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strengthens bank capital requirements and introduces new regulatory requirements for bank liquidity and bank leverage, Residential Credit Solutions (RCS) notes in a whitepaper. Under Basel III, MSRs are capped at 10 percent of equity instead of 100 percent, and RCS says the MSR deduction could significantly reduce banks' calculated capital ratios, leading those institutions subject to the new requirements to re-evaluate their MSR exposure. Miller agrees. He says even though full implementation of Basel III is five years out, the higher capital requirement for MSRs "is likely to encourage financial institutions to divest some of their servicing assets." U.S. financial institutions have already begun scrutinizing their balance sheets, looking for areas they can tighten up to add more cash to the coffers or to skirt some of Basel III's more stringent parameters. MSR assets are in the financial cinchers' line of sight, and because non-bank servicing companies are exempt from the Basel III accord, they stand to capitalize on sales of MSRs from banks that are subject to the more stringent monetary requirements. Regulatory Considerations On top of the sheer mathematics of servicing costs and Basel III capital constraints, FBR points to a number of regulatory headwinds that should solidify servicers' business models and direct mortgage servicing contracts from larger institutions to smaller shops that specialize in delinquent accounts. The Consumer Financial Protection Bureau's (CFPB) recently issued servicing standards represent yet another catalyst of increased servicing costs for traditional servicers, especially those with a large portion of troubled mortgages in their portfolios. Generally, the goal of the standardized set of procedures and practices is to provide borrowers with more transparency when interacting with their servicers. The CFPB's rule calls for earlier contact with borrowers who are approaching foreclosure and education on the various options to help them hold on to their homes. When the rule takes effect January 2014, servicers will not be able to complete a foreclosure until a decision has been made regarding the borrower's application for a workout solution, such as a loan modification. Many traditional servicers lack the infrastructure to satisfy the proposed standards, and the cost of implementation could be high, according to FBR. "We believe that the CFPB's proposal will likely serve as a further impetus for traditional servicers to transfer portfolios 68 to nonbank servicers with special servicing capabilities," FBR stated in a recent market report. GSE Influence The findings of a study by the Federal Housing Finance Agency Office of Inspector General (FHFA-OIG) also tout the effectiveness of special servicers in today's high-delinquency environment. FHFA-OIG conducted an audit of the transfer of servicing on higher-risk loans to specialty servicers, specifically evaluating the 2011 sale of $73 billion in servicing rights repurchased by Fannie Mae from Bank of America. FBR points out that the inspector general's evaluation validated the price that Fannie Mae paid for the portfolio as well as the way the loans were transferred to the special servicers on the receiving end of that deal. "We believe that the findings of the report open the door to additional transfers to specialty servicers, especially those with high-touch platforms, and prove that more than $300 billion in mortgages still need to be transferred," FBR stated. The federal report touched on several key points including higher-risk loans, in particular. The FHFA-OIG report disclosed that approximately 70 percent of Fannie Mae's losses are coming from a "specific portfolio of mortgages with a combined principal balance of approximately $300 billion to $400 billion." Fannie Mae had started a program to repurchase servicing on these loans and transfer them to specialty servicers to reduce losses, FBR notes. However, to date, Fannie Mae has transferred $130 billion of these loans, leaving $170 billion to $270 billion still to be moved under the GSE's repurchase-transfer program. In addition, Fannie Mae has been operating under justification of its High Touch Servicing Program, from which the GSE believes it can demonstrate a 20 percent reduction in credit losses. According to FBR, the FHFA-OIG report gave "significant ammunition" to the GSEs for future transactions, by stating, "It should be noted that the 'break-even' point for the transactions … was well under 20 percent. In most cases, the cost … could be justified with less than 5 percent savings." FBR says it suspects the GSEs have been waiting to conduct additional servicing transactions pending the outcome of this OIG report. "This is especially true given the finding of the FHFA OIG that 'the amount Fannie Mae paid was consistent with the amounts it had paid to other servicers,'" FBR stated. The report does recommend additional scrutiny and rigor in determining price, the firm's analysts note, but it also highlights the benefit such transactions afford in reducing credit losses. "[W]e expect the [GSEs] to restart their transfer program," FBR said. "The ultimate decision to transfer these assets from the big banks to the specialty servicers lies with Fannie Mae and Freddie Mac, not the companies themselves." Indicative Trading Pattern Fitch Ratings is also expecting to see a strong surge in MSR transactions. The agency says Bank of America's January 7 announcement of agreements to sell $306 billion in MSRs is likely an indication of trades to come. Bank of America sold the servicing rights to 2 million mortgage loans to special servicers Nationstar Mortgage and Walter Investment Management Corp. The loans are owned by Fannie Mae, Freddie Mac, Ginnie Mae, and private-label securitizations; 232,000 are 60 or more days delinquent. Both Bank of America and Fannie Mae indicated specialty servicers will be able to mitigate losses on these past-due loans. "We believe that other banks with large MSR assets may also begin to complete sales or pursue other strategies to limit their size on bank balance sheets," Fitch said in a recent credit market report. The agency's analysts specifically point to Wells Fargo and JPMorgan Chase as banks likely to fall in line with Bank of America's approach. Fitch says Bank of America's transactions indicate "a market exists for these assets," and furthermore, that market appears "relatively attractive now." Bank of America's success securing deals with Nationstar and Walter Investment— despite having "one of the more challenging servicing books compared with other large institutions," according to Fitch—implies there are nonbank servicing shops eager to purchase MSRs. Fitch says the only hindrance to future MSR transfers could be capacity constraints. Zacks Equity Research notes that Bank of America's mortgage servicing expenses stood at $3.4 million in the third quarter of 2012, largely because of the extra hiring the company had to do in order to ensure it was adequately staffed to work with borrowers who'd fallen behind on their payments. While Bank of America's recent transfer is likely "the last large shift of high-touch, creditsensitive assets" into the specialty servicer sector, the acquisition pipeline will continue in the space in the form of incremental transfers, according to FBR. The firm's analysts say they are "confident" that $200 billion to $300 billion more in MSR assets will change hands over the next 12 to 24 months.

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