Rafferty Capital Markets’ Vice President Richard X. Bove provides an outlook on Wells Fargo & Co (NYSE:WFC)’s sale of $39 billion in mortgage servicing to Ocwen Financial Corp (NYSE:OCN) being halted by New York State’s Superintendent of Financial Services, Benjamin Lawsky.
New York State denies Wells Fargo and Ocwen Financial’s transaction
Benjamin Lawsky, Superintendent of the New York State Department of Financial Services halted indefinitely the sale of $39 billion in mortgage servicing to Ocwen Financial Corp (NYSE:OCN) from Wells Fargo & Co (NYSE:WFC). The reputed price on the deal was $2.7 billion. This action raises a few interesting questions. The bottom line is that the actions of the state in this and related issues will ultimately lower the willingness of banking companies to make home loans.
Fundamental conflict in Wells Fargo issue
At the heart of the matter is a conflict between the United States government and mortgage loan servicers. The government does not want to see homes foreclosed upon. To stop or slow the procedure it has put in place:
• The Home Affordable Mortgage Program (HAMP) and related activities;
• It has worked with state attorney generals to sue (successfully) mortgage servicers (banks) who foreclose;
• It has litigated against multiple firms where it believes that irregularities have occurred; and
• It has fought hard against the automation of the foreclosure process (robo-signing).
The government has not discovered many institutions that have taken homes away from people who have been paying on their mortgages although that has certainly occurred in a surprisingly small number of instances. The government’s fundamental view, which has been certified in the Qualified Mortgage Standards set up by the Consumer Financial Protection Bureau (DFPB) is as follows:
- If a consumer defaults on a loan it is the lenders fault for having underwriting the loan in the first place, and, therefore,
- The lender must be punished,
- By taking a loss on the loan either through modification, forbearance on the foreclosure, or, if applicable, selling the loan back to the originator, and if
- The originator is still in business it should be penalized with fines and other sanctions.
The fact that a foreclosure
- May actually be beneficial to the homeowner by easing his/her financial burden or that
- Moving houses from people who cannot afford them to people who can afford them helps stabilize communities and assist in their growth is
- Not an issue the government cares about,
The government’s goal is to keep people in their homes.
The government’s goal is directly contrary to the legal requirements of the loan servicer. The loan servicer is required to foreclose upon homes where payments are not being made and to resell the foreclosed home for the best price possible as quickly as possible. If the servicer does not take this action the lender’s risk is magnified meaningfully by the possibility that the recovery on the defaulted loan may drop to zero – a more normal recovery in recent times has been 35% of the value of the loan.
Ocwen Financial Corp (NYSE:OCN) is primarily a loan servicer. The company’s initial successes were in acquiring FHA backed loans from loan originators and obtaining collections from the government or through the disposition of the property itself. In recent years it acquired Litton Loan Servicing from Goldman Sachs Group Inc (NYSE:GS), Homeward Residential Holdings from W.L. Ross, and the home loan servicing rights of Ally Financial Inc (NYSE:GOM).
While Ocwen Financial Corp (NYSE:OCN) may originate loans in other parts of its company, it does not lend money as a loan servicer. Its job is conceptually very simple. If a homeowner is in default on loan payments, Ocwen must get the lost payments foreclose. Therein lies the problem. The government does not want Ocwen to foreclose and it does not like the procedures Ocwen uses to foreclose.
Consequently, the government took action questioning Ocwen Financial Corp (NYSE:OCN)’s procedures. Plus, the government believed Ocwen had a responsibility to keep homeowners in their houses and it was the government’s belief that Ocwen was not meeting this responsibility. Therefore the government through multiple facilities sued Ocwen. The result was an agreement with the CFPB and other parties in which Ocwen agreed to:
- Give foreclosed-upon consumers $125 million in relief; and
- Provide, about to be foreclosed upon homeowners, $2 billion to reduce the principal on their home loans.
Why the Wells Fargo and Ocwen Financial’s transaction is halted?
