As the mortgage servicing industry continues to evolve and adapt to new challenges and opportunities, it’s important to stay informed about the latest trends and developments. In the episode, Seth Sprague of Richey May will be discussing the servicing trends and how it is impacting the mortgage industry in these times.
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Servicing Trends with Seth Sprague of Richey May
Listeners. I’m excited to have joining Mark and I on the podcast today. Seth Sprague of Richey May. He is the head of consulting services at Richey May and has been doing so since May of 2022, so coming up on a year there. Before that, he was one of the principals at StratMor. He was there from 2019 to 2022. Previous to that, he was the Executive Vice President at Phoenix Capital. This is an individual that has extensive servicing background, 27 plus years at it. Excited to have him here. Seth, welcome to the podcast!
Thank you so much for having me. I’m really excited to be a guest. What’s the saying? I’m a longtime listener and first-time guest.
Yeah, so glad. Yeah. Good deal. So, Seth, given all your knowledge been the experience in the mortgage servicing area, what’s going on in the market, especially what are the macro trends in servicing area, especially when it comes to released or retained?
David, the current trend right now is it’s a very interesting time given where we are with the origination space and the challenges of pretty much low volume. Low margins. Though as we are here in early April, it looks a little bit more like we’ll have a spring season and a summer season. So, I guess the most recent news is that folks are thinking again about retaining servicing and the customer relationship. For those that did retain servicing in 2020 and 2021, they certainly enjoyed some great cash flows off their servicing at the experience in 2022, and I think increasingly what we’re seeing is companies are realizing that value of the customer relationship from a long-term perspective is very beneficial to not only their origination business but also their cash flow.
Seth, with a recent announcement by FHFA about the servicing and having been able to continue for those that qualify. That’s an interesting phrase about the deferment of payments due to hardship. What is that going to do? Does that change in your perspective, who will be selling servicing release?
It certainly is an interesting announcement by the FHFA on hardship and kind of six months of forbearance with the attack on the mortgage at the end. I always like to highlight a couple of things about forbearance. I think it’s a fine per part to put in the waterfall of loss mitigation. I think we have to be somewhat judicious about tacking on principle at the end of the payment under the CARES Act and Covid, it worked great! property values were increasing 20% a year, and borrowers missed payments and actually came out of missing payments with more equity. I do have some fears that forbearance in general if you’re not experiencing rising property values could create some stress and strain for those borrowers, but I think it’s a critical element in the waterfall as far as changing the liquidity, it certainly changes the cash flows, right? All of a sudden, a borrower as long as they’re making a qualified contact with their servicer, and I want to emphasize that it really is important that those borrowers are talking to their mortgage servicer and they’re walking through what that hardship is, so that they could get them to the best position and if forbearance is the position that gets them to stay current, I think it’s a wonderful solution, but I’m not sure it’s a solution that will work for all and work for all in all circumstances. And in particular, if we have declining property values in a market, I think that forbearance may actually hurt the borrower because they can potentially be losing equity as opposed to a more sort of real-time solution.
I think Seth is right on target. Seth, when we discussed this in the podcast, we were focusing on three things, and I’d like you to opine on them if you don’t mind. The first thing we were focusing on there was not what was produced in the media, there was not an idea of what really qualified. It just says if they qualify, and we don’t know if it’s exactly what qualified under Covid 19 or not. The second thing was they just talk about tacking the payments on the end, and they don’t really say who’s going to bear the burden of any interest or accrual on that. because they said they’re attacking the payment on the end without any interest accrued on it. So, they got fat. And then you just brought up this third thing, which I think is very important. Everybody’s not created equal. In that respect, when people are doing this, do you think that the borrowers might treat it like a negative AM loan was a couple of decades ago, and that negative payment on the end, if it takes away some of its equity might entice them to walk away from it rather than pay out their commitment as they move on through the loan and get in hardship times again.
