WE’RE HEARING…that an old joke that used to get passed around at mortgage conference cocktail receptions might not be as funny today as it was back then.
The joke was this; “We lose money on every loan we originate, but we make it up in volume.”
The backstory was that while indeed lenders often produced loans at a loss, they earned a profit on the back end when they aggregated pools of loans for sale the secondary market. “Servicing release premiums” were a key aspect of those back-end profits. The mega-servicers had an appetite for economies of scale, and they were bidding high for the servicing asset. That was before the industry boom turned into a bust, of course.
If you’re trying to rely on servicing to turn a profit today, you’re probably having a difficult time staying in the black. Gone are the days when the big boys paid generously to feed their giant and highly profitable servicing machines. And despite falling delinquency rates and stabilizing home prices, a confluence of factors are continuing to make it difficult to squeeze a profit out of servicing operations, Mortgage Bankers Association associate vice president Marina Walsh told me. She spent a couple of days last week in meetings with some of the industry’s top servicing executives, and she heard a lot about how challenging it is to make a buck in today’s environment.
Last year, the largest mortgage servicers reported net losses from their servicing activities. The culprit? Declining productivity. Under the gun from regulators, attorneys and bad press, servicers have had to throw bodies into their servicing centers in order to comply with new rules and procedures, leaving them unable to service as many loans per employee as they did in the past. Consent orders, changes to investor guidelines and a settlement with attorneys general across the country also have added to the burden. There have been fundamental changes in what is expected of a servicer, Walsh said. The CFPB’s requirement that servicers provide borrowers with a single point of contact is just one example of how the business has changed.
Today, lenders are typically reporting servicing direct expenses of $300 per loan, much of the increase reflects higher costs associated with managing loans in default.
“In the old days, that could have been as low as $70,” Walsh said. “The direct cost of servicing has been rising for five years.”
Overall, she estimated that lenders are servicing about 700 loans per employee today, about half of what they could achieve five years earlier.
Because mortgage servicing is a for-profit enterprise, lenders cannot allow the hemorrhaging to go on forever, she said.
Already, some servicers are trying to find ways to “operationalize” some of the new activities, relying on technology to improve productivity. What servicing executives are seeking is a sustainable model for doing business that doesn’t involve throwing bodies at every compliance challenge to bandage each new crisis.
“They are going to have to find ways to be more efficient under the current regulatory requirements. That’s the rub and they all know it.”
She is also hopeful that regulators will provide the industry with more guidance on how they can achieve compliance without breaking the bank. She said the CFPB may propose new servicing rules as early as June that could help servicers sort out the new environment.
“There needs to be some stability and clarity in terms of all the rules coming out.”
Loans being originated today under new underwriting guidelines are considered to be far less risky than loans originated during the boom years, when subprime lending was a big part of the market. But those underwriting improvements aren’t translating into lower servicing costs—at least not yet. Some of mega-servicers still have foreclosure moratoriums in place as they struggle to ensure they are complying the new regulatory regime.
“These big guys are still trying to work through their legacy portfolios. They still have a ways to go in terms of managing that legacy portfolio.”
Some big servicers have been selling off pieces of their legacy portfolio, in part because of Basel III capital requirements. But the MSR sales also allow them to focus their resources on the “more pristine” book of business being originated today.
The silver lining in all of this? Lenders are reporting strong loan production profits today. The MBA’s quarterly Mortgage Performance Report, which focuses on the activities of small- and medium-sized independent mortgage companies, found that companies included in the report total net loan production income of $2,256 per loan on average, a figure that includes secondary marketing income income. However, lenders also reported higher loan origination production costs in the fourth quarter of last year.
Walsh said the servicing numbers in the quarterly performance reports are not indicative of the market as a whole, because none of the mega-servicers are included. She estimated that firms included in the performance report account for about 5% of servicing volume outstanding, although an increasing number of mortgage companies have started retaining servicing rights, often outsourcing operations to a subservicer. Many likely anticipate that there will be a better time to sell servicing rights in the future.
Ted Cornwell has covered the mortgage markets since 1990. He is a former editor of both Mortgage Servicing News and Mortgage Technology.