What New York State is basically saying, by preventing Ocwen Financial Corp (NYSE:OCN) from making the Wells Fargo & Co (NYSE:WFC) servicing purchase, is that it does not believe Ocwen has yet to live up to this agreement. Ocwen, in the state’s view, is not an acceptable home loan servicer, as yet, and should be prevented from making more acquisitions of servicing portfolios.
Ocwen Financial Corp (NYSE:OCN) is, therefore, in a very difficult position. If it carries out the requirements of its business it must foreclose as rapidly as possible. If it does this the state is likely to restrict its ability to grow its business. If it does not foreclose quickly, the state may applaud its activities and allow it to make more acquisitions of servicing portfolios. However, its clients, the lenders who are not being repaid, will be put at greater risk.
Wells Fargo & Co (NYSE:WFC), of course, is a big bank. It is believed to be the largest originator and servicer of home mortgages in the United States. It is:
- Currently originating $50 billion in home loans per quarter;
- Holding about $259 billion of these loans in its portfolio;
- Servicing a total of $1.8 trillion of these credits; and
- Holding an additional $80 billion in home equity loans.
Like many big banks, Wells Fargo & Co (NYSE:WFC) has been fined, sued and forced into agreements concerning mortgages that are contrary to the interests of its depositors and shareholders. It is believed that the big bank has modified ¼ of a million mortgage loan agreements to help keep people in their homes at a cost in the tens of billions to its constituents.
It is clearly in the interest of the government to prevent the conveyance of mortgage servicing portfolios from Wells Fargo to Ocwen.
- Wells Fargo & Co (NYSE:WFC) has $168.0 billion in equity while Ocwen Financial Corp (NYSE:OCN) has $1.7 billion.
- Wells Fargo is heavily regulated and can be easily forced into agreements by the government concerning its mortgage portfolios; Ocwen, despite its agreement with the CFPB, is lightly regulated in comparison.
- Wells Fargo ability to hold on to troubled mortgages if necessary far exceeds Ocwen’s ability.
- Wells Fargo & Co (NYSE:WFC) has greater capability to offer forbearance than does Ocwen.
Therefore from the government’s perspective, it makes sense to prevent the movement of a portfolio from very strong hands (Wells Fargo & Co (NYSE:WFC)) to relatively weaker hands (Ocwen). So it is taking the logical step and preventing this transaction.
Potential Consequences for Ocwen Financial
The skirmish between the State of New York and Ocwen Financial Corp (NYSE:OCN) is relatively small in the overall mortgage battles. However, it does highlight a broad assumption being made by the government in these encounters. The government believes that the need to make mortgages in the banking industry is so overwhelming that these companies will continue to underwrite these loans no matter what the potential consequences. It is the government’s assumption that banks cannot give up the profits that they derive from this activity.
I lack the ability and resources to do the appropriate study but I now question whether making mortgage loans is an attractive business for banking companies. I see a number of impediments that suggest that this is no longer a good business.
- Underwriting the loan
- The process takes much more time than in the past; is more labor intensive; and more costly.
- If the loan is not a qualified mortgage, the capital cost for underwriting is much higher.
- Selling the loan
- There is increased competition from low cost non-bank originators.
- The securitization process has become more costly
- The risks on each sale are quite high since any defect in a loan makes a bank vulnerable to having to buy it back when it is in default.
- Holding the mortgage in portfolio
- With interest rates near all-time lows putting long-term credits on the books is a highly risky pursuit.
- There are meaningful capital penalties if the loan is to be serviced in-house.
- Servicing Fees
- The price received from servicing has not covered the cost of servicing for some time.
- The legal issues associated with servicing have cost banks tens of billions of dollars in the past 5 years.
- Litigation can come from any source.
I am not sure that any bank has done the cost studies to validate its loan pricing. The assumption being made by the banks is therefore close to that of the government:
- This is a short-term problem that will go away soon.
- Historic profitability will be restored in the sector.
At some point, however, it is my belief that the cost of being in the mortgage business may outweigh the benefits. The only solution for the banks is to
- Raise the cost of mortgages which will
- Lower the prices of housing and
- Reduce economic growth.