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Secondary market.


Few people would take issue with the proposition that mortgage companies need to improve their ability to finance mortgage production and mortgage servicing operations. Traditionally, mortgage bankers have gotten financing from one or a combination of the following: commercial banks, commercial paper, internal financing from a parent company or through a variety of investor funding and purchase/repurchase techniques.

Several developments have created an environment that is likely to cause a different type of financier or equity investor to be attracted to the mortgage business. First, the shrinkage in the number of banks and thrifts as a result of financial institution insolvency has resulted in the elimination of numerous credit lines to mortgage lenders. Second, bank regulators, through their tougher examinations of bank real estate lending departments (where loans to mortgage bankers originate) have created a "chilling effect" on most types of commercial loans related to real estate finance. Third, the high inventory of bargain-priced mortgage banking assets, mortgages and mortgage servicing rights held by the Resolution Trust Corporation has created tremendous mortgage servicing investment opportunities. Fourth, while bank/thrift regulators are expected to relax the limits on purchased mortgage servicing rights (PMSR) as a core capital component, they have made it clear that there are definite limits on the ability of a financial institution to grow through the acquisition of PMSRs unless those rights are held in an independently capitalized subsidiary. Fifth, Fannie Mae and Freddie Mac have both established a procedure for allowing a servicer to pledge servicing rights as collateral for loans. Combining these events produces an imbalance in the supply of funds in relation to the investment opportunities.

Many mortgage companies are trying to find solutions. Many ideas are being discussed. The challenge for the mortgage banker is to find a way to acquire the servicing asset with someone else's money, share in the servicing profits and minimize any adverse effects on regulatory capital requirements. In a very broad sense, these ideas usually involve the notion of a servicing-only entity that functions as a subservicer for investors in servicing. Alternatively, some companies are looking at the possibility of selling beneficial interest in servicing. The sale or assignment of any interest in servicing is prohibited by secondary market agencies.

In an effort to figure out ways to fund the acquisition of mortgage servicing, the creation of a structure to allow passive investors to own an interest in mortgage servicing is a concept the secondary market agencies should seriously consider. There are two basic alternative structures that may have some merit for further study. Moreover, there are numerous bells and whistles that can be added to these basic structures. One structure involves record ownership of servicing being maintained by the servicing operator with all, or a portion, as divided or undivided beneficial interest in servicing being sold off to passive servicing investors. This should be the easiest alternative for the agencies to accept because it is just a slight variation on the master servicer/subservicer and the pledge of servicing themes. However, the benefits to the servicing operator and the servicing investor may be limited, depending on how the accountants would view the transaction. Is the transaction a sale, a financing, or a deferred gain situation?

Another scenario would have the servicing investor owning both the legal and beneficial interest to servicing and then contracting with a servicing operator on a subservicing basis to actually carry out the servicing function. The mortgage servicer and investor share in the servicing income and a servicer also receives a contribution to fixed costs.

Several other obstacles must be overcome. The secondary market agencies established framework for its participants requires lenders to be originators and/or servicers of mortgage loans. In effect, the agencies require that participants be actively involved in the mortgage business in order to have an ownership interest in mortgages being serviced. Other than as a shareholder of a mortgage corporation, there currently is no format for companies or individuals who would like to invest in the mortgage servicing business but don't want to get involved in operations. It is expected that the agencies would have several other concerns about approving passive servicing investors in mortgage servicing rights. The agencies would want to make sure that their right to seize servicing and the obligation to properly service mortgages are in no way impaired by the presence of a passive investor holding an interest in the servicing. Probably the best way to address this concern is to qualify the investor as an "investing servicer" subject to some of the responsibilities and obligations of traditional servicer of record. Also, the agencies may be concerned about whether or not transfers of beneficial interest may somehow run afoul of federal income tax rules, thereby creating a taxable excess servicing interest strip. This concern is more serious where the beneficial interest being sold is divided rather than undivided. Lastly, as a policy matter, the agencies would have to address whether or not the introduction of passive investors as partners in the mortgage business is a positive development. There may be a concern that passive investors are in mortgage servicing just for the investment angle and not in it for the long haul. We believe this skepticism is understandable because we are dealing with an unknown. However, the role played by passive investors in servicing is not too much unlike the role stockholders play in a publicly owned mortgage company. They own a residual interest; they are in it for the income/dividend benefits; they come and go; but they provide an important source of capital for the firm.

Because the agencies now permit servicers to transfer interests to banks to secure loans, the transfer of a beneficial interest in servicing is just one step removed. If the industry can benefit from additional capital as a result of sales of beneficial interests in servicing without creating significant operational risks, then the agencies should move forward.

Michael S. Taliefero Vice President
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Title Annotation:financing mortgage production and servicing operations
Author:Taliefero, Michael S.
Publication:Mortgage Banking
Article Type:column
Date:Dec 1, 1990
Previous Article:Technology.
Next Article:Economic trends.

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