Profit Run Might Stall
While the financial performance of servicing rights has been volatile in recent years, the industry's operational profits have continued to rise steadily, according to an analysis by the Mortgage Bankers Association. In fact, servicers have been posting annual gains in operational profit per loan dating back at least six years, with the strongest annual increase coming in 2005.
Those gains have been driven by rising loan balances, which boost servicing revenue, and strong credit performance, which helps keep costs in line. But with home price growth slowing and delinquencies rising, one of the MBA's top researchers says that growth in servicing profitability could slow once 2006 numbers are compiled.
Marina Walsh, director of industry analysis in the research and business development department of the Mortgage Bankers Association, said that hedging of mortgage servicing rights also proved challenging amid the flat yield curve environment last year, a condition that has persisted into 2007.
"No one's hedges seem to be working based on our preliminary data for 2006," she told MSN.
She said that servicing fees will likely come in flat for 2006, while the direct cost of servicing per loan may increase, putting some pressure on operational profitability.
In addition, an increase in delinquencies may mean that servicers have to incur additional interest expense related to advances they make to MBS investors. That additional interest expense could also crimp profitability, depending upon the relationship between a servicer and its investors.
"It will affect direct expense and it will also affect the MBS interest expense."
In recent years, the MBA has also started comparing the performance of predominantly subprime mortgage servicers and prime servicers.
One trend that has emerged is prime servicers may be able to learn something from their subprime peers as defaults increase. Traditionally, subprime lenders have posted direct costs that are three times as high as the cost of servicing a prime loan. But when it comes to default management, the gap shrinks.
"Subprime servicers are good at servicing defaulted loans," Ms. Walsh noted. "If you see delinquencies rising on the prime side, you are going to have to see operationally how servicers are going to handle that."
One strategy may be for prime servicers to rely more heavily on "special servicers" to take over the management of prime loans that go sour.
In 2005, the most recent year for which data were available, servicers posted an average operational profit of $476 per loan for prime credit product, according to the MBA's servicing operations study.
The study also found that subprime servicers' fully loaded expenses were about $725 per loan, or three times the average by the industry's largest prime servicers.
That was the highest in the history of the MBA study, formerly known as the servicing cost study.
The MBA found that servicers are capitalizing on increased efficiency in their operations. The number of loans serviced per employee in prime credit shops rose to 1,455 in 2005, up from 1,188 just a year earlier. The direct annual expense associated with servicing each prime quality loan fell to a record low of $69 in 2005, down from $80 a year earlier. Indirect costs, such as corporate allocations, interest expense on servicing assets, bank charges and MBS interest expense, also declined in 2005.
On average, lenders saw loan balances rise 10% last year, helping to boost servicing fee income and escrow interest earnings. Average per-loan servicing fees totaled $472 in 2005, up 21% from a year earlier. Net escrow earnings from custodial accounts rose 39% to $115 per loan in 2005.
Servicers also benefited from slower portfolio churning as the refinancing wave from 2003 and 2004 diminished.
The steady growth in operational profits contrasts with a mixed up and down picture when you look at financial profits from servicing, which are determined largely by the market price of the asset. Low interest rates have sparked refinancing, which reduced servicing values in recent years.
Ancillary fees totaled about $50 per loan serviced in 2005, reflecting lower charges for statements, payoff quotes and other borrower-requested items than were prevalent during the heavy refinancing years.
Not surprisingly, perhaps, subprime servicers collected three times the amount of late fees per loan as prime servicers.
Snapshot: Operational Profit Per Loan
Note: Data are for prime loans. (c) 2007 Mortgage Servicing News and SourceMedia, Inc. All Rights Reserved. http://www.mortgageservicingnews.com http://www.sourcemedia.com