I think it presents that danger to your point, that a repeat person that goes through that process could end up with a pretty large balance in a negative amortization or a negative equity position, which certainly could lead to them potentially walking away from that mortgage. I think the qualification of this, I’m hoping that we get some clarity as to what that means because I think this is an automatic, I think is not where the industry really wants to go. I think it really needs to be part of that waterfall and look, We all know that foreclosures and kicking people out of homes is not what we’re trying to do, but we have to realize that servicers who are in the position of having to advance or in some cases get missed payments, right? when you jump from payment 12 to 19, you actually lose that servicing revenue and you never earn it back. And so, the more we burden those servicers with those costs, it’s only going to increase the overall cost of mortgages because quite frankly, part of that MSR value, whether you sell it through an SRP or capitalize it, is part of the gain on sale calculation so higher expenses actually mean higher rates to consumers, and that’s what we’re really trying to avoid is adversely selecting or having costs to borrowers go up. But sourcing costs are going up. Therefore, MSR values don’t increase with such an announcement.
Seth, how does the current origination environment that we’re experiencing today impact the servicing side of our business on a go-forward basis?
I think that the easiest way to describe it is and everyone’s seen me present before. It depends on the solution. It depends on the company. It depends on where they’re at in the cycle of sort of cost-cutting on their origination side and balancing their servicing. A lot of the customers here I deal with at Richey May have retained servicing and speak to how wonderful it is to cash flows that they’re producing, which they’re using to offset some origination expense right now.
Others have said, hey look, I needed to get a war chest of cash in last year to fund or help fund the projected losses on origination so they sold servicing. So right now, I think we’re in that interesting state where I think we’re flexing from people looking to sell, servicing for cash to actually going, I’m going to be cash positive here, if not by the March 31st, certainly in the second quarter, which gives me the opportunity to actually start retaining servicing and the critical question is, what servicing do they retain? And what do those cash flows look like? And I think companies that just blanketly retain servicing are really going to start looking at the risks of the servicing that they’re going to retain and release and doing a lot more analytics around it than just by, perhaps just taking every other loan or setting some very general rules. I think there’s going to be a lot more analytics thrown at what gets retained in this next cycle.
I find that comment very interesting since I just developed a model that does that. Yeah. Yeah, that’s a whole another conversation for the two of you to get advertisements. Seth. Yes. One follow up question of that, if I could when you’re talking about it’s one thing to talk about retention of servicing or so, but what is happening, what are you seeing in the market today? because this question has come up a little bit, and I haven’t been in touch with as, as much as I’d like to be recently, but is it a buyer’s market or a seller’s market right now in servicing?
I think it’s shifted a little bit to definitely being more of a buyer’s market at this point where buyers are dictating the terms. 2022 was a record year in terms of unpaid principle balance brought to either the co issue or the bulk market, and there was a little bit of buyer fatigue. I think from a buy side, what you’re seeing change right now is the counterparty strength and the deal size. For example, if I could do one $10 billion deal with a company that I’m comfortable with their financials or doing five, $2 billion deals, there’s a real sort of market differentiation in terms of the size of the deal, the number of bidders and the execution, for example, it’s rumored that Wells is obviously selling servicing. Wells is viewed as a completely different counterparty than even a large independent mortgage banker, and therefore may attract a premium price due to the deal size and potential for different deals. The real issue that some of the sellers are facing today is they’re of a one and done seller, right? They’ve retained a chunk of servicing and they want to sell it, and they may retain more in the future. Those parties get a lot closer due diligence, and some of the buyers just don’t fit as aggressively on those deals because it’s a one and done, you have to put all the plumbing in place and they’d rather get a more consistent seller in their stable than just a one and done seller.
So, you’re basically saying you think that people in the market, if they’re going out to do that one and done, they’re going to be probably stressed a little bit more to get the kind of price they want out of it potentially because somebody might be looking at bigger deals, or they’re bringing more loans at once, or somebody with more established selling practices.
