In what comes as the latest proof of diminishing attractiveness of the mortgage servicing industry, banking giant Wells Fargo (NYSE:WFC) is reportedly looking to sell a portfolio of mortgage servicing rights (MSRs) worth about $41 billion [Wells Fargo Said to Be Selling Mortgage Servicing Rights, Bloomberg, Sep 12 2013]. The servicing rights for government-backed loans, which forms but a small fraction of the $1.9 trillion in mortgage servicing rights owned by Wells Fargo, should be an attractive buy for standalone mortgage-servicing companies like Ocwen (NYSE:OCN), Nationstar (NYSE:NSM) and Walter Investment Management (NYSE:WAC). This move also follows a slew of job cuts announced by Wells Fargo over recent months to downsize its mortgage-focused operations (see As Refi Boom Wanes Wells Fargo Cuts Headcount At Mortgage Lending Unit).
Strict government regulations have forced the big banks to rethink their mortgage-servicing strategy even as lower margins put pressure on their bottom line figures from the business. Bank of America (NYSE:BAC) was the first among the banks to begin shrinking its mortgage serving portfolio – selling MSRs worth $10.4 Billion to Nationstar last June.
We maintain a $46 price estimate for Wells Fargo’s stock, which is about 10% above the current market price.
The role of a mortgage servicer involves looking at the nitty-gritty of mortgage installment payments on behalf of the actual investors in the mortgage. While this primarily includes managing the billing and collection of the monthly payments for all underlying mortgages, it is also the servicer’s responsibility to take care of the foreclosure process in case a mortgage turns bad.
The country’s biggest banks have traditionally been the largest servicers of mortgages, with Wells Fargo leading the pack with MSRs of just under $1.9 trillion at the end of Q2 2013. JPMorgan Chase comes in at a distant second with a $832 billion mortgage-servicing portfolio followed by Bank of America with its $759 billion portfolio. Quite notably, Bank of America had $1.6 trillion in MSRs at the end of Q1 2011 – more than double its current figure.
The table below summarizes the changes in the size of MSRs for the country’s five biggest banks – which are also the five biggest mortgage servicers – over the last 10 quarters and is based on figures provided by them as a part of quarterly regulatory filings.
|(in $ mil)||Q1 2011||Q2 2011||Q3 2011||Q4 2011||Q1 2012||Q2 2012||Q3 2012||Q4 2012||Q1 2013||Q2 2013|
|Bank of America||1,610||1,578||1,512||1,379||1,313||1,224||1,142||1,045||949||759|
|U.S. Bancorp (NYSE:USB)||183||185||186||191||200||207||211||216||220||224|
The trend seen above is unmistakable: the banks, which have actively focused on the mortgage business over the recent years (Wells Fargo and U.S. Bancorp) are the ones that have seen a growth in the size of MSRs, whereas the other banks have shrunk their portfolio over the period.
But Wells Fargo’s decision to sell MSRs worth $41 billion is a marked departure from this trend and highlights the changing scenario in the mortgage industry. Worth just over 2% of the bank’s total mortgage-servicing portfolio, the MSRs up for sale are not really a significant part of Wells Fargo’s business and their profitability is further limited by the fact that the customers who borrowed these loans do very little business with the bank otherwise. The sale of these “non-core” loans is, hence, not expected to impact Wells Fargo’s operating value much in the long run – something that can also be verified by making necessary changes to the chart above.
However, if the portfolio sale is actually a precursor to more such sales by Wells Fargo in the near future, then it would mean a drastic change in the bank’s outlook towards the business and will result in a slower growth in the MSR portfolio (if at all) over the years compared to what we estimate in the chart above.
Disclosure: No positions