Servicing: All It’s Cracked Up to Be?By Rob Chrisman,
Rob Chrisman's Perspectives
Servicing is a big deal, and how it is handled can make or break a company. STRATMOR offers mortgage lenders a range of options to assist them with their servicing operations, a big help given that servicing costs have risen and the risks inherent to loan servicing became front page news during the recent industry downturn. STRATMOR provides data, insights and consulting to help lenders better understand the costs and the opportunity associated with retaining servicing. Let’s look at some servicing basics and trends in the channel.
Servicing valuations are influenced more by the cost to service than prepayment speeds. Let’s say that again: Cost to service has become more impactful to valuations than prepay speeds! Do the math – if you have a $300K FHA loan, Servicing can be valued around 4:1 – call it 2 points, or $6,000. This is all buried in the net price that the consumer receives through lenders putting it on their rate sheets.
Let’s say that loan is a low FICO with scant reserves. These loans are thought to have a very high propensity to default. When that loan trades in the servicing market, the potential dollar loss that the FHA servicer needs to absorb (due to HUD not having clarity on certain servicing guidelines, and how and when they will pay the costs, versus what the servicer must absorb) can easily eclipse the $6,000 investment.
Loan officers should know that the value of mortgage servicing rights (MSR) changes almost as often as bond prices in the mortgage-backed security market. The MSR value is the sum of a present value of the future income streams from all mortgage servicing related cash flows, and is impacted by assumptions on prepayment speeds, mortgage age and type, and the rate as which these cash flows are discounted. As a result, the value of the MSR for the same pool of loans may vary company by company.
The most significant driver of mortgage servicing rights value is actual and anticipated portfolio prepayment behavior. As interest rates rise, prepayment speeds generally slow, and as interest rates decline, prepayment speeds generally accelerate as borrowers often elect to prepay their mortgage loans by refinancing at lower rates. Because residential mortgage loans typically contain a prepayment option where borrowers can pay off their mortgage prior to scheduled maturity, the stream of cash flows generated from servicing the original mortgage loan is terminated when the loan is paid off.
As such, the market value of mortgage servicing rights is very sensitive to changes in interest rates, and tends to decline as market interest rates decline and increase as interest rates rise. When mortgage loans are paid off or expected to be paid off earlier than originally estimated, the expected future cash flows associated with servicing such loans are reduced. To determine value of MSRs, companies use models that divide the servicing cash flows into the servicing fee, the net cost to service, the float on taxes and insurance, the float on principal and interest, the gain from prepayments, and the loss due to compensating interest, but it can never be an exact science as the market is always moving.
So, who is buying servicing rights on a flow basis? Looking at the top 5 during the first half of 2017, the non-banks dominated the scoreboard: Lakeview Loan Servicing, Matrix Financial Services (part of Two Harbors), Pingora, RoundPoint Mortgage Servicing, and New Residential Mortgage.
Equally important are the sellers of servicing. Banks (Citi jumps to mind) across the nation are electing to reduce or eliminate their mortgage operations, in part due to Basel III concerns. MSR investors, such as PHH and Seneca, are looking to reduce or eliminate their MSR holdings. Independent mortgage bankers are looking to monetize a portion of their servicing assets for cash, and lower the percent of their net worth tied up in the MSR asset.