Washington's shadow looms as the servicing business is eyed with more intense scrutiny.
As the 101st Congress moves into the homestretch before lawmakers go home to campaign and the action gets hot and heavy on the serious business remaining, servicing is getting caught in the crossfire. In the current budgetary environment, every tax cut or spending increase must be paid for with money taken from someone else's tax preferences or spending programs. Such an environment encourages lawmakers to leave no substantial revenue rock unturned or no industry underinvestigated as a potential bankroller for a package of tax cuts or spending hikes.
For a long time, the mortgage servicing business was a virtually invisible industry to federal lawmakers and regulators, and thus it enjoyed a hiatus of sorts from intrusive legislation and rulemaking that made a direct assault on the profitability of the business. But not so anymore.
And while there are good aspects about the fact that lawmakers and regulators are learning more about the servicing business--which raises the odds it won't get seriously damaged unintentionally and that its importance to housing is likely to be better understood--there are some bad aspects to this as well.
In the current session, both a major tax bill (H. R. 4210) that was stopped short of enactment only by a presidential veto, and a bill (H.R. 3542) introduced by the powerful chairman of the House Banking, Finance and Urban Affairs Committee requiring interest payments on all escrows, would significantly erode the value of servicing if they were to become law. The tax bill provision, championed by the influential chairman of the House's tax writing committee, would have doubled the amortization period for servicing--thus seriously reducing valuable depreciation benefits, while the escrow bill would require 5.25 percent interest to be paid on all escrow accounts retroactively. So, servicing has clearly come in for some scary close calls in this session of Congress, and it's not over yet.
Furthermore, it's not just the Congress that has been the scene of potentially negative developments for servicing. Regulatory actions originating out of Washington, D.C. during the past year or so also have had a significant impact on the servicing market and on the active players still buying servicing.
To look further into these developments, Mortgage Banking approached some professionals whose job it is to value and sell servicing every day to see how these machinations in the nation's capital have affected the buying and selling of servicing. In a three-way interview, we spoke with key members of the servicing consulting and brokerage firm of Cohane Rafferty Securities, Inc., in Harrison, New York, to get an industry reading on what's taking place in Washington. We spoke with Thomas J. Murray, managing director with Cohane Rafferty, based in Englewood, Colorado, Elizabeth Workman, executive vice president and head of the analytics area of Cohane Rafferty, where she has overseen the development of the complex models used to estimate the value of servicing portfolios, and Bill Curley, executive vice president of sales and trading.
We asked all three for their thoughts on some of the critical federal government developments that have cast a cloud over the servicing market in recent times.
MB: Some legislative proposals introduced in the current session of Congress would have a major impact on the value of servicing if enacted. The one that comes to mind first is the Escrow Account Reform Act of 1991 introduced by House Banking Committee Chairman Henry Gonzales (D-TX). The provision that people in the servicing business seem most concerned about is the one requiring interest on all escrow accounts--both existing and new--at 5.25 percent. Could you describe the impact on servicing values if such a provision were to be enacted?
Workman: It will adversely affect the value of any servicing that has escrow balances and where, currently, the servicer is not required to pay 5.25 percent interest in those balances. But the precise impact will vary according to the facts and circumstances of the particular institution and the nature of its portfolio. We've done quite a lot of sensitivity analysis regarding the impact of this legislative proposal on servicing values. As an example, I looked at a sample portfolio of Fannie Mae [mortgage-backed security] MBS loans in the state of Minnesota.
In the case of conventional loans, currently in Minnesota, the payment of interest on escrow balances is not required if the escrow is maintained in connection with a loan for which the original principal balance exceeded 80 percent of the lender's appraised value at the time loan was made. Otherwise, a rate of not less than 5 percent per year must be paid. So, for conventional Minnesota loans you might or might not be already paying interest on escrow deposits.
Given a hypothetical 30-year, fixed-rate, current note rate, Fannie Mae MBS portfolio of Minnesota loans for which no interest is now being paid on escrow deposits, the basis-point impact on value was about 37 basis points, or 24 percent of the value. Of course, we used specific prepayment, float earnings rate, discount rate and other assumptions in this analysis. The value impact I just cited is very specific to the analysis we performed.
The general point I would make is that the impact can be quite large, but it will vary according to the level of average escrow balances associated with a given servicing portfolio and whether the servicer is currently required to pay interest on escrow deposits, and, if so, at what level. For instance, in the example I just mentioned, we assumed a starting average escrow balance of 1 percent. If the average escrow balance was .75 percent instead, the value impact of going from no interest paid on escrow balances to 5.25 percent was 28 basis points, or 19 percent.
Murray: What you're also saying is that if you were in a state such as California, where [the required interest on escrow accounts is] already 2 percent, that the marginal impact is less.
Workman: That's right. Using my...