They’ll either get less participation or less aggressive bids. Either one of which means they’re just not going to get that same value. And I’m going to emphasize again, the servicing cash flows that they’ve got in 2022 are phenomenal. And the values, they may not be achieving those values because the bidders regardless of the counterparty, just don’t believe prepayment speeds could stay that slow, delinquencies could stay that slow for the life of the cash flows. And let’s face it, we all know in this call, but 2020 and 2021 production, it’s two and three years old at this point. You’ve chunked through some of the strongest cash flows. That loan is amortizing at a different rate due to its low interest payment that even on a 30-year loan, a larger portion of even the first three years of cash flows are principle than at a 6 ½ or 7% mortgage rate. And so even though you’re three years into the cash flows, you might be 50% into the expected life of those cash flows already.
Exactly. Point, exactly. Good point. Yeah. Good point. Very good point. As we look at where we’re at as an industry, what areas should companies that currently service or may get into servicing be aware of that will make a difference in 2023 that’s different from 2022?
I think there’s a couple things. One is really understanding those cash flows and what natural decay is doing to their servicing fee income. Even though they’re not seeing explain. Just for those that don’t not understand servicing, when you say natural decay, let’s start, let’s a little construct around that. Yeah. So natural decay is just that amount of principle that’s with every payment. So as that, as I refer to it in my terminology as that loan chunks down just due to the natural payments over time, those lower balance, those lower wack loans have a higher principal component than interest component than we traditionally think of, with a six or seven or 8% mortgage. And so really understanding kind of the cash flows as to how they look over time and they’re declining over time is important. I think the other element that we continually hear across our client base is escrows, right? What is the value of escrows, those T and I payments that you can earn potential flow on, and are you earning the float on it? And are you really getting all those cash flows that you can from escrows? Banks have a natural ability to earn that full float. IMBs tend to have to put those deposits either with a warehouse lender, MSR financing company, and they may not achieve the same value that’s present in the cash flows. That’s generating that fair value. So those are the two items to be aware of. The other piece that has been a concern, that’s probably going on right now, is escrow shortages, right? Due to those rising property values over time, most people are going to be short escrows. That’s cash that servicer has to advance. And as we talked about already, the origination business isn’t that strong right now. Gain on sales isn’t that strong right now, so it’s another cash outlay that’s going to occur. I think going forward, property values probably aren’t going as much as they were, so we’ll have less of that in the future, but we’ll have rising delinquencies, which will also cause escrow advances. So, it’s really understanding your risk on the cash side of servicing and are you cash positive or negative is really what I’m trying to emphasize to folks.
I’d jump in there on that too, Seth. What are you seeing in your consulting side of the business is happening with the delinquency ratios on the loans during that period when they were, two and three quarter to 4%? Are you seeing that delinquency rates are performing on a much lower level than they would’ve been in the past when rates were 7% or 8%. Alright. Is it holding true that the lower interest rate people are better payers of mortgages than the people from a decade ago in or in the 2008 or nine market or whatever?
It’s a great point, Marc, It certainly seems to be that trend. I draw a line somewhere in, April of 2022 in forward production and looking at those delinquency trans due to the higher P and I payment that they’re making due to a higher mortgage rate. And you’re seeing a higher delinquency rate off of immediately on those loans, which sort of speaks to that stress and let’s face it, those folks that have equities, they could get a second, they could get a home equity line, they could stay in that low mortgage rate and could still get a blended mortgage rate. I think you’re going to see maybe more some like closed end seconds potentially produced instead of HELOCs for a blended rate for borrowers. I think it’s critical that servicers really track the borrower information and try to understand that they’re getting a second and they’re changing that LTV but there’s so much equity in a lot of that 2020 production and even the 2021 production that waterfall of losses just isn’t there, but if you look at the FHA data, which is public, and you start looking at 60 FICO scores and below you’ll see double digit delinquencies. And that’s in a great employment situation, right? If we do lose one or 2% off that employment number, know, those FHA borrowers are going to become stressed very quickly.
Yep. I agree. How do you think the regulatory environment around servicing and capital has changed materially in in the last, I’ve got to put a time period on this for you, say the last three years, four years.
