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» VISIT US ONLINE @ DSNEWS.COM JUDICIAL REVIEW INDUSTRY INSIGHT When borrowers stop making their monthly contractual principal and interest (P&I) payments, an increased level of services is required of the servicer to manage the default servicing process, Deloitte explained. Most often, servicers are required by the governing servicing agreements to continue to advance P&I payments to the investors as well as make any required payments to taxing authorities and insurance companies to keep the property in good standing. In addition, servicers are required to incur the costs associated with following up with the borrower, sending them notices, beginning legal proceedings for foreclosure, maintaining security and property preservation for certain properties, obtaining required appraisals, and in some cases, even the activities involved with marketing and selling a foreclosed REO property. All of these expenses incurred by the servicer on behalf of the borrower and advanced to third parties create a receivable, which may be repaid through borrower or investor reimbursement or liquidation proceeds from the loan, Deloitte noted. Recoverability by the servicer is dependent on the alignment of servicing practices with the relevant servicing agreements and may differ among investors. Typically, the benefits of servicing are expected to be more than adequate to compensate the servicer for performing the servicing, and the contract results in a servicing asset, according to Deloitte. However, if the benefits of servicing are not expected to adequately compensate a servicer for performing the servicing, the contract results in a servicing liability. Adequate compensation is a market-based factor and does not necessarily consider the servicer's internal costs to service, Deloitte said. According to analyst Paul Miller and his advisory team at FBR Capital Markets & Co., banks are currently the largest U.S. mortgage servicers, holding roughly 90 percent of the servicing market share. However, we're likely to see a shift from bank-dominance in the servicing space over the coming months and years. Since 2010, FBR says MSRs with unpaid principal balances of roughly $554 billion transferred from banks to nonbank servicers. "[W]e expect more to come," Miller said. "[L]arge banks hold approximately $4 trillion of servicing assets and continue to originate mortgages, a portion of which could be transferred to nonbank servicers." The most active buyers as of late have been Nationstar, Walter Investment Management Corp., and Ocwen Financial Corporation. POINT— COUNTERPOINT Fitch estimates the cost of servicing a performing mortgage could increase by as much as 25 percent to 50 percent from pre-crisis levels. For nonperforming loans, the agency says servicing costs are likely to double, or more. "We believe the spike in cost will place additional emphasis on economies of scale and are likely to drive consolidation in the industry," Fitch added. Officials say the strains of the housing downturn have exposed flaws in the way mortgage servicing fees are structured. With current market conditions, servicers must manage high levels of delinquencies and provide for the extra attention, time, and manpower it takes to service borrowers who have fallen behind on their payments. Federal Reserve Governor Sarah Bloom Raskin told an audience at the Maryland Bar Association's Advanced Real Property Institute nearly a year-and-a-half ago, "When mortgage delinquencies are high, mortgage servicing is not profitable, and servicers may feel extra pressure to cut costs as much as possible . . . . [I]t is imperative to reconsider the compensation structure so that servicers have adequate incentives to perform payment processing efficiently on performing mortgages, and to perform effective loss mitigation on delinquent loans." In a new series of whitepapers, Deloitte explores the mathematics of valuing MSRs, which the firm notes take into account prepayment speeds and delinquency trends, which may fluctuate based on interest rates, trends in home prices, and other macroeconomic conditions. In addition, Deloitte says there is often a lack of transparency coupled with unique transaction characteristics with respect to MSR trades, which can contribute to increased subjectivity of recorded values. Changing Landscape INDUSTRY INSIGHT Rising Costs BEST PRACTICES S ales of mortgage servicing rights (MSRs) have become more and more prevalent as costs associated with handling delinquent loans have increased. Analysts at Fitch Ratings warned back in February 2012 that increased foreclosure costs compounded by credit, compliance, regulatory, and other real-estate owned expenses were beginning to have "a profound effect on the mortgage banking industry." Fitch explained that traditionally, fees from performing mortgages had been sufficient to cross-subsidize defaulting loans. With defaults at elevated levels for years now, however, that's no longer the case. International Impact Basel III comes into play when considering the cost of servicing. The international statute RECENT MSR SALES FROM BANKS TO NONBANK SERVICERS FROM 2010 TO PRESENT Bank UPB ($ in Billions) Non-Bank Servicer Ally (ResCap) $185 Ocwen and Walter Barclays $22 Ocwen AmTrust Bank $23 Nationstar and MetLife Goldman Sachs $41 Ocwen Morgan Stanley $27 Ocwen First Tennessee $26 Nationstar Bank of America $73 Fannie Mae Bank of America $10 Nationstar Bank of America $20 Non-Bank J.P. Morgan $15 Ocwen Bank of America $18 Nationstar Aurora Bank $63 Nationstar MetLife $10 Nationstar Bank of America $10 Nationstar Bank of America $11 Ocwen Total Sold = $554 Billion Source: Company filings and FBR Research 67

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