9.22.26 Builder Business; BSI’s Larry Goldstone on Servicing; Fed Path Forward

Robbie ChrismanWelcome to the Chrisman Commentary, Daily Mortgage News Podcast. I'm your host, Robbie Chrisman. Topics on today's episode include builder business, some additional thoughts on the Fed with no economic data today. In my interview with BSI's Larry Goldstone on the servicing landscape, industry consolidation and lessons learned from previous market cycles. Here, take a listen, do a little preview. I mean this very tongue-in-cheek when I ask this. Is anybody retaining servicing out there currently? What's the current servicing landscape like?Larry GoldstoneUh, in fact, there are lots of people that are retaining servicing, believe it or not. Some of the largest originators do retain servicing. Rocket Mortgage retains servicing. I guess they would be the number one largest retail originator out there. They have a unique strategy. They retain their retail servicing for their retail customers, but they sell uh most of the servicing that they obtain from third-party originators, uh, correspondent and wholesale channels. UWM, they're also in the news quite a bit these days. They have a sizable retained servicing portfolio as well. And most of the large originators out there do have a large retained servicing portfolio. You know, in the loan origination business, you have to retain some servicing and you probably have to sell some servicing. So servicing sales are generally driven by a need for cash. Uh, originators can't make enough money by simply selling a securitized loan and retaining the servicing. And so some part of their portfolio of originated loans needs to be sold, service released. And so that's where market participants like ourselves come into play and help the market provide liquidity, provide cash and capital so that originators can do more of what they are in the business to do.Robbie ChrismanThanks to this week's podcast sponsor, SpringEQ, the home equity expert. See why SpringEQ is the clear choice in home equity, helping over 150,000 homeowners access almost $15 billion in equity by visiting mortgage.springeq.com slash equity. The focus is definitely on market share or the march for market share in a decreasing residential volume environment. And some of the conversation is focused on builder business. Builders have been using capital to temporarily buy down rates or offer 30-year rates permanently 1% below prevailing market rates. They don't want to cut prices and devalue other properties in the same subdivision as recent sales. And along those lines, Lennar delivered a sobering report recently, not only about missing earning estimates, but also the general residential industry. For the link to that, as well as the latest shows, thought leadership, and more, visit ChrismanCommentary.com. The Federal Reserve's hawkish pivot has somewhat restored market faith in its political independence and inflation fighting credibility. Supported by a dot plot signaling higher for longer rates, the central bank is expected to implement at least two more quarter point hikes to remove lingering economic accommodation. The next FOMC meeting is scheduled just a week before U.S. midterm elections, and though the optics of that aren't great, economic data will ultimately dictate policy, making an October hike likely unless incoming data demonstrates that underlying inflation is falling toward the 2% target rapidly. Put another way, the bar for tighter policy remains low and financial conditions are not yet restrictive. Fed chair Warsh's restrained communication style may be preferable to excessive Fed transparency, particularly given his skepticism of unreliable frameworks like the summary of economic projections and estimates of the neutral rate. Instead, he recognizes that excessive money and credit growth ultimately drives inflation. Yet Warsh's emphasis on money conflicts with the Fed's continued use of ample reserves and an expanding balance sheet. If he wants to take, or if he wants markets to take his inflation-fighting approach seriously, the Fed would need to prioritize controlling money and credit growth over uncertain forecasts and theoretical estimates of neutral rates. That makes it likely that tactical investors are positioned to fade rallies in the near-term Fed funds' futures ahead of this continued tightening cycle. For today's interview, I wanted to welcome to the show BSI's Larry Goldstone to talk about the servicing landscape, industry consolidation, and lessons learned from previous market cycles. He's president of capital markets and lending at BSI Financial Services and has nearly four decades of experience in the mortgage and financial services industries, including more than 10 years with BSI Financial, where he works on all aspects of mortgage servicing, including capital market strategies, communications, data analytics, and strategy leadership. He's helped BSI grow into one of the top 10 buyers of flow mortgage servicing rights and has developed a new retention refinance group for the company. What are you seeing among clients who are selling servicing?Larry GoldstoneI don't think there's a symptom of anything. Let's put it that way. There are really two flavors of mortgage servicing rights out there. Current coupon, which would be servicing rights that are based upon or that are origin based on current originations. And current coupon servicing rights have a unique risk