Citi's Focus on New Mortgages Spurs $982 Million Sale of Servicing Rights

Citigroup,  (C)  which agreed Monday to sell servicing rights on about 780,000 home loans, will use the resulting capital to expand in new mortgages, a business where CEO Michael Corbat sees potentially higher returns.

New Residential Mortgage (NRZ) will pay Citi about $982 million for rights to service the loans, which are backed by Fannie Mae (FNMA) and Freddie Mac (FMCC)  and have outstanding balances totaling $97 billion. The New York-based banking giant said it's exiting the servicing industry altogether by 2018, a move that comes amid a pullback by many of its peers.

Indeed, Citi, Bank of America (BAC) , HSBC (HSBC) , JPMorgan Chase (JPM) , PNC  (PNC) , U.S. Bank  (USB) , and Wells Fargo  (WFC) serviced just 36% of all U.S. residential mortgages --  with a total of about $3.5 trillion in unpaid principal balances -- in the third quarter of last year. That compares with 60% just before the September 2008 financial crisis, according to data from the Office of the Comptroller of the Currency and the former Office of Thrift Supervision.

While Citi could have gained a competitive edge by increasing its scale in mortgage servicing, the bank's strategy has been to funnel resources into businesses with the biggest growth opportunities, said bank spokesman Mark Rodgers. Servicing involves collecting monthly payments, insurance premiums and taxes on behalf of another mortgage-lender rather than extending credit. 

"Servicing loans of non-core Citibank clients was not a strategic path to future business growth," Rodgers said in an e-mailed statement. "We see opportunity to capture greater value by focusing resources on originating loans to deepen relationships with current and new clients."

Richard Bove, a Rafferty Capital Markets analyst with a buy rating on the stock, isn't so sure.

The sale is likely a "big mistake," he said, noting that Citi continues to exit profitable operations such as insurance, asset management, brokerage, and consumer finance. 

Financial institutions generally originate, service, sell or hold mortgage loans, Bove added in a phone interview, and the one that "always loses money is originating the loans because basically, there are all costs there and no benefits, no revenues."

The reason banks like lending to new home buyers, though, is that it lets them form or further relationships with customers who will then buy other products, Bove said.

"It's a bait-and-switch product now, as opposed to a product which is utilized solely for its profits," Bove said. "It's still the best way to grab a customer and then cross-sell them products."

While the shift by larger financial institutions away from servicing creates an opportunity for companies like Ocwen (OCN) , Walter Investment (WAC) , Nationstar (NSM) , and PHH (PHH) , it's one that comes with risk.

Last week, Citi agreed to pay $28.8 million to settle claims by the Consumer Financial Protection Bureau that its mortgage-servicing subsidiaries, CitiFinancial Servicing and CitiMortgage, failed to provide borrowers with proper options for foreclosure relief and misled them about how deferred payments work.

"Citi's subsidiaries gave the runaround to borrowers who were already struggling with their mortgage payments and trying to save their homes," said bureau director Richard Cordray said in a statement. 

The serving-rights transaction is expected to close by June, pending regulatory approvals, but Citigroup won't fully exit the mortgages servicing business until 2018, when it transfers the last pieces to Cenlar, a loan service provider. 

The sale will curb pre-tax earnings by $400 million in the three months through March, though executives say it will reduce expenses in the future.

Citigroup dropped 0.9% to $56.61 on Monday, driving its year-to-date loss to 4.75%. New Residential Investment fell 3.7% to $15.66. Both companies are based in New York.

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