R. Christopher Whalen
Feb 13, 20238 min
February 13, 2023 | Premium Service | The continuing battle in Washington over the proposed acquisition of conventional servicing software monopoly Black Knight (BKI) (k/n/a Loan Processing Services) by Wall Street data monopoly Intercontinental Exchange (ICE) seems to be drawing growing scrutiny. Just imagine putting two legacy technology monopolies, one in housing finance and the other in global markets, in a single value-killing burrito!
Politico reports that Federal Financial Analytics managing partner Karen Petrou, one of the most respected banking consultants in Washington, has a new paper urging the Federal Trade Commission to block Intercontinental Exchange’s acquisition of Black Knight, citing potential systemic risks. We worry more about the 50-year old technology.
FedFin disclosed that the paper was funded by an unnamed entity “for which this transaction has raised competition concerns” but said it retained full editorial control over the work. Karen’s book on the Fed is an important read BTW.
ICE has said the deal would lower costs for lenders and improve the homebuyer’s experience. If you believe that, then we have a couple of bridges to the multiverse decorated with hot new NFTs we’d like to sell you. A BKI spokesperson said the new FedFin paper was inaccurate, adding that it was funded by competitors. That sounds an awful lot like Warburg Pincus portfolio company Sagent Lending Technologies.
We published a discussion of the ICE+BKI transaction with former FHA Commissioner and Mortgage Bankers Association head David Stevens (“David Stevens on GNMA Capital Rule & ICE + BKI”). Our view is that the BKI purchase is a horrible deal for ICE shareholders, a value killer of epic proportions for one of the most highly valued utility stocks on Wall Street. BKI trades on a 9 price-to-earnings ratio. ICE trade over 40 P/E today. Any questions? Next!
The concerns raised by Stevens and others about operational risk was just illustrated by the market outage at the New York Stock Exchange, a unit of ICE. But ICE has been reportedly lobbying regulators by saying that they will improve the consumer experience in mortgage lending. Again, looking at the goals for cost-savings and earnings post-close in ICE's public disclosure, we cannot see how there will be any money -- or people -- left to drive change in BKI's antiquated platform.
“Black Knight is reportedly placing the Empower loan origination system up for sale in order to gain antitrust approval for its acquisition by Intercontinental Exchange,” reports National Mortgage News. “From the day the deal was signed, most expected that Black Knight would have to divest the LOS, the No. 2 most used system behind acquirer ICE Mortgage Technology's Encompass.”
In our latest column in NMN, we note that it is financial instability in depositories and not systemic risk from nonbanks that poses the biggest the biggest threat to the housing finance sector. The fact that the Financial Stability Oversight Counsel (FSOC) frets about nonbank risk, but ignores the growing insolvency of the banking system due to QT, is a national scandal.
Speaking of key bank mortgage lenders servicing the government market, on Friday Credit Suisse (CS) finally closed "part" of the sale of its Structured Products Group (SPG) to Apollo Global Management (APO). While the media is focused on the larger restructuring of CS into a gentle asset gatherer, the disposition of the US mortgage business will determine whether the process succeeds or fails.
“The full sale is expected to be completed in the first half of 2023,” reports Inside Mortgage Finance. “Credit Suisse expects to book a pre-tax gain of $800 million from the full sale of its securitized products group. Apollo will operate its new SPG as Atlas SP Partners.” But what about the rest of the sale of the CS US mortgage business?
The completion of this transaction is important for a number of reasons, but first and foremost because it advances the objective of restructuring the struggling Suisse lender. But there are significant implications for the mortgage sector and especially the world of Ginnie Mae servicing assets.
We picked up some CS shares earlier in 2023 on premise that the bank will eventually be fixed and neutered into an asset gatherer a la UBS AG (UBS). We can recall years ago during a fishing trip when UBS Chairman Alex Weber promised to "de-risk" the bank. He did. But our worry: What happens to the market for Ginnie Mae assets if CS simply exits the space?
Disclosure: L: CS, CVX, NVDA, WMB, JPM.PRK, BAC.PRA, USB.PRM, WFC.PRZ, WFC.PRQ, CPRN, WPL.CF, NOVC, LDI
For example, there is as yet no word on the sale of CS unit Specialized Portfolio Servicing or the purchase on certain assets from Rushmore Loan Management Services. These transactions were previously announced by CS at the end of 2022. Consider the remarkable message to customers on the Rushmore web site. Notice the first word in the paragraph: "Possibly"
Our surmise is that CS informally approached the Fed and other regulators for permission for SPS, a wholly owned unit of Credit Suisse Holdings (USA) Inc., the top-tier parent for CS in the US, to buy the Rushmore assets. The answer from the Fed apparently was negative.
