On REITs and Mortgage Servicers

Amidst the blast of New Year news about expensive sales and competitive leasing, New York-based financial information and statistics company Fitch Ratings Inc. issued two real estate-centric reports today. 

Neither were exactly upbeat.

First, Fitch said that real estate investment trusts’ ratings are headed downward.  Then, it said new federal rules set to kick in this week will create problems for mortgage-servicing companies, and increase borrowers' costs.

On the first issue, Fitch said that U.S. REITs have shrunk their debt and strengthened their credit profiles. The company reported that its "U.S. REIT upgrade/downgrade ratio" has been about 10-to-one since the beginning of 2011, but the "deleveraging initiatives are largely complete and credit metrics may soon reach an inflection point."

Fitch reasons that during the economic crash, REIT bonds ran aground and companies were forced to dip into reserves and borrow to pay mandated dividends. This in turn compelled REIT management to deleverage—lower their debt, reduce their borrowing—as well as improve the quality of their real estate holdings and heighten their risk-avoidance procedures.

The moves have been matched with an improving economy characterized by "rising occupancies, rental rates, and net operating income." And U.S. REIT bond performance, Fitch explains, has improved in comparison to non-financial industry corporations and industrial companies.

The result is some stock is undervalued, making share buybacks a recent "hot topic" for REITs. But the Fitch statement notes that credit ratings would deteriorate if firms go back to high debt or sell assets to finance sizable stock-repurchase programs.

"Given that equity investors generally favor strong, investment-grade balance sheets," the report says, "Fitch believes the improvement in REIT credit over the past several years is a secular change."  It adds that "rising interest rates and growing development pipelines support a stable outlook for the sector."

The Fitch Ratings statement on REIT values can be found in full HERE.

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Next, Fitch looked at this Friday’s long-anticipated Consumer Financial Protection Bureau requirements for mortgage servicing companies.

The companies are the receiving agencies for mortgage lenders, accepting payments on loans and providing accountings and related services over the course of the loan term. 

But homeowners have had problems with obtaining refinancings and payment records, a problem accentuated when many individuals, families, and businesses couldn’t meet their obligations after the economy crashed in 2008. 

Mortgage loans were a big part of the economy’s problems.  The mortgage servicers often provided faulty information not only to borrowers who sought relief to fight off foreclosures, but also to the lenders, who rely on servicing company information in packaging and selling the portfolios of loans, often to federal government institutions.

Many of those large lenders are now settling claims for defrauding the federal government on the mortgage sales (see QuidnuncRE’s most recent, HERE).  And last year, the CFPB, the new consumer watchdog agency set up under the 2010 Dodd-Frank Act, moved to curb mortgage servicers’ bad practices.

Many sectors of the real estate industry say that the laws to protect consumers will drive up prices and hurt sales.  Today, Fitch said that it’s the small U.S. residential servicing companies that face the challenges of increased costs, which could affect their ability “to grow through strategic acquisitions.”

Fitch reports that “[m]any U.S. residential mortgage servicers have been working diligently to meet new the servicing requirements,” including rules on borrower notifications and interactions. The big companies have done that as part of their settlements in several cases.

Regardless of size, the mortgage servicing companies must make structural changes.  For example, they are now required to make an effort to tell borrowers when payments are missed, and install procedures to deal with family members upon the death of a borrower.

Fitch expects the CFPB rules to have an impact on mortgage servicers' business and operations in 2014, and notes that "many large servicers have already made significant progress" in anticipation of the Jan. 10 effectiveness date for the new requirements.

"Where the potential problem lies, however, is with smaller independent/non-bank servicers," says the report.

It also says that 2013 "saw a notable amount of mortgage servicing rights transferred due to servicer consolidation and acquisitions." The smaller operations have picked up the more difficult underperforming loans that large mortgage service companies don’t want. Those loans, says Fitch, "are difficult and expensive to manage effectively within regulatory guidelines."

The result is a dynamic market that is in transition "as these smaller servicers struggle with the requirements and costs of the new servicing guidelines."  Compliance "will mean more recordkeeping and infrastructure improvements," and, it says, likely raise the minimum number of loans that a company needs to take on to be profitable.

Fitch notes,

If properly managed, the required changes can be implemented without major challenges. However, the change[s] place higher fixed costs on servicer operations. Since larger servicers may more easily absorb higher fixed costs, smaller servicers may struggle as they seek to balance the cost of regulatory rule compliance with the need to maintain or grow their servicing portfolios, address their competitive position for new acquisitions, and manage their overall profitability.

Despite the problems noted for potential acquisitions, the Fitch statement predicts more industry consolidation.  The report concludes, "Mortgage servicing is a cost-control and cost-competitive business function, and the new CFPB regulatory requirements will likely pressure this further."

The Fitch statement on mortgage servicers can be found HERE.

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