This is Part 1 of a Three-Part Series on Loan Servicing. We will explore
at a high level what loan servicing is, the different types of loan
services, and what industry leaders are thinking about now given
market conditions.
Part 1: What is an MBS?
Let’s contextualize this. First, let’s do a quick review of
loans. Later, we’ll revisit loan servicing and how that gets
done.
Loans are debt instruments issued by public or private
entities to finance the development, purchase, or operation
of property. They’re collateralized by the asset underlying
the debt or the borrower’s equity and creditworthiness.
Loans are highly illiquid. They’re tough to issue and hard to
sell for intrinsic value. So, companies standardize them
(button them up), pool them (bundle them up), and
securitize them (back them up).
This process is called “securitization.” It takes one loan,
puts it in a pool with similar loans, and labels the pool of
loans with a rating from AAA to non-investment grade.
Now that you have a securitized pool of loans, you can go
to investors and sell slices of your pie (bonds) at specific
prices/yields based on the investor’s risk-reward appetite,
alias tranching. Selling off portions of these securities as
bonds makes the loans liquid.
In real estate, these loans are backed by mortgages.
Therefore, what is created through the securitization
process is called a Mortgage Backed Security (MBS).
MBS are much more liquid than a single loan. A great
feature of MBS is they allow the issuer to recover cash from
the issuance of a loan and make more loans in the primary
market, or borrowers. In addition, these loans are collateralized
by real assets that have an underlying intrinsic value.
MBS are held in a Real Estate Mortgage Investment Conduit
Trust (REMIC). Two important notes here: 1) REMIC Trusts own
the mortgage loans and issue the bonds collateralized by
the mortgages; and 2) REMIC Securitizations are tax-
exempt conduits – meaning they don’t get taxed.
A Master Servicer is assigned to service the REMIC Trust
through a “Pooling and Servicing Agreement” (PSA). The
Master Servicer services the loans by collecting the
mortgage payments and distributing them to a trustee, who
then pays the bondholders.
What happens if a loan is at risk of or in default? The loan
gets sent to a Special Servicer. The PSA defines the Special
Servicer’s role. The Special Servicer is generally responsible
for managing the work-out and/or foreclosure process of a
defaulted loan.
Special Servicing is fee-based. They earn fees for receiving
a loan, servicing it, a resolution fee, and a disposition fee if
the loan sells. You may be able to spot a few conflicts of
interest in this particular business model.
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