The legal groundwork has been laid for servicers to borrow against their agency servicing. These so-called acknowledgment agreements will enable those short of capital to buy some of the abundance of new servicing that's going to come onto the market.
When the refinancing boom of 1991 to 1992 ultimately subsides, it will become critical for a number of mortgage banking companies to be able to sell some of the servicing accumulated during the boom.
The heavy origination volume will have created large inventories of servicing rights for many companies. Some companies will also have built up their servicing portfolios during this time, either through purchases from the Resolution Trust Corporation, or buying from other originators who were selling servicing released, or through other means.
For those companies that have "gone public" during this period or were already publicly held and subject to the public reporting requirements of the Securities and Exchange Commission, the scrutiny of Wall Street research analysts and their shareholders will be focused upon their ability to attain projected profit levels during future periods of less attractive origination activity. Companies that are subsidiaries of publicly reporting parents also face similar earnings pressure. For those companies still privately held, but contemplating going public sometime within the next few years, it will also be important to establish a record of profitability during a less favorable origination cycle.
Gains from sales of servicing rights will be the principal (and in some cases the only) method by which many of these companies expect to achieve their targeted earnings levels. Increased selling pressure due to these "earnings-driven" considerations may put unprecedented strains on the current servicing market. Such selling pressure must be matched by increased purchasing demand and liquidity, if the required sales are to be carried out within desired time frames and at acceptable prices.
In general, this increased demand and liquidity can come from two sources:
* expanded purchases by traditional sources, primarily banks, thrifts and mortgage banking companies;
* purchases by new sources, primarily private investor groups and other investors with no prior connection to mortgage servicing.
The need for a broad and efficient secondary market for servicing rights has never been greater. The demand for purchases by traditional sources, however, will be negatively affected by the capital treatment of purchased mortgage servicing rights (PMSR) for banks and thrifts. The valuation haircut required for PMSR under the capital guidelines for regulated financial institutions effectively increases the amount of risk-based capital required for purchased servicing. Hence, the required yield for a bank or thrift purchase of PMSR will be higher than for non-discounted competing assets. This may well inhibit this sector of traditional servicing buyers from increasing their purchases.
The mortgage banking sector may offset this impairment to buying demand from banks and thrifts with continued strong demand of its own, as mortgage bankers attempt to replace servicing rights lost to "runoff" and sales, and to build their servicing portfolios. However, this sector has limited capital resources and will need to rely on new methods of funding to finance increased servicing purchases. Purchases by non-traditional sources, such as private investor groups not hindered by regulatory constraints, could also become an important supplement to the servicing rights market.
Recent developments in the rules governing the pledging of and investing in servicing rights should go far toward facilitating increased purchases by traditional sources, as well as by new investor groups. In the past two years, significant policy changes with respect to the pledging of servicing rights have been adopted by Fannie Mae and Freddie Mac. In 1990, both agencies, for the first time, officially sanctioned the pledging of servicing rights to secure borrowings and adopted forms of acknowledgment agreements to govern certain rights of the parties to such borrowings. The forms of such acknowledgment agreements were refined in 1991 to address certain concerns of servicers and the bank lending community.
This year, GNMA is working with industry representatives to produce an acceptable acknowledgment agreement. In addition, in certain individually negotiated transactions, Fannie Mae has adopted a triparty servicing agreement and contract addendum ("tri-party agreement") to permit private investors to acquire Fannie Mae servicing rights directly, provided an approved subservicer is designated and enters into the tri-party agreement.
Creative application of these new tools, as well as continued refinement of the forms, should increase liquidity and thereby broaden the market for servicing rights.
Agency acknowledgment agreements
The agency acknowledgment agreements are extremely important in furthering the development of the secondary market for servicing rights because they provide for the first time a set of rules to clarify the rights of secured parties to pledged servicing rights. These rules provide protection against one of the principal legal risks to secured parties in servicing-secured...