NEW YORK (The Street) -- As beleaguered mortgage-debt collector Ocwen Financial Corp. (OCN) moved to sell off its portfolio under pressure from regulators, more than a few veteran mortgage-industry executives were surprised that one of the buyers turned out to be JPMorgan Chase & Co. (JPM).
Big banks exited the mortgage-debt-collecting business in a hurry from 2009 to 2014, and it was easy to see why. They paid billions in fines and did untold damage to their reputations in exchange for a paltry fee -- roughly $500 per year before expenses on a typical $200,000 mortgage. Another big factor was the new capital rules known as Basel 3, which penalize banks with heavy exposure to the mortgage-debt-collection business, known as mortgage servicing.
Banks would still make home loans, of course, but it appeared they were happy to leave the servicing to non-bank specialists such as Ocwen, Nationstar Mortgage Holdings (NSM) and Walter Investment Management (WAC).
The exodus, though, was apparently short-lived. In addition to JPMorgan Chase, PNC Financial Services Group (PNC), Regions Financial Corp. (RF) and SunTrust Banks (STI) have all been bidding for mortgage-servicing assets, frequently called mortgage-servicing rights. Aided by borrowing costs that are lower than those of the non-bank servicers, some banks are earning eye-popping returns of more than 20% on MSRs. And the returns are amplified by leverage and complex hedging strategies. But even proponents say the risks are substantial.
JPMorgan Chase declined to comment. The bank still has yet to confirm that it is buying MSRs on $45 billion in mortgages from Ocwen, though the deal has been widely reported and was confirmed to The Deal by a person with knowledge of the transaction. Wells Fargo (WFC), PNC, SunTrust and Regions also declined to comment on their strategy regarding MSRs or MSR hedging.
"I do think it's an attractive asset but I think it's kind of shortsighted to think that it's going to be a 20% yielding asset for the long term," says Bob Koets, a trader at Boca Raton, Fla.-based AVM Solutions who consults with banks on their MSR-hedging strategies.
Most people have never heard of MSRs, but these assets and related hedges are among the most volatile instruments on bank balance sheets. That's because their value shifts constantly with changes in interest rates. The largest banks all hedge this risk, though the hedges can at times be more volatile than the MSRs themselves.
"If you don't have MSR hedging expertise -- and frankly most people don't -- and we get into volatile times, then there's a lot of risk," Koets said. "It's not easy." Asked whether bank losses on MSRs or MSR hedges could represent a systemic threat, Koets replied, "absolutely."
In fact, several institutions, including a set of fairly large and well-known banks, have foundered on MSRs. And some experts believe the business is about to get much more difficult to operate. That's why some big banks are staying out.
Still, just as many are finding the lure of returns irresistible. While many of the banks could withstand a complete collapse of their MSR operations -- thus rendering the systemic risk somewhat remote -- the resulting hit on their stock prices would not be pretty. So it pays to keep an eye on which banks are going in even further.