternative for everyone involved, although how successful Fannie has been at transplanting loans remains difficult to say. What is known is that Fannie has consolidated its servicing acquisition efforts in a team at its Plano, Texas, loss mitigation operation, according to people familiar with Fannie's staffing. The Plano employees are in charge of purchasing loans from servicers and transferring them to subservicers of Fannie's choosing. Among the major recipients of the subservicing business are Nationstar, Green Tree and Seterus Inc., an IBM unit.
There is little in the public record to indicate what criteria Fannie used to select those three specialty servicers as primary partners. (Sources who spoke with American Banker were unclear about the identity of the fourth company with which the GSE is working.) The companies have generally declined to discuss the work they do for Fannie Mae, and the three that are known either did not return calls or declined to acknowledge their work for either of the GSEs. Outside observers' opinions of the quality of their work vary.
It is known that ties exist between personnel at Fannie and the servicers. In 2009, Green Tree hired Patricia Cook, formerly Freddie's chief business officer, to run its business development unit. Daniel Mudd, the chief executive officer of Fortress, the Nationstar parent company, ran Fannie from 2004 until its 2008 collapse.
Before handing contracts to specialty outfits, Fannie must acquire rights to service them from the previous owners. Though the GSE can simply seize servicing rights in the event servicer's defaults or is guilty of egregious conduct, it has generally avoided such drastic steps.
"My sense is that they're paying a good price for these servicing rights," says Derek Chen, a mortgage bond analyst for Barclays Capital. "The servicer may not be doing as good a job as Fannie would like them to, but they're doing an acceptable job, and Fannie can't acquire [servicing rights] for free."
The pricing and terms under which Fannie is acquiring the rights are unknown. It paid Bank of America more than $500 million for rights to service a $73 billion a portfolio of which 12% of loans were seriously delinquent, according to The Wall Street Journal. That struck industry observers as remarkably expensive in light of the fact that the portfolio appeared to be in need of costly care.
"The servicing rights may not be worth much, or might have been of negative worth," says Barclays' Chen. Others say that Fannie's hands may have been tied by old contracts that required it in any repurchase to pay at least 2.5 times the value of the annual servicing fee.
The terms of servicing rights repurchases are politically sensitive. At a hearing this month, Rep. Maxine Waters, D-Calif., grilled acting FHFA head Ed DeMarco about the purchase of servicing rights from B of A and whether it posed a risk to taxpayers. Waters and three other House Democrats sent a letter to the FHFA's inspector general, Steven Linick, calling for an investigation into the purchase, saying the sale "could limit B of A's potential liability to investors for its current servicing violations." Waters also asked the FHFA how "Fannie determined that $500 million represented a fair value for the servicing right to these loans?"
The concerns are bipartisan. Rep. Darrell Issa, R-Calif., has pledged to investigate the Bank of America deal, which he said could be a "backdoor bailout."
Some industry participants who do business with Fannie characterize its servicing deals as legitimate and resulting in higher-quality servicing. Fannie executives have been secretive about the deals over fears that they will become a polticial hot potato, regardless of how much sense they make, these people say.
The notion of paying megaservicers for the privilege of taking over their botched work may be politically unpalatable, but the only alternative would be protracted litigation over whether Fannie has the contractual authority to simply seize the servicing rights, its supporters say.
To be sure, it is possible that the savings to Fannie from getting the loans into the hands of better services may be far greater than the cost of acquiring the rights. Fannie has also protected itself by withholding some of the cash price of the rights. In the Bank of America case, if the loan portfolios are in truly terrible shape, the seller will not receive full payment.
"The Bank of America transaction is expected to generate credit savings and provides compensation back to Fannie Mae if certain performance thresholds are not realized," an FHFA spokeswoman says.
After acquiring the servicing rights, Fannie farms out the work to its shortlist of servicers. The nature of those contracts aren't clear either: Fannie may be hiring those companies to manage portfolios on a fee-for-service basis, or it could be simply reselling the servicing rights to them.
In both scenarios, industry observers suspect Fannie is alleviating the financial strain of these companies' efforts to bulk up on servicing. Managing a portfolio of loans requires making massive up-front outlays of capital in the form of principal and interest payments. Through its access to government money, Fannie could bear that burden and make it much easier for its special servicing partners to scale up.
"[The subservicers] get a giant bunch of volume with no worries about advances or the cash flows, which is one of the biggest worries of being in that business," says Stephens at United Capital Markets.
Key industry trade groups have also complained that Fannie's move may turn it into a government-backed rival. By using its access to federal financing to buy servicing rights, it could outbid others for servicing and stymie the recovery of the private market.
Industry participants fearful of Fannie's push believe it may be connected to its recent support for revising standard servicer fees, which are traditionally set at 0.25% of a loan's balance each year. If that fee is cut, it would free up money that potentially could be paid to the Fannie.
"Fannie Mae is the driving force in the FHFA's servicing compensation initiative, trying to drive down minimum service fee and capture more of the cash flow for itself," Stephens says.
The Mortgage Bankers Association raised similar concerns in a letter earlier this month to DeMarco.
"Fannie Mae recently purchased from a private enterprise servicer a significant servicing portfolio," the MBA wrote. "This puts Fannie Mae in the position as a direct competitor of private sector servicers. Isn't Fannie Mae's direct involvement in the servicing fee project a potential conflict of interest?"
Defenders of Fannie's servicing deals told American Banker that there are only a few entities with the infrastructure and resources to take on a serious volume of GSE business. All are based on subprime servicing platforms and are said to have sturdy systems for handling troubled loans.
Miller at FBR Capital Markets, discussing Seterus, the IBM unit, says, "Nobody really knows these guys, but the servicing community has told me that they are competent."
To critics, Fannie's reliance on such a narrow group of subservicers is cause for suspicion that undisclosed financial incentives are at play.
They may have incentives of their own. A group of servicing companies recently banded together to form the Residential Special Servicer Coalition. The trade group aims to persuade regulators and the GSEs to dislodge more servicing business from the big banks and parcel itout to other servicers, including its members.
There is reason to believe that other companies could potentially take some of the work. Bank of America agreed to pay $8.5 billion and to hand off the servicing of 275,000 loans to special servicers in a pending massive settlement with private mortgage securities investors earlier this year.
Just how other such large pieces of business will be parceled out appears likely to remain highly contentious for some time to come.
Stephens says that, with Fannie's subservicer agreements, "Just like with any contract, you'd hope to see an open competition to get the best possible price and the best possible performance."
"If that happened," he says, "we didn't see it, and they're getting into a business that has a 30-year life."