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Between settlements regarding fraudulent foreclosures and new banking rules, the big boys in the banking industry are having a hard time figuring out what is profitable and what isn't. One of the departments that banks lately find they would rather do without is mortgage servicing. Once a lucrative side business for mortgage originators, the activity has become more of a drain than a gain for the biggest of banks.
Bank of America (NYSE: BAC ) recently sold the rights to one of its servicing portfolios, valued at $10 billion, to Nationstar Mortgage Holdings (NYSE: NSM ) . Nationstar has been gobbling up offerings such as this for the past year or so and is poised to hold the No. 1 position for a non-bank in the home mortgage servicing industry by the end of this year. In addition to the B of A purchase, the loan servicer bought rights from Aurora Bank, formerly of Lehman Brothers Holdings, and has agreed to take on a whopping $374 billion of bankrupt Residential Capital's portfolio, if the court agrees.
Nationstar isn't the only servicer to take advantage of this golden opportunity. Ocwen Financial (NYSE: OCN ) has also been scooping up the big banks' cast-offs. Over the past several months, Ocwen has taken on Litton Loan Servicing, once belonging to Goldman Sachs (NYSE: GS ) , as well as Saxon Mortgage Services, Morgan Stanley's (NYSE: MS ) servicing arm. It is rumored that they may be interested in ResCap's rights as well.
Why the exodus? Big banks have been under pressure to clean up their act ever since the mortgage crisis began, but things have really been heating up this year. The $25 billion robo-signing settlement reached in February of this year with state attorneys general and the Department of Justice forced Bank of America and four other banking behemoths to restructure their servicing units to avoid additional fraudulent foreclosure practices. Then there's Basel III.
The international lending guidelines known as Basel III were unanimously approved for public comment by the Federal Reserve Board, much to the banks' dismay. Since mortgage servicing -- the actual collection of payments and dealing with escrow and borrowers -- is valued separately from the actual loan, it is considered an asset, which can be put toward capital requirements. Basel III will limit mortgage servicing rights to 10% of Tier 1 capital, however, so banks will either have to pony up more capital or reduce the value of the servicing rights. Banks have elected to sell.
Banks have also seen the value of their mortgage servicing portfolios decrease because of refinancing at the current rock-bottom rates. Bank of America unloaded close to $900 million of its holdings last year and now retains only about one-third of its former portfolio.
While selling mortgage servicing rights may help with capital requirements, it won't end the banks' responsibility for foreclosure fraud: Both Morgan Stanley and Goldman Sachs have been put on notice by the Fed that, despite the divestiture, it will still have to make good on any borrower complaints.
As banks continue to slim down or eliminate their MSR portfolios in an effort to keep up with new regulations, Nationstar and Ocwen are bulking up. Under the right conditions, servicing loans can be profitable. According to Fortress Investment Group, the parent company of Nationstar, the value of shed MSRs could top $4 trillion. I'll be keeping an eye on these companies, as they continue to try to make lemonade out of the lemons that are the mortgage meltdown and the foreclosure fraud mess.
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