Business Insights

The Impact of Mortgage Servicing on Liquidity (and what to do about it)

This is the second in a three-part series on managing liquidity in mortgage banking, featuring Richey May’s Director of Mortgage Banking Seth Sprague. In Part 1, we took a look at the state of liquidity and its impact on both mortgage origination and servicing. In Part 2, we dive deeper into the implications for servicing. In Part 3, we’ll explore industry best practices.

In January 2023, Wells Fargo announced it was shutting down it’s correspondent channel and would downsize its mortgage servicing portfolio, despite that channel representing 42% of its 2022 loan origination business.*

The news from the nation’s #1 mortgage servicer and #3 mortgage lender had been rumored, but the historic change still had a large impact  on the industry. Consequently, management teams that participate in the correspondent channel and/or invest in mortgage servicing rights (MSRs) had even more questions – namely, how does this impact my strategy?

We asked Seth Sprague, CMB our resident expert on mortgage banking, for his insights on how the new normal might impact the liquidity of independent mortgage banks (IMBs). Here’s a half dozen or so of Sprague’s pearls of wisdom.

What do we need to know about managing liquidity and mortgage servicing rights?

Sprague: MSRs are a minimum 250% risk-weighted asset for banks under Basel III. That represents a significant capital charge to invest in servicing. So as we see many bank failures and greater capital requirements, banks have to assess their willingness to continue to invest in MSRs.

Is this a bigger issue for larger IMBs?

Sprague: Some large IMBs rely on their ability to monetize servicing to help fund operations. If the MSR market gets saturated with volume, IMB liquidity could be impacted.

How do reps and warrants factor into the equation?

Sprague: Reps and warrants from someone like Wells Fargo are important when it comes to servicing. Investors will say, do I want to buy from Wells or from somebody that’s not a depository? It’s an important concept when it comes to servicing values and marketability, especially if there are multiple deals in the MSR market at the same time.

What about warehouse lending? What does that dynamic do to their costs?

Sprague: You could see where there’s this trickle-down effect across multiple segments of liquidity for IMBs. And as each one of these sources of liquidity gets chipped away, their overall costs go up because either the profitability is coming down or fewer people are willing to lend, which means those remaining lenders can charge higher rates or more favorable lender terms.

So where do IMBs need to focus from a servicing perspective?

Sprague: I think it’s very important to understand servicing cash flows, the cash in and cash out of servicing, which would include servicing advances. It’s also important to understand the potential gap between a level three fair value asset for accounting purposes and the bid level in the MSR market. It is equally important to spend time looking at the actual cash flows, including advances, generated from servicing, because that’s the true cash impact of servicing.

What closing advice do you have for an IMB in the servicing space?

Sprague: Understand what your strategy is and how you’re executing on it. Do you have the right benchmarking data? Have you outsourced appropriately? Have you gotten to a variable costing model versus a fixed costing model? Do you have a clear understanding of the retained/released decision and what are the drives being used in that decision? Does it make sense that the retained value is so much higher than the aggregator bid for certain loans?

And what’s the end goal?

Sprague: At Richey May, we work to understand our clients’ strategy and use our data and expertise to evaluate and fine tune execution. Strategies need to change and adapt to the current market conditions, whether that includes more outsourcing, adjusting the retained/released strategy, or taking a more macro look at liquidity. There are no magic solutions out there, it takes data and effort to evaluate and create the right strategy for each lender. It’s all about helping our clients return to profitability as quickly as possible, without taking on undue risks.

To learn more about managing liquidity and maintaining profitability in servicing, or to tap into more of Seth Sprague’s expertise in mortgage banking, email us at info@richeymay.com.

*“Wells Fargo, once the No. 1 player in mortgages, is stepping back from the housing market,” CNBC, JAN 11, 2023