profile. They've got a lot of uh convexity characteristics, which means if interest rates go up, they have the potentially the potential to appreciate in value. And if interest rates go down, they have the potential to depreciate in value. And the unique thing about mortgage servicing rights is that they they are not backed by any principle. So if a mortgage loan pays off, your investment is gone. 100% of your investment is gone. As opposed to if you invest $300,000 in a mortgage loan, you collect interest on that loan. But if the loan pays off, you at least get your $300,000 back. So current coupon servicing rights have a particularly interesting risk return profile, and there are lots of different ways to monetize that value, hedge that value, and capitalize on that investment. Then there's the low note rate flavor, which are mostly uh servicing rights that were originated in the COVID pandemic era, 2020, 2021, 2022, maybe a little bit in 2023. Those are characterized by very, very, very low note rates: 3%, 3.5%, 2.5%. Those homeowners likely aren't going to be refinancing or paying off the mortgage. And so consequently, the risk profile for a servicing investor or mortgage servicing rights investor in those kinds of servicing rights is very low. Consequently, the returns tend to be very low. And similarly, there are very little convex, there's very little convexity characteristic, meaning if interest rates were to go very, very low, those loans could pay off. But as interest rates continue to go high, there's really no more appreciation value possible in those servicing rights because they can't prepay any more slowly than they're already prepaying today.Robbie ChrismanWho is buying and who is selling? And I mean that more in the sense of the why behind it.Larry GoldstoneSo I think the why behind it is really it's definitely evolved over time. Uh, I would say today, a lot of the big buyers are folks like Rocket Cooper, Bayview, Lakeview, Freedom Mortgage, Carrington, even BSI, although we're not as big as a lot of those other guys. So they're all buying because they see an opportunity to monetize the relationship with borrowers beyond simply the collection of a fee to service their mortgage loan. Collecting a fee to service a mortgage loan is a relatively uninteresting business. It's a back office intensive bill and receipt kind of a business. In the conventional space, uh, there aren't a lot of delinquencies out there, and so there's not a lot of default servicing required. It's really just a question of who can be the most cost efficient, who can be, who can process payments the best, who can have the cheapest, I don't know, banking relationships and lockbox facility, what have you. But what's more interesting is being able to try to monetize those borrower relationships. Mortgage originators spend a lot of money buying leads. They partner with Lending Tree, they partner with lead generation firms, they buy leads, they market aggressively, all with a goal of trying to find uh new mortgage borrowers. In the case of someone who buys a portfolio of mortgage servicing rights, you have a captive lead, if you will. They are now your client. And therefore, if you can monetize that client relationship by offering additional mortgage products over time, uh there are some folks in the industry who have suggested that there could be a cross-sell opportunity of three to five addition mortgage loans over the life of a relationship. In today's market, there's a lot of second mortgage lending going on for a lot of folks that have very low note-rate mortgages. They have a lot of equity that has built up on their property as a result of home prices going up so much since the early 2020s. And so they don't want to sell their home or they don't want to refinance their home, but they'd like to get equity or cash out of their home. And the second mortgage market has been growing dramatically over the last three years as people take out second mortgages to take equity out of their homes. These loan products are profitable for mortgage originators, and a very profitable way to originate these loans is to find leads. And the way to find leads is to buy mortgage services rights.Robbie ChrismanMost people in the industry know you from Thornburg back in the aughts. Everyone really liked it, and I know you're very proud of it. If we could talk about a little bit on what you built, but more importantly, how that has led you to where you are today. That'd be very appreciated.Larry GoldstoneSure. I mean, yep, you're right. Thornburg Mortgage was a 17-year uh experience in my career. I've actually been fortunate that I have not had that many uh employers in my career, pretty much stuck with five uh career opportunities, uh, other than a short stint as of, I don't know, call it a private equity guy and venture capital guy. But after Thornburg Mortgage filed bankruptcy and I went out on my own to do some venture capital work, private equity work, just sort of set up my own business. I got introduced to BSI Financial Services and the CEO at BSI. And my relationship, and I've been with BSI since 2012. And so here we are in 2016 or 26, I'm sorry. So that's that's that's uh 14 years with BSI. Um my relationship started on a very informal way. The CEO of BSI knew me from my Thornburg mortgage days and was interested in engaging me to, I don't know, talk generally about the mortgage industry and the mortgage business. As we