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FHFA Begins Devising Alternatives for Mortgage Servicing Compensation

The ""Federal Housing Finance Agency"":http://www.fhfa.gov (FHFA) has issued a 28-page document that presents several alternatives it plans to consider for how ""Fannie Mae"":http://www.fanniemae.com and ""Freddie Mac"":http://www.freddiemac.com compensate mortgage servicers.


The report is part of ""joint initiative announced by FHFA and HUD"":http://dsnews.comarticles/fhfa-to-work-with-fannie-freddie-and-hud-develop-new-mortgage-compensation-plan-2011-01-18 in January to revise the compensation model for mortgage servicing. The new payment models are also being considered for companies that service Federal Housing Administration (FHA) loans on behalf of ""Ginnie Mae"":http://www.ginniemae.gov.

Currently, the typical compensation structure pays the loan servicer from a strip of the interest on each mortgage, an ""IO"" strip, regardless of loan status, FHFA explained. The agency says the IO strip is a difficult asset to manage and results in a servicer receiving more than enough income to cover the expenses of servicing performing loans, but not enough when a portfolio includes a significant number of nonperforming loans.

FHFA says this arrangement decreases the flexibility needed to ensure optimal servicing of nonperforming loans during times of high defaults like the industry is currently experiencing.

""As the recent problems in managing mortgage delinquencies suggest, the current servicing compensation model was not designed for current market conditions,"" said FHFA Acting Director Edward J. DeMarco.

DeMarco said the goal of this initiative is to explore alternative models for single-family mortgage servicing compensation that improve service for borrowers, reduce financial risk to servicers and investors, and provide flexibility for mortgage guarantors, such as Fannie and Freddie, to better manage loans that go delinquent.

The agency says another drawback of the current servicing compensation structure is that it results in the


creation of a mortgage servicing right asset, which ""is difficult to manage and separate from a servicer's core competency of servicing mortgage loans.""

A recent report from _American Banker_ cites data from the servicing advisory and brokerage firm ""Interactive Mortgage Advisors"":http://www.interactivemortgageadvisors.com/, which shows that the value of mortgage servicing rights has increased roughly 15 percent since the end of the third quarter of 2010 thanks to rising interest rates.

""According to FHFA's report"":http://www.fhfa.gov/webfiles/19719/FHFA_Servicing_Initiative_-_Background_and_Issues_2011-02-14_3pm_FINAL.pdf on servicing compensation and possible alternatives, as of the first quarter of 2010, the nation's top five lenders controlled 59 percent of the single-family mortgage servicing market.

The document outlines various alternatives to the current pay model, including a fee-for-service compensation structure for nonperforming loans and reducing or eliminating the minimum mortgage servicing fee for performing loans. FHFA provides extensive analysis of the alternative scenarios that encompasses illustrations of cash flows and accounting, capital calculations and requirements, and mortgage rate setting.

FHFA says the ideas, models, and alternatives included in the presentation should be used as starting points ""to generate thinking and to explain concerns with the current compensation system.""

The agency said it is coordinating the efforts of the initiative to gather feedback from the industry, consumer groups, investors, and other regulators and government agencies. FHFA has established a ""dedicated Web link"":http://www.fhfa.gov/Default.aspx?Page=324 to post information related to the servicing compensation initiative, including background materials and issues that should be considered as development moves forward.

When the ""administration released its plan"":http://dsnews.comarticles/obama-administration-lays-out-plan-for-winding-down-fannie-and-freddie-2011-02-11 for winding down Fannie Mae and Freddie Mac earlier this month, officials stressed that one of the near-term reforms on the agenda is restructuring servicing compensation.

The topic is garnering attention from a number of regulatory agencies. In a ""speech to housing finance professionals"":http://dsnews.comarticles/fed-governor-calls-on-servicers-to-make-home-retention-priority-2011-02-14 earlier this month, Federal Reserve Governor Sarah Bloom Raskin underscored the need for the industry to consider a new pricing model that better compensates servicers for the handling of nonperforming loans and provides them with incentives to keep borrowers in their homes.

FHFA said in January that implementation of a new servicing compensation structure is not expected to occur before the summer of 2012.