May 21: Note on the value of servicing; cyber crime – risk #1 for financial companies; should “going public” be a goal for every lender?

Totally unrelated to anything about mortgages, a prank caller tricked Burger King employees in Coon Rapids, MN, into smashing the outlet’s windows by telling them that there was a gas leak. Be careful out there! The biggest threat to the US financial system is cyber risk, said Securities and Exchange Commission Chair Mary Jo White. The SEC has found shortcomings at major securities exchanges, clearinghouses and dark pools, she said. “What we found, as a general matter so far, is a lot of preparedness, a lot of awareness but also their policies and procedures are not tailored to their particular risks,” she said.


Speaking of which, no one is immune from this. Fred Gibson Jr., acting inspector general of the Federal Deposit Insurance Corp., told a House Science, Space and Technology subcommittee that a criminal investigation has begun into the removal of tens of thousands of people’s personally identifiable information from the FDIC’s computers. He said the matter is in the “pre-indictment phase, which limits my ability to discuss it directly.”


Switching gears to rates that borrowers see, the value of servicing is certainly changing for a multitude of reasons, which in turn can impact borrower’s rates & prices just as much as the bond market. The value of servicing has declined recently, and some believe that the demand for mortgage servicing rights is soft is possibly related to some companies mis-modeling speeds (i.e., under-predicting prepayment speeds) which makes their fair value pricing too strong and bids to appear weak but obviously not appropriate to tell that to the world. But others are not seeing decreased demand for bulk packages, just lower execution related to lower rates. And still others are seeing the demand weaken on a co-issue basis. Nothing is set in stone. Fluctuating values make setting borrower’s rate sheets even that much difficult.


And Matt Maurer with Denver’s MountainView Capital Group writes, “It is not all doom and gloom in the MSR market. Yes, MSR values went down in the first quarter. And yes, we saw several cohorts such as lower coupon FHA and VA servicing prepay faster than expected. The majority of large MSR holders, however, are successfully hedging their MSR asset. For those that hedged, the move down in rates offers an opportunity for increased origination revenue and to use of the money earned from their MSR hedges to pay the implied SRPs on their new production. And, in general, if we see a rise raise in servicing costs or faster than expected speeds, we see a move down in not only bulk MSR pricing but co-issue MSR pricing and corresponding pricing as well.


“Those that yell out that co-issue is always the answer are not telling their clients the whole story. We at MountainView are a big fan of the co-issue market and are active assisting our clients participate in the co-issue market given all of the benefits from certainty of execution and timely payment of proceeds to being able to take advantage of ‘mis-calibrated’ co-issue grids. There are, however, also a lot of benefits to retaining and potentially selling bulk. The servicer keeps the customer, receives valuable early month MSR cash flows (which outweigh early costs) and eventually take advantage of the stronger relative execution (i.e. lower required buyer returns) that were seen in the large majority of the 50+ bulk MSR packages that MountainView has marketed since the beginning of last year. With unlevered MSR returns of 8 to 9 percent being attractive to bank and non-bank MSR buyers in today’s low yield environment, we expect demand to hold steady. That being said, the decision to retain and hold servicing and/or retain, aggregate, and sell bulk should not be made lightly as servicers need to understand the valuation, compliance, and operational risk and cash flow needs of retaining servicing.”


“Rob, I work for a mid-sized mortgage bank and there is a rumor that the CEO wants to go public. What do you hear about that?” Well, I hear it is a pretty expensive process. But in a broader scope, keep in mind that there are big shifts going on in banking and lending right before our eyes. For example, J.D. Power & Associates reports that for the first time in 11 years, the largest banks have outscored the smaller banks in customer satisfaction. Analysts say the shift is due to the generational change in the workplace and the fact that younger people prefer digital delivery seen more commonly at the largest banks and so tend to stay there.


But getting back to your question, if one uses stock value as a proxy for value, most banks and non-depository lenders’ values have plummeted in the last six months. On May 10th I wrote:


“…analysts are hard-pressed to find a single publicly held non-bank residential lender that made money in the first quarter of 2016, or that has seen its stock price improve this year. Put another way, practically every lender not part of a bank has not only lost money so far this year, but has seen its stock price worsen & in some cases plummet. And most of them have not had a profitable year in a few years! Let’s hope that employees don’t have their entire 401(K) held captive in company stock, and that the lessons learned eight years ago aren’t forgotten.


“Want some examples of stock prices in the last six months? Nationstar (-14%), Ocwen (-69%), PMAC (PFSI -19%), Impac (-25%), Walter/Ditech (-58%), PHH (-15%), Stonegate (-30%). Redwood Trust, after being down 30% at one point, has rebounded to actually be up 1% in the last six months. How about the banks, with their lower cost of funds, other product lines, and core bank earnings? Not much, if at all, better: Bank of America (-21%), Wells Fargo (-12%), Citi (-20%), Chase (-9%), US Bank (-4%).