When a bank holding company is not in good graces with the Fed, then permission to expand any activities is unlikely to be forthcoming. Archegos Capital, living wills, capital levels and other supervisory issues suggest that CS is no more likely to get an OK to acquire the assets of Rushmore than Deutsche Bank (DB) was to acquire the loan administration business of Wells Fargo before COVID. For the record, we'd like to be proven wrong.
Last week Mr. Cooper (COOP) announced the acquisition of the Rushmore business sans the servicing assets, which are supposed to be going to SPS. In the event that a sale to SPS does not occur, another buyer may need to be found for these non-agency mortgage exposures. Clip from COOP earnings presentation below.
The more important point is that the “other part” of the US mortgage financing assets inside CS still do not seems to have a home. The importance of the CS business not taken by APO et al is not fully appreciated by investors in government-insured loans and MSRs. These exposures include assets related to mortgage servicing advances on GNMA MBS that cannot easily be replicated at other lenders.
What happens or not regarding these Ginnie Mae exposures inside CS and the issuers dependent upon them is perhaps the most important question in mortgage finance. Much of what remains of the world of correspondent lending, for example, may be destroyed if CS exits the commercial lending space without finding a replacement. Several large Ginnie Mae issuers, in the event, would be forced to downsize significantly.
In the post 2008 period, all of the big warehouse lender banks led by JPMorgan (JPM) and Citigroup (C) worked diligently to make sure that nonbank issuers were not dropped from funding books without first finding another warehouse and MSR lender. Wells Fargo (WFC) stepped into the market in those dark days, but now the fourth GSE is exiting the correspondent loan market. Unless a large US depository steps up to buy SPS and, more important, the Ginnie Mae advance portfolio of CS, we have a hard time constructing a happy ending for this story.
Biden Taxing MSRs?
Last week at the Southern Secondary sponsored by the Texas MBA, a comment made during a panel got a lot of people riled up about another run by the Biden Administration to tax MSRs at inception. After several discussions this week, we have begun to understand the continued concern about future risk of taxes on MSRs expressed at TX MBA session last Monday. Bottom line is that the ruckus was caused by poor drafting in the Inflation Reduction Act, as discussed below.
Two years ago when the Mortgage Bankers Association and the mortgage industry fought off up-front tax on MSRs at inception, they were forced to educate MCs about how mortgages work. For Senator Elizabeth Warren (D-MA) et al, this was a revelation. This led Senate Democrats to insert language in tax bill mandating Treasury to adjust "reasonable compensation" standard for servicing MSRs if appropriate. A rule making process by Treasury is expected.
The increased data on and official awareness of excess servicing strip (ESS) trades comes into play here. If the industry is selling half or more of the strip to finance MSRs, then what is the reasonable compensation? The answer is that historically the whole strip was meant to be available to support loss mitigation through the cycle, especially for GNMA. In a falling interest rate environment, however, rising asset prices tend to push down gross and net credit losses, allowing for ESS.
Of note, the risk function at GNMA is thinking of imposing a bank like provision on all existing and future ESS trades allowing the issuer to suspend payments if loss mitigation expenses rise above a certain amount. See the standard template for bank preferred securities as an example. This was an important part of the industry discussion with GNMA last September. Six months later, ESS may be the only way to raise capital for the GNMA market.
Given the above, additional education may be needed to prevent another attempt to tax new MSRs, which would destroy the value of servicing assets and might include all payment intangibles. Such a tax might exclude NOLs, BTW, which is another pet project of Senate Democrats in their endless effort to raise taxes. All of this said, it is important for issuers not to overreact, says one insider. Defining “reasonable comp” for tax purposes is in play largely because of the way the provision in the Inflation Reduction Act was drafted.
“Congressional intent on MSR taxation has been made clear twice recently with The Tax Cuts and Jobs Act ("TCJA") and now The Inflation Reduction Act IRA,” he notes. “We don’t want to make a bigger deal of this with Treasury. They simply need to codify the safe harbor from the 1990s.”
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