Automation Helps Mitigate Mortgage Servicing Rights' Risk
Increased regulatory scrutiny in recent years has included a greater focus on how mortgage-related assets such as servicing rights are recorded on the books, a risk some are mitigating by finding ways to ensure their values are substantiated.
Larger servicers have had to be careful to incorporate factors such as delinquency rates if assets are distressed, for example, said Loren Morris, SVP/general counsel and chief compliance officer at Retreat Capital Management, an industry advisory firm and services provider who has clients in this space.
But while larger players may have models they can use to do this, those models may require some relatively significant investment and may be complex, and smaller players may find accessing these to be more of a challenge, said Thomas J. Healy, president of new joint venture financial modeling software provider Level1 Analytics, which recently released automation aimed at addressing this concern.
“I think the models that already exist tend to be expensive and complicated to use, and many of the companies I talk to are somewhat frustrated that they can’t get reliable defensible accurate models,” he said.
There have been alternatives used to value servicing rights, some more viable than others, but they have not been ideal, Healy said.
“One of the people we are talking to right now [is] using Excel spreadsheets, which the regulators do not like. It’s not validated. It’s not controlled,” he said. “The audit controls as far as who is changing assumptions aren’t there.”
Another alternative has been to obtain valuations as a service, something Healy said his company has been doing. “But in talking to our clients, they want more and more a model they can use in-house” with built-in audit controls, he said.
The need for this has surfaced relatively recently for these players relative to their larger counterparts because the regulatory scrutiny.
“It’s only been in the last couple of years that the regulators have become more demanding about who has to do mark-to-market valuations,” Healy said. “That’s been migrating down the food chain to the smaller servicers.”
He said, “Another thing is…there is a growing interest in retaining more servicing. Some of the servicing values are…at an all-time low” which is attractive to those who view the economic value of servicing as greater than the market value.
Healy said there has been some use of modeling not only as an evaluation tool but as a management tool to “start to select which loans in the pipeline you want to retain versus release.”
He said the company also has in the works a loan valuation tool currently set for release in the first quarter of next year.
The servicing rights tool is available for a monthly licensing fee with a two-year additional agreement and fees depend on using entity’s size. It is cloud-based, operable from iPads and other portable computers, and allows certain privileges/levels of access, Healy said. 1st Source Bank, South Bend, Ind., was the only beta tester of the product but since its recent release there have been “a few other users” and a lot of interest, he said.
The model evaluates a portfolio in four steps.
It starts with the uploading of data to a secure site, followed by an application of definitions through a “translator” that can be based on the client’s definitions or Level 1’s, the latter of which Healy said some prefer because they are “defensible.”
Then the servicing rights model is used to value the portfolio using prepayment tables that Level1 updates twice monthly, followed by a download of the reports in whatever format the user prefers, he said.
Healy said the loan valuation model the company plans on releasing will access a proprietary database of daily rate sheets from a variety of sources in an effort to value loans in a portfolio based on comparable loans being priced in the market, “so you don’t have to argue about prepayment speeds and yield curves because we know [what a lender will pay] for this loan today.” If there is not a comparable mortgage, the loan is run through a cash-flow model.