got to know each other a little bit better, he had a more specific agenda around uh looking for opportunities for BSI financial to grow uh into the future. At the time that we met, BSI was a special servicer or specialty servicer, primarily of defaulted and non-performing loans, primarily loans that had come out of the great financial crisis for borrowers who were overextended or home prices had gone down or banks that had failed or what have you. But it became apparent a couple of years after the great financial crisis that that was not going to be a long-term growth opportunity. It was a good strategy for a short-term opportunity, but not a good long-term strategy. So he and I began talking about the next things that BSI Financial might be able to do. And over the next two or three years, uh, we decided to build out the capability of buying mortgage servicing rights in addition to just seeking clients to sub-service mortgages. And when you buy mortgage servicing rights, we're partnering with institutional investors, initially just uh friends and family uh with a small amount of money, maybe $5 million. Then we found an insurance company that was interested, that was in the mortgage space, that was interested in buying what's called excess spread off of mortgage servicing rights, and they had about $10 million to invest. And so uh we invested that for them. And then as we got more experience and built out the infrastructure, which involved software to model cash flows and sourcing product to purchase from mortgage brokers and independent mortgage bankers, negotiating contracts for the purchase of servicing rights, et cetera, uh we began to search for larger pockets of institutional capital. And uh we engaged in 2017, late 2017, early 2018 with a couple of fairly large private equity credit funds that were in the mortgage space and were interested in acquiring mortgage servicing rights. And um the unique thing about the way that institutions acquire mortgage servicing rights is through a partnership with BSI. And the reason for that is because BSI uh brings a number of critical elements to the table. One, we're approved by Fannie, Freddie, and Ginny to own mortgage servicing rights, and you need to, if you're gonna buy Fannie Freddie, Ginny mortgage servicing rights, you need to have a Fannie Freddie Ginny approval or ticket. Two, we're actually a servicing operator. So we service loans in all 50 states, and if you're gonna buy servicing rights as a on a passive basis, you definitely need a partner that knows how to service mortgage loans. And so BSI has that as well. And while there are other sponsors, if you will, of uh excess spread structures, there are very few sponsors who are actually operating platforms as well. And so, as an institutional investor, you are engaging not only with a notable and experienced capital markets partner, but also with an operating platform that's going to service your loans. So we started buying servicing rights for these clients and these institutional partners in 2017, 2018, and then along, and that went very well, and they were very successful, and we were adding more capital, but then along came the uh COVID pandemic, and that created some financial distress in the mortgage servicing rights and the mortgage market more generally. Liquidity and bank financing dried up for buyers or sellers of mortgage servicing rights, and BSI happened to have all of its tickets, its platform, uh access to flow and bulk servicing platforms, and uh we went through a very substantial growth spurt between 2020 and 2022 or early 2023. So that's what brings us to where we are today.Robbie ChrismanI was looking on your website and it talks about BSI leading the evolution of mortgage servicing using a mortgage fintech platform. What does a fintech platform in the servicing space entail?Larry GoldstoneA mortgage fintech is somebody who relies very heavily on technology as a way to manage costs. In the mortgage servicing business, cost destruction, cost management is a really important thing to do. And so uh servicers struggle all the time with ways to lower their cost per loan when it comes to servicing, particularly when it comes to agency servicing, Fannie, Freddie, and Ginnie servicing. Those are servicing contracts or servicing requirements that are very prescriptive in nature. Fannie, Freddie, and Ginnie have guides that are very detailed and they are very prescriptive about how it is that they want you to service their loans. And therefore, they lean very heavily into innovators, people who can innovate with technology because the process that you employ is the same process over and over and over again. So whether it's things as simple as boarding loans or your call center operation and how you need to run your call center operation to more complicated functions like loss mitigation and default servicing, uh, there are rules and requirements for every step of the process. And therefore using technology and now particularly AI to help automate and augment uh our human resources and our staff.Robbie ChrismanCan we speak briefly about the economics of retaining servicing these days? The why behind that?Larry GoldstoneUm, sure. I think that, you know, one of the whys is um the servicing fee that one collects as compared to the cost of servicing. You know, I guess if you were to buy 25 basis points of servicing on a conventional loan, it is very likely that your cost to