The evolving market for servicing rights: a review of the many factors shaping the value and demand for mortgage servicing rights.

Author:Levine, Jeffrey. M.
Position:Servicing
 
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Twenty-five years ago, when I started out in the mortgage banking industry, the consensus was that mortgage servicing rights (MSRs) were always worth a point (that is, 100 basis points). In other words, a portfolio of $1 billion of Fannie Mae, Freddie Mac or Ginnie Mae servicing was worth $10 million. Ironically, while peaking at values as high as 175 basis points in the mid-2000s, MSRs are now trading back to the 1985 levels I referred to above. (Figure 1 shows historical values of MSRs over time.) * Before I delve into the reasons for this, I think a primer would be helpful. What are MSRs? Are they an asset or a liability? * Simply put, MSRs represent the net present value (NPV) of the cash flows associated with a servicer's obligation (the liability) to service mortgage loans for the underlying investor. These include the right to earn service fees, ancillary fees and float income on custodial funds and borrower escrows (the asset). Add to this the nuance that repurchase exposure to government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac travels with ownership of the MSRs, as well as obligations to fund servicing advances on delinquent loans--a major issue today--and the distinction between whether or not MSRs are an asset or a liability, or both, becomes very murky. * Servicing rights are quoted in the market as both a percentage of the unpaid principal balance (UPB) of the underlying mortgage loans and as a multiple to the weighted-average service fee (net of guaranty fees) to which the servicer is entitled to earn on the pool. In Figure 2, assuming a 25 basis point net servicing fee, a pool of MSRs worth 100 basis points would be valued at a 4.0x multiple.

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Figure 2 MSR Cash Flow Summary Year Beginning Service Fees Ancillary Fees Total Income Principal and Float 1 $1,000,000,000 $2,384,216 $382,379 $2,766,595 2 $901,982,063 $2,079,455 $368,383 $2,447,838 3 $773,761,846 $1,778,846 $321,383 $2,100,229 4 $661,445,358 $1,519,635 $279,597 $1,799,232 5 $564,740,580 $1,297,380 $243,377 $1,540,757 6-30 $0 $7,094,703 $1,647,490 $8,742,193 Total $16,154,235 $3,242,609 $19,396,844 Original UPB $1,000,000,000 NPV Cash $10,011,904 Flows NPV 1.00% (% UPB) NPV 4.0 Multiple * Year Beginning Principal Expense Pre-Tax Net Present Value Income 1 $1,000,000,000 $420,266 $2,346,329 $2,224,822 2 $901,982,063 $366,996 $2,080,842 $1,787,724 3 $773,761,846 $325,191 $1,775,038 $1,380,488 4 $661,445,358 $287,645 $1,511,587 $1,064,171 5 $564,740,580 $251,298 $1,289,459 $821,722 6-30 $0 $1,855,037 $6,887,156 $2,732,976 Total $3,506,434 $15,890,411 $10,011,904 Key Assumptions 0.25% Annual Service Fee 200 Prepayment Speed (PSA) $75 Cost to Service 10.00% Pre-Tax Discount Rate * Multiple of annual service fee SOURCE: MILESTONE ADVISORS The multiple is a net present value calculation, taking into account scheduled amortization on the underlying mortgages, as well as unscheduled prepayments (typically from refinances), discounted at a required rate of return or yield. Unlevered yields for prime GSE MSRs have typically ranged from high single-digits to low double-digits, or 8 percent to 12 percent, with the higher yields associated with Ginnie Mae or other less liquid, smaller blocks of MSRs, and haven't changed much over time.

Banks have been the most optimal owners of prime MSRs. This is due to their ability to leverage the investment with deposits and other liabilities, as well as maximize the value of MSRs associated with hedging the asset, holding the custodial funds and cross-selling other financial products to the underlying borrowers.

Consolidation in the MSR sector has been significant as economies of scale--not to mention liquidity and capital to fund the asset--have allowed banks to be the dominant owners of this asset.

In fact, the top five servicers (80 percent bank-owned) now control more than 65 percent of the MSR market (see Figure 3), servicing collectively $6.43 trillion in mortgage debt as of March 31, 2010. This is up significantly from 1995, when the top five servicers only controlled 15 percent of the market.

Figure 3 Top Servicers--Third Quarter 1995 vs. First Quarter 2010 ($ millions) 1995 Rank Company 3Q95 Volume Market Share 1 Countrywide Funding Corp. $127,580 3.60% 2 GE Capital Mortgage Services $113,900 3.30% 3 Fleet Mortgage Group $100,900 2.90% 4 Norwest Mortgage Inc. $100,110 2.90% 5 Prudential Home Mortgage Co. $80,300 2.30% 6 NationsBanc and affiliates $77,580 2.20% 7 Chase Manhattan Mtg. Holdings $74,220 2.10% 8 Bank of America $62,310 1.80% 9 GMAC Mortgage Co. $58,940 1.70% 10 Chemical Bank and affiliates $52,820 1.50% 11 Home Savings of America FSB $49,500 1.40% 12 Mellon Mortgage Co. $45,700 1.30% 13 Great Western Bank FSB $43,020 1.20% 14 Citicorp Mortgage and affiliates $40,900 1.20% 15 BancBoston Mortgage Corp. $39,650 1.10% 16 PNC Mortgage Co. $37,550 1.10% 17 First Union Mortgage Co. $37,270 1.10% 18 Barnett Mortgage Co. $32,970 0.90% 19 Source One Mtg. Services Corp. $28,560 0.80% 20 Wells Fargo Bank, National City $24,530 0.70% Total $1,228,310 35.10% 2010 Rank Company 1Q10 Volume Market Share 1 Bank of America $2,151,451 21.83% 2 Wells Fargo & Co. $1,797,759 18.24% 3 Chase $1,376,310 13.96% 4 CitiMortgage Inc. $699,782 7.10% 5 Residential Capital LLC (GMAC) $406,902 4.13% 6 U.S. Bank Home Mortgage $191,846 1.95% 7 SunTrust Mortgage Inc. $176,108 1.79% 8 PNC Mortgage/National City $154,099 1.56% 9 PHH Mortgage $153,060 1.55% 10 OneWest Financial $115,000 1.17% 11 MetLife Home Loans $109,181 1.11% 12 Aurora Loan Services Inc. $91,455 0.93% 13 American Home Mtg. Srvg. Inc. $90,224 0.92% 14 Branch Banking & Trust Co. $89,339 0.91% 15 Cenlar FSB $85,000 0.86% 16 Dovenmuehle Mortgage $75,500 0.77% 17 HSBC Mortgage...

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