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TH E M R EP O RT | 51 O R I G I NAT I O N S E R V I C I N G A NA LY T I C S S E C O N DA R Y M A R K E T SERVICING THE LATEST Continued Writedowns of MSRs Eroding Investor Confidence Kroll Bond Rating Agency anticipates continued downward pressure on bank and non-bank earnings due to MSR risks. K roll Bond Rating Agen- cy (KBRA) recently released a research report entitled, "Mort- gage Servicing Rights: Catching the Falling Knife," discussing mortgage security risks (MSR) and investor confidence. In May 2016, KBRA noted that continued writedowns of MSRs has diminished investor confidence in a number of non-bank mortgage firms. This negative impact of MSR adjustments has also taken a toll on the earnings of depositories, according to the report, and gives another negative factor for inves- tors to take into consideration with bank financial results. The report stated that since September 2008, when the fair value (FV) of MSRs held by U.S. banks peaked at over $80 billion, the value of the payment intan- gibles has reduced to currently be $36 billion. KBRA said that even allowing for writedowns, pur- chases, and sales of legacy MSRs by commercial banks over that period, the FV of the aggregate MSRs has decreased by half over the past seven years. Likewise, the report noted that this decrease reflects the dramatic change in sentiment on the part of investors in regards to this asset class. KBRA suggested, however, that you cannot blame FV accounting for the market volatility caused by Fed monetary policy. Instead, they attribute the volatility seen in the market for MSRs to being another example of the downside of market manipulation by the Federal Open Market Committee (FOMC). They shared that at the peak of "quantitative easing" by the FOMC, MSRs were trading to the tune of four times cash flow. According to the report, investors were drawn to distressed mortgages as an asset class because of the possibility of large returns from resolving delinquent loans. However, they note that these new investors learned that apparent front-end returns for a distressed mortgage portfolio typically fall away as the more attractive assets are resolved. KBRA reports that while MSRs were once trading at 4-5 times annual net servicing rev- enue, starting in early 2015, MSR holders began to see a deteriora- tion of market prices and liquidity. They said this is in part because of the continued low interest rate environment and stable prepay- ment rates, but it is also because of the erosion in servicer profitability when the compliance costs rose. The report shared that a major issue some investors have expressed to them over the past year is the MSRs sellers' practice of immediately soliciting the un- derlying borrowers for mortgage refinancings in pools they've just sold to investors. KBRA cites that these practices violate standard in- dustry terms and don't contribute to investor confidence, especially with prepayment rates already at high levels. Additionally, KBRA said liquid- ity in the market for MSRs is rapidly disappearing due to falling interest rates and the negative impact of adjustments in the FV of MSRs on the earning of banks and non-banks alike. They said added cost due to regulation both for the loan origination and servicing businesses has seemingly lowered enthusiasm for what they call naturally occurring negative duration asset. KBRA said regulators and policymakers need to take notice of the dwindling liquidity in the MSR market and consider what it says about the economic model for loan servicing. Market liquid- ity for bulk sales of FHA and VA loans has largely diminished as commercial banks and institu- tional investors have exited the Ginnie Mae market, KBRA said. As for what the firm expects for the future, as Q 3 2016 earnings reports for banks and non-banks approach, they expect to see continued downward pressure on earnings for banks and non-banks due to adjustments to MSRs. Additionally, the trend in terms of interest rates, prepayments, and other factors that affect estimated valuations for MSRs is something KBRA feels indicates revenue multiples are likely to decrease for the rest of 2016. In terms of liquidity, KBRA suggested inves- tors and regulators also need to consider the number of bulk MSR sales that have not taken place in 2016 due to the lack of investor demand. The Potential Effects of Consumer Complaints on Servicers CoreLogic finds complaints related to overpayments of escrow accounts are a main contributor to the CFPB's mortgage complaint database. C omplaints made by consumers to the Consumer Financial Protection Bureau (CFPB) are difficult to track and address, but they can potentially cause significant reputational damage to mortgage lenders and servicers if common issues in the complaints are not handled properly, according to a recent report from CoreLogic. CoreLogic used tax servic - ing data to evaluate the reasons for CFPB mortgage complaints and found that the number of overpayment-related escrow ac - count refunds is one of the main factors of these complaints. Escrow accounts are often required by the lender or servicer to pay taxes and hazard insur - ance premiums for the borrower on top of monthly mortgage pay- ments and likewise, the servicers typically evaluate the principal, interest, tax, and insurance on an annual basis and charge borrow - ers on a monthly basis, according to CoreLogic. The report states that if the borrowers overpay, they will receive a refund at the end of the year, and the over - payment can be due to various reasons such as borrower over- payment during closing, double payments by both the borrower and the servicer, and inaccurate annual bill estimation. Where the problem lies is if borrowers learn that they have been overpaying for months without the opportunity for a Continued on page 51 A major issue some investors have expressed to over the past year is the MSRs sellers' practice of immediately soliciting the underlying borrowers for mortgage refinancings in pools they've just sold to investors.