I would say that the scrutiny on MSR values is certainly going up. The advisory bulletin issued earlier this year by the FHFA, which directed the enterprises being Fannie and Freddie to take a closer look at MSR valuations when managing counterparty risk. I think that’s something to be aware of. Having talked to the FHFA, they’re not trying to rewrite the MSR accounting rules, but they certainly want to acknowledge that if there’s a mismatch between people have it marked on their books and where they can trade it, that has a direct impact on the equity. So, we’ll be interested to see how Fannie and Freddie roll that out. We did get some alignment last August between the FHFA and Ginnie Mae around non-bank capital rules. Obviously, Ginnie Mae has that risk-based capital element to it which has been delayed till 2024, but that starts to feel a lot like basl three for non-banks, at least from an equity position. I think a lot of scrutiny is going to be placed around the equity side to MSRs. And let’s face it, we’ve had bank failures and bank failures were that they had a whole loan portfolio or an MBS portfolio that until they had to monetize it, the loss was on paper. And I hate to say it, but in the MSR side, we have some of that going on, right? We have a fair value and then we have a trading value, which is lower and that sort of is analogous to what happens to those banks, right? That there’s a run-on banks. They had to sell those MBSs and take the loss. If IMBa have to do some of those losses, it could be really harmful for their equity, which is really where I think that advisory bulletin from the FHFA is pointed at.
When you look at the regulatory environment again, and you’ve already talked about the capital changes and how it has an impact on the balance sheets of a lot of these companies. What are some of the other risk factors that people need to be taking into consideration? Is there anything out there that you’re saying, this is not something people are looking at, but I’m really concerned about? This goes off into the origination sites so David, you may even want to comment on this, but if you’re doing more of a distributed retail channel you’ve got some sort of receivables out there for expenses that you’ve incurred for those offices, if those offices go away, are those receivables really collectible? We’re all struggling. You’re shaking your head no, I think that there’s. as you’ve got, obviously Richey May’s just gone through its busy season with the audits. I think there’s a lot of things to look at, including receivables, I think loans held for investment, which are either repurchase loans or if you got stuck with some Ginnie Mae early buyouts, right? You bought out a 3% wack EBL loan and rates went to 7% and all of a sudden that’s not trading very well. I think there’s some hidden potential losses there. I think my biggest concern going forward though, is actually repurchase risk. Repurchase risk has been elevated. I’m concerned about the equity of IMBs to actually fight those repurchases. It was one thing when I was at SunTrust in 2008 and we could just hire 300 people to fight agency repurchases. We’ve had such staff reduction in critical areas of independent mortgage companies because they had to cut expenses that some of them just don’t have the bandwidth to fight these repurchases.
Is that an opportunity? We’re seeing several law firms step into that space and trying to really go in. Is that an opportunity for some third parties then to go in and help mitigate?
Absolutely. I think there’s a lot of work for folks that are experts on the origination quality side to help try to fight those repurchases for folks.
We have a sponsor on the podcast, Seth, Candor Technology, who has automated underwriting with AI involved, et cetera. And one of the things they’ve done, they’ve created, if they do the underwriting they have actually have an insurance policy to protect on repurchases if they missed anything. What do you feel about that concept in the industry? It seems to me it’s pretty innovative and can be a big deal, but it most repurchases are around the underwriting aspect, one aspect of it or another. How do you feel about that?
I think a lot of the repurchases are either on the, on, on the appraisal side or on the underwriting side, so I’m not sure if that policy covers on the appraisal side or not. I think some of this, I’m just going to use the analogy, Jello on the wall, right? It’s, hey, I’m not really a fond of that loan, so I’m going to push it back to you and see if I can get a repurchase. I think there’s some of that going on as well between the agencies and some of the aggregators. I think some of these are very valid. I think others aren’t. And I think that’s where when you start layering in an insurance policy, it starts to get a little tricky there as to the real reason. Indemnification letters, we’ve certainly changed how repurchases are going. So, a true repurchase is a little less likely than indemnification. And I don’t know if that insurance policy covers indemnifications or not. And I think that’s where they’re going to get out of having to pay.
Yeah, I think that’s something needs to be checked out. We need to ask them about indemnifications, and you point well taken between the underwriting and appraisal side, I doubt very seriously it would underwrite the appraisal the insurance policy would underwrite the appraisal. That’s so much that’s still a third-party environment.
