The non-bank servicer
The non-bank servicer is what the name implies: a company that services loans as a primary business but isn’t a bank. Typically a bank will service its own loans that it has put on its balance sheet. The big banks like Wells Fargo (WFC), Citigroup (C), and J.P. Morgan (JPM) will typically service their own loans. However, some of the smaller originators may choose not to put these loans on their balance sheet and may decide to sell them. Often, these loans may end up being serviced by one of the big non-bank servicers like Nationstar (NSM) or Ocwen (OCN).
The advancing issue
While the day-to-day servicing business is pretty mundane, low-margin, and a matter of scale, servicers do have one big issue to contend with: advances. If you buy a mortgage-backed security, you’re entitled to your scheduled principal and interest payments. What happens when borrowers are late or stop paying? As an investor, you still get your principal and interest payment in full. So who makes up the difference? The servicer. The servicer will pay the bondholders their scheduled principal and interest payments even if the borrower doesn’t make them. These are called “advances.” A servicer will get repaid those advances when the loan is foreclosed or modified. But since the timeline can be long, the servicer may have to make advances for quite some time. In fact, as the subprime bubble burst and delinquencies soared, banks were basically giving away MSRs for the value of advances. MSRs were nearly worthless for a period.
Basel III helps non-bank servicers
Recognizing the massive contingent liability that servicing entails, Basel III changed the way banks handle MSRs. Banks are permitted to have MSRs as a certain percentage of their balance sheet, but if they reach a certain threshold, the banks incur capital charges (in other words, they have to keep more reserves than the value of the MSR). This means that banks have been sellers of mortgage servicing rights, which has depressed their values. The non-bank servicers have been the buyers.