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environmental change. A lot can't, or are going to have a hard time surviving." He says just the cost associated with proving compliance adds significant fixed costs to a servicer's infrastructure. The size of RoundPoint's compliance area is four times what it was in 2012, according to Worrall. The additional expense that comes with compliance is diametrically opposed to the idea of economies of scale servicing, Worrall notes. ECONOMIES OF SCALE In a "Housing Insights" report published last month, the economics team at Fannie Mae noted that the "mortgage servicing business provides perhaps the clearest example of the benefits of scale economies in the primary mortgage market." The GSE's economists cite data published by the Mortgage Bankers Association for the period between the second quarter of 2012 and the second quarter of 2013, which shows that direct servicing expenses for servicers of fewer than 2,500 mortgage loans were 13 percent higher per loan than direct servicing expenses for servicers of more than 50,000 loans. This pre-2007 cost-of-service model just isn't going to work in the post-2014 era because of the cost to comply, according to Worrall, who says that may not necessarily be a bad thing. "I'm not an advocate of the economies of scale model because I think that type of thinking got us into this situation in the first place," Worrall said. "Large servicers had built businesses to service lots and lots of loans and had not built in the capabilities to handle a default event like what occurred in 2007 and 2008." It's the same age-old problem with all companies, according to Bill Glasgow, president of Glasgow Management, Inc., and a former servicing executive with OneWest, JPMorgan Chase, Bear Stearns, and IndyMac. "If you expand too fast, you end up finding out that it costs a multiple, several times over, to fix the problems you create, as opposed to growing in a more sustained, methodical way," said Glasgow, whose consulting firm specializes in improvements in mortgage servicing operations. MARKET SHIFTS According to Glasgow, the servicing business is changing hands in direct relation to capital structures. Until now, it's always been the big national banks that were the primary providers, not only of lending but also the servicing side of the business, Glagsow explains. "And now you see them, in many respects, exiting at least a percentage of that business, and some of them clearly want to get out of managing the default side of the business, 46 which is spawning an avenue of growth for nonbanking companies such as Green Tree, Ocwen, and Nationstar," he said. In a commentary note released November 18, the analysts at FBR Capital Markets addressed this very topic. "As a result of the current capital and regulatory environment, larger banks are stepping back from the origination and servicing market," they wrote. "This bodes well for smaller banks and nonbank originator/servicers, as they can step into the hole left by the big, money center banks, allowing them to gain significant market share." FBR's analysts went on to say, "Nonbank market share in both the origination and servicing sectors has risen meaningfully during the past four years. Many banks have announced their departure from and lessening involvement in different origination channels and have disclosed layoffs as they have decreased capacity. This trend should continue as Basel III capital standards, headline risk, and tighter regulations discourage banks from maintaining a strong presence in the mortgage market." RISKS OF UNTETHERED EXPANSION Glasgow, however, worries about the pace of this shift within the marketplace. "If, and only if, the Ocwens, Nationstars, and the Green Trees of this world—and this is a big if—if they can demonstrate that they can grow at the level and pace they are growing today without getting themselves into compliance issues and adversely impacting the consumer, then I would imagine this model will survive for at least the next five years, though a lot will depend on the position or future of the GSEs," he said. The industry witnessed the ramifications of such maneuvers just last month with the actions taken by federal and state officials against Ocwen Loan Servicing. The CFPB and 49 state attorneys general filed a consent order in federal court requiring $2.125 billion in restitution to remedy what CFPB Director Richard Cordray described as "systemic misconduct." On a press call with reporters, Cordray noted that Ocwen "has been greatly expanding its business in the years since the housing collapse." Today, Ocwen is the nation's fourth-largest mortgage servicer and the largest nonbank servicer. "It has acquired smaller competitors such as Homeward Residential and Litton Loan Servicing. And it has taken on servicing duties for some of the big banks. Today its customers number in the millions," Cordray said. "Because Ocwen bought the mortgage servicing rights to millions of existing accounts, for many borrowers Ocwen was not their first servicer. For these struggling homeowners, the Consumer Bureau believes that too often trouble began as soon as a loan transferred to Ocwen, with Ocwen failing to honor trial modifications that were agreed upon by previous servicers." "There's been consolidation for the past 10, 20, 30 years but nothing like what we've seen here in just the last few years," Glasgow said. SQUEEZING THE BUSINESS MODEL "[W]hile the effects of the economic crisis are receding, bankers are now facing a wave of increased regulatory requirements," Federal Reserve Governor Duke said in that speech back in January 2012. "For the most part, the new regulations are directed at the largest institutions, whose failure would pose the greatest risk to the financial system, or at the lending practices that led to the crisis. Even so, the changes are so sweeping that many industry analysts have questioned whether the overall weight of regulation poses a threat to the future of the community bank model." Since the beginning of the recession, the industry has had to deal with paradigm shift after paradigm shift, according to Worrall. As a result, "shops are retooling to performing loans," he said. Worrall sees the prevailing business model of the future as large loan servicers working with primarily performing mortgages. Indicative of this transformation within the industry, Roundpoint, which has historically been a special servicer, has begun focusing solely on performing loans. Worrall says Roundpoint got into the MSR market in 2012, but activity was limited. In 2013, it ballooned and pricing almost doubled from what the company was paying for MSRs the year before. In order to survive in this new marketplace, Worrall says it's paramount for any company to allocate significant corporate resources for monitoring and complying with the swiftly changing regulatory environment. Secondly, he says it's important to provide a good experience for the consumer because whether still trying to hang on as a special servicer or executing the economy of scale model, the only way to succeed is with a business model that stresses customer service. "You look at companies that are truly committed to this business—Wells as an example—that have weathered the storm, and you're never going to see those types of institutions exit," Glasgow said. "On the other hand, if we were so worried about the American-US Air merger, then we should be as equally worried about concentrating mortgages with just a handful of servicers." Glasgow points to Washington Mutual, Fleet, and even Citi as examples of what

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