And to this point, I think Candor has also got the ability to go in on and help with the mitigation risk by going in and re-underwriting it as after the fact. So, they’re able to put some services to that. So, shout out to candor in their credit creativity, what they’re doing to bring innovation even into the servicing area and the area of repurchases. If you could wave a magic wand and change about servicing, what would that be?
I think my answer pretty much changes every day, Dave, based on what’s going on in the market but my continual theme and I know Mark has lived through this pain, given his background, but, and this is really a unicorns and lollipop concept, a national policy around foreclosure timelines and certainty of what the waterfall looks like. Across all investors, even if we could just get it for the Ginnie Mae book. So we level playing field. I’m a simple guy, I like to explain to people, look, you’re running an origination business where you can’t really control volumes that much and you certainly can’t control gain on sale. Yes, there’s some things you could do, but you really don’t have control there and then you layer in a potential servicing business, particularly in the Ginnie Mae space, where you have some of long timelines and a lot of advances and now you have unknown on both sides. If we could wave a magic wand and say, look, servicers are responsible for six months of advances maximum, and then we’re going to do something. I think that would help create liquidity. I think it would help create a certainty around though what those losses could be, and I think it would clean a lot of things up. I know that’s a very broad comment to make because we have to deal with the FHA, VA, USDA. The more we could make a level playing field about this is what your losses are, they’re capped, and then we’re going to do something else. I think would really help improve the liquidity, not only in the Ginnie Mae space, but just make more people want to be in servicing, because then at least it’s a modellable amount of expenses. and all we’re dealing with is the severity or frequency.
Look, if I can, wave a magic wand. I think Ginnie Mae I would say the 19-basis point servicing strip should be outlawed. I just think that’s just not enough servicing cash flows, I realize that’s a best execution and its capital, but I’m just not a fan of, given where delinquencies are in the, in that book sometimes the 19 base point servicing trip, I know why it was put in. I understand it was bank driven. It was capital light. But I think if you think about a, a hundred thousand dollars loan with a 19-basis point servicing strip it, it’s really hard to see that loan being profitable. Yep. And so, I think there’s some issues around there. Look, Fannie, and Freddy have a very efficient process on getting advances back. It’s a known amount you’d have to advance on an MBS. The more we can make it look like that in the Ginnie Mae side, I think would really help liquidity.
I think your point was well taken about give an example of the foreclosure timelines. It, can you imagine how bad of war we’d be in today if federal bankruptcies were not a federal law regulating them because you have some states right now that can take 18 to 24 months to foreclose a piece of property out. And I’d even go so far as Seth to say, maybe we ought to put some restrictions on how long it takes to evict somebody out of a property too because in California you can take 18 months to get somebody evicted.
Yep. So, there’s a lot of things that really affect this business. And who do they affect? They’re for all prob bar and all negative mortgage lender. And if you’re a small lender, that can have a dramatic effect. So, I think you’re 199% on target with your comments.
Protecting that servicing cash flow and understanding what that cash drain of servicing is, anything we could do to fix that or make it a defined amount improves liquidity, ultimately lowers cost to borrowers, right? Because at the end of the day, all these servicing costs and all these advances we make, and all the foreclosure, all that stuff ends up coming into gain on sale, and ultimately it gets passed onto the consumer.
I’m deeply concerned about the liquidity where we look at who’s holding the bulk of the MSRs out there. It’s banks and we look at what happened as SVB and the mark to market that could just really have a big impact on everything.
Yep. And you look at the latest origination numbers from, housing Policy Council and, Ginnie Mae servicing is dominated by non-banks. Ginnie Mae servicing is the area where these advances most likely to occur. And that creates that liquidity problem and those are the ultimately the borrowers that need the most help in getting into the mortgage. We know we’re going to have high LTV, we know we’re going to have not 800 FICO scores in that book, but then we place all the burden on the servicers and those servicers have to go get advanced lines from Goldman or from whoever’s left standing, and we’ve seen Credit Swiss, right? They’re not in the business anymore and you could read the same disclosures I have at public companies, but people that had credit Swiss are going somewhere else. They get that financing, and that financing isn’t cheap, right? No. It’s one thing when rates are zero, and so you’re a zero plus 250 or 300 base points. We’re not at zero anymore. So, you’re talking seven, 8% MSR financing lines, you’re talking seven, 8% s MSR advanced lines. That doesn’t really work. That’s the entire yield of the servicing.