“What is the culprit? Were all of these stocks overvalued six months ago? Their earnings have shown mixed numbers. There are plenty of lesser reasons, but the primary reasons seem to be servicing, or related to it. Whether it was hedged or not, plenty of management teams thought servicing would be on their books much longer. When those loans pay off, and after the early pay-off penalty expires for whoever originated the loan, it is a hit to the asset side of the company’s balance sheet. And any company that paid above-market premiums for servicing, well, they took a bigger hit. Industry experts are watching the impact of Basel III on banks’ servicing portfolios – is there a natural buyer for those portfolios? Or will the run-off equal the new production coming in?


“These results, of course, have plenty of employees of non-publicly traded firms asking senior management about how their company is faring. Certainly smaller lenders who were able to take advantage of larger investors paying up for servicing benefited by selling the product servicing released. And certainly there is concern among any profitable lenders owned by venture capital firms who are arguably quicker to pull the trigger on unprofitable ventures.”


In today’s business world, “going public,” seems to be the ultimate dream of the entrepreneurial class. It’s not enough to simply start and run a successful business. The measure of success is whether shares in the company can be sold to a wide audience of investors. The dream is that going public makes company founders wealthy, but it also relegates them to the status of significant shareholders instead of owners. Often when you ask the founder or CEO of a small publicly held company if they made the right decision, they will reply, “No. Instead only reporting to 1-2 people, now I have thousands of stockholders who are my bosses.”


But the majority of community banks and lenders have stayed private, or perhaps issued small amounts of stock to key employees – a great way to build loyalty and to help financially. They have continued to be dominated by the closely-held model.


There are certain advantages and disadvantages that come with being a closely-held company.

Some disadvantages include greater difficulty in raising capital for expansion or improvement. After all, owners usually tend to be reluctant to sell additional shares that could dilute their control, as they usually get decent dividends from earnings based on ownership. Closely-held non-bank lenders and banks can also struggle with succession issues at times. What happens if the CEO/founder is hit by the proverbial bus?


There are also a number of distinct advantages that closely-held companies have over bigger, widely-held banks. According to a recent FDIC study, closely-held community banks are nimbler in decision-making, tend to be better at avoiding excessive risk, and regularly outperform widely-held banks. The research surveyed 1,357 community banks that represented 50% of all community banks in three FDIC districts in the central part of the country.


While the scope of the survey does not represent a complete portrait of the country as a whole, it provides an interesting window into closely-held banks which can easily be translated to non-bank lenders. The extent of closely-held ownership in the sample was obvious. About 67% of the banks were closely held with an identified primary owner that could be an individual or a small group with controlling interest. The vast majority had family or community ties as well. In nearly 50% of the banks the key officer was also a member of the ownership family or group.


In terms of ROA and ROE, the closely held banks consistently outperformed widely held banks in the region. The average ROA for closely-held banks was 30 basis points higher than for widely held banks in 2014, although the advantage had narrowed somewhat during the previous 3 years. On ROE, closely-held banks in the sample had a more than two percentage point advantage over widely-held banks in each of the 6 years ending in 2014.


The FDIC paper’s authors found that closely-held banks had lower levels of balance-sheet risk than widely-held banks. This is presumably because owners of closely-held banks have more of their own money at risk and are not as pressured to produce short-term results because they own the bank after all.


Steve Brown with PCBB writes that, “Being unconstrained by short-term pressures also gave closely held banks an advantage in decision making. Without the pressure to perform in the short-term that comes with widely-held shares, closely held banks were freer in their ability to make decisions. The authors noted this allowed them to make and carry out long-term plans more effectively.”


The FDIC’s report observed, “These favorable comparisons between closely-held and widely-held community banks suggest that the closely-held organizational form is by no means an impediment to performance, and may well be one of the keys to their success.” Who needs an IPO when you can beat the big guys with a privately held community bank or non-depository lender?



(Rated PG.)

A priest was being honored at his retirement dinner after 25 years in the parish.

A leading local politician and member of the congregation was chosen to make the presentation and to give a little speech at the dinner. However, he was delayed, so the priest decided to say his own few words while they waited.

“I got my first impression of the parish from the first confession I heard here. I thought I had been assigned to a terrible place. The very first person who entered my confessional told me he had stolen a television set and, when questioned by the police, was able to lie his way out of it. He had stolen money from his parents, embezzled from his employer, had an affair with his boss’s wife, had sex with his boss’s 17-year old daughter on numerous occasions, taken illegal drugs, had several homosexual affairs; was arrested several times for public nudity and gave VD to his sister.

“I was appalled that one person could do so many awful things. But as the days went on, I learned that my people were not all like that and I had, indeed, come to a fine parish full of good and loving people.”

Just as the priest finished his talk, the politician arrived full of apologies at being late. He immediately began to make the presentation and gave his talk.

“I’ll never forget the first day our parish priest arrived,” said the politician. “In fact, I had the honor of being the first person to go to him for confession.”





(Copyright 2016 Chrisman LLC. All rights reserved. Occasional paid job listings do appear. This report or any portion hereof may not be reprinted, sold or redistributed without the written consent of Rob Chrisman.)

Rob Chrisman