Came 2020 and the commercial banks seemed to be expanding their grips on both mortgage and lending services. It has become a U-shaped graph since; what with banks falling out of love with residential servicing and going into a long gestation period. It is the non-bank lenders like Freedom Financial, PennyMac, and Mr.Cooper who are taking the best part of refinancing volumes; whether it be for the retail channels or the direct ones.

Michael Fratantoni, Chief Economist for the Mortgage Bankers Association feels that “It is important to note that a growing share of mortgage originations can lead to an increase in the servicing share, as originators often have the option to retain or sell the servicing on a loan,” he wrote in a column for International Banker. Many non-bank originators (independent mortgage bankers, or IMBs) tend to be opportunistic, for example, retaining mortgage servicing assets when market values are low, selling when they are high.”

Not only from the residential servicing, but banks have also been categorically retreating from C&I credits and auto loans. This said, their shrinking appetite for the mortgage industry seems the oddest, given that the volumes for mortgage industry production have shot up by 30-40% in this pandemic year.

At the end of Q2, the U.S banks’ cumulative “assets serviced for others” came down to $5.7 trillion. This figure was $6 trillion at the end of 2019. Bank figures for “one-to-fours” has seen sharp declines. For instance, where $680 billion’s worth was sold in Q2 of 2016, only $448 billion’s worth was sold in 2020.

Notably, the mortgage servicing rights (MSR) valuations have come down chiefly because of the low mortgage rates and anticipation of increased prepayments (via prepayment models).  This is simple to understand. Any time a consumer goes for prepayment, the MSR owner becomes fearful of asset evaporation. The threat can be reversed though if a servicer can seize back the evaporating asset through the refinance process. 

While the big lenders still get to seize back a large part of prepaid assets, it goes all downhill for the smaller issuers. The prepayment sword keeps hanging on their neck. The rule of the game is as follows. Real Estate Investment Trusts will keep buying loans. IMBs will keep creating loans. But if as an end-investor or a tiny issuer, you are not in the position to refinance a prepaid asset, you should come out of the market before it gets worse for you. 

This perhaps is the reason why the big banks go for an early buyout (strategic or leveraged) of government-sponsored loans before refinancing them and holding the loan in their portfolio or selling it to MBS. It may be a decent bet in the current situation to focus on the large non-bank issuers that are making and recapturing fresh MSRs in the portfolio at bottomed-out valuations.