service is probably in the neighborhood of three basis points or something like that. So very low. And so consequently, you've got 22 basis points of excess spread, uh, which can be a very attractive return on capital. Further, you can leverage that by borrowing against it. You can get you can borrow up to 60%, or in some cases 70% of the value of that servicing portfolio. And so that amount of leverage will definitely increase and enhance uh an investor's return. And so you can see investors in this space getting low teens uh type returns. And so that's very attractive to a lot of institutional investors. Do you see a Thornburg type company potentially re-entering the business? Well, um I don't see uh I don't see, I have not seen, let's put it this way. I have not seen uh another company try to replicate the Thornburg mortgage approach to mortgage lending. And I think that, you know, Robbie, that's that's the distinguishing characteristic of about what made Thornburg mortgage so special. It wasn't so much that it was just a jumbo mortgage lender or a non-agency mortgage lender, because there are lots and lots and lots of those. And in fact, over the last three years, the non-agency mortgage market has exploded uh across product types and just sheer size. But I think that the Thornburg mortgage product and approach to lending was a much more common sense approach, much less prescriptive, much less or much more borrower-friendly. Um we were able to make loans to people who had interesting financial situations. Uh, we never made bad loans, but sometimes automated underwriting and technology where you don't take into account the unique nature of an individual's personal financial situation can allow you to can allow good loans to slip through the cracks. And I think that it was our ability to connect with homeowners, connect with correspondent lenders, work with their borrowers, be very hands-on, be very customer service oriented, spend the time that was required to make sure that we were making good loans for everybody concerned. That was the defining difference that Thornburg Mortgage brought to the market. And there are still people that want to see that. Today. They wish I would come back. I just haven't been able to quite figure out how to do that just yet.Robbie ChrismanWell, you're here at BSI Financial. People that want more information can go to bsifinancial.com. Anything else you want to share with listeners today before we go?Larry GoldstoneMassive uh consolidation that has been going on in the servicing business over the last two or three years. It's just been mind-boggling, quite frankly, uh, in terms of what's been going on. Uh, it sort of all started with the SLS sale to um by Computershare to um NewRez/Rithm. And then you've just seen a whole sort of long line of interesting M&A transactions, capital markets transactions, uh big servicers um acquiring other big servicers, platforms merging and consolidating. I think it's been really fascinating what's going on, unprecedented, as I as I indicated. And so also kind of worth kicking around a little bit in terms of what it might mean for the future of mortgages, homeownership, uh, as homeowners face off against servicers who are ever larger in size. You know, try to get somebody at Verizon to answer the phone, try to get somebody at ATT to answer the phone. At some point in time, it's going to be equally difficult to get someone at a servicer to answer the phone. It's a fascinating time in my view. Uh, it's probably not going away, but um, but it's pretty interesting. Okay, very good, Robbie. Thanks for watching. Appreciate it.Robbie ChrismanFinally, a little rally in the bond markets yesterday as oil prices moved lower. The two's ten spread narrowed five basis points to 21 basis points. There was no economic data of note, as is the case today, though today's session will feature a $69 billion two-year note auction. We begin the day with agency MBS prices better than Monday's close by an eighth to a quarter, the two-year yielding 4.72, and the 10-year yielding 4.92 after closing yesterday at 4.96%. Let's wrap up with a joke and some housekeeping. It's late September and two guys are out hunting in the middle of nowhere. After climbing a particularly steep hill to get to a vantage point, one man collapses. He then starts frothing from the mouth and convulsing. Managing to get one bar of service on his mobile phone, the other man dials emergency services. The operator asks, What's your emergency? The man says, I was walking in the woods, and then now I think he's dead. The operator responds, Sir, I'm going to need you to speak clearly and slowly. Please stay calm. I was out hunting with my friend Dave. He suddenly collapsed and I don't know what to do. I think he's dead. He's dead? He seems to be. I need you to make sure he's dead. Yeah, okay. I'll be right back. So he puts the phone down, and on the other side of the call, the operator can hear the crunching of crisp bottom leaves, then silence. The sound of a rifle startles the operator. Sir, are you okay? asks the operator. To which there's silence. Sir? says the operator. The man picks up the phone and says, Okay, what next? Thanks again to SpringEQ for sponsoring this week's podcast. SpringEQ is the clear choice in home equity, helping over a hundred and fifty thousand homeowners access almost fifteen billion dollars in equity. To learn more, visit mortgage.springeq.com/equity.