What is the other side? What’s the ugly downside of this whole scenario? Who’s holding it?
Yeah. The downside of this scenario is that there’s a significant reprice in that scenario of MSR values, which again, let’s face it, is going to cause mortgage rates to go up. But at the end of the day, Chopra the other day made the comment, right? His biggest concern is a large servicer fails. I would just modify his comment. A large servicer fails whose service is in-house, right? I hate to sound cavalier, but if it’s at a sub-servicer and what we’re dealing with is advancing payments or cash, that’s to me, a much more solvable problem than when you have a servicer who’s servicing in house goes out because all of a sudden you lose the staff. And that’s where you really get that borrower impact. Not that, sub servicers are great. They all get their fair share of complaints. But if it’s at a sub-service or I have a cash problem, if it’s in-house, I have a cash and an operational problem and that does keep me up at night that we can have a large failure like.
So, let’s talk a little bit of what you made the move over to Richey May, and you’re running the consulting division and what are you doing? Tell us a little bit about what your focus is there and why people should want to pick out the phone and call you. There’s a lot of good reasons. You’re a great good knowledge. Richey May’s a well-established firm, but give us a little more insight into what you’re focusing on there.
Yeah, Richey May offers a wide range of services, what they’re really known in the independent mortgage spaces for tax and audit work but we also do a lot of cybersecurity help, so outsource CTO penetration testing. I’m trying to help us develop our business intelligence platform, so we’ve got a BI platform I for more real-time analytics around that. We do a lot of work on servicing and retained and released and really, it’s trying to help IMBs understand the risks they’re either keeping or the risks they’re selling and what their cash flow risks are, and really just trying to help them be profitable through that. We also do outsourcing, right? Internal audit and outsourcing. So, I’ve got sub-service oversight underneath me, all of the sub-servicer reviews, we go into at once for 40 customers. Because you go in and do one audit as opposed to 40. So, we do that for eight or nine of the top large sub-servicers. And it really is a good service for our customer base. It’s a really good service for the sub-servicers as well, but most of my time is spent if I’m not doing policy work. It’s spent trying to really help companies understand the risk, retained their capital market structure, and their servicing structure, and understanding, does this asset make sense for them. Or I should say more importantly, do these cash flows fit with your strategy? Define your strategy and let’s retain servicing that makes sense for your strategy or not retain servicing if that fits for your strategy.
Excellent. I know there’s going to be a lot of questions, so we’re going to want to have you back and to talk about this. What is the best way for people to connect with?
The best way is obviously just reach out to my email address. It’s [email protected], You could also find me on LinkedIn where it’s got both my cellphone contact information and my Richey May email address. I do post on LinkedIn fairly regularly, just mortgage stuff. And so that’s how people best can find me is just through Richey May website, www.richeymay.com. [email protected] or even on my LinkedIn account are always to find me.
Yep. Just in case for anyone whose spelling challenge. S P R A G U E is how you spell Sprague. And you put an S in front of it and you got to put an S on. Yeah. Double S and you got it. There you go. Very good. One s and then Sprague. Very good. Seth, thank you so much for coming on and joining Mark and I today and being on the podcast. I really appreciate it.
It’s always a pleasure to talk to you, David, and Marc, it’s nice to meet you as well. And David, anything I could do to try to help this industry get a little bit better is what I’m here to do.
That’s what we’re both, we share that giving. Thank you so much. Appreciate it, Seth.
Thank y’all.
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About Seth Sprague
With extensive experience in mortgage banking and mortgage servicing, Seth Sprague will lead Richey May’s Mortgage Banking Consulting Services practice. He will also serve as a strategic leader for the entire Richey May suite of services, including profitability and operational reviews, strategic planning, mortgage servicing rights (MSRs) strategy, retained versus released, and cash flow optimization.