Fourth Quarter a Mixed One for Servicing Values
The fourth quarter of 2007 demonstrated once again how volatile the value of mortgage servicing rights can be, even in a period when interest rates were only nominally lower than at the beginning of the quarter.
The 55 basis point drop in the 10-year U.S. Treasury yield during the fourth quarter was nothing to sneeze at, but it wasn't the biggest drop in rates that MSR managers have faced in recent years either.
The largest mortgage servicers in the industry seemed to manage the challenge pretty well.
Countrywide Financial wrote down its MSR valuation by $1.6 billion, though much of the damage reflected lower values for its residual interest in securitized loans. However, the MSR writedown was more than offset by Countrywide's $1.98 billion in hedging gains, as analysts at Friedman Billings Ramsey pointed out in a recent report on the company. As a result, Countrywide reported a net gain of $365 million from MSR valuation changes.
Still, Countrywide's MSRs remain arguably the company's most valuable asset in today's mortgage lending environment. The company valued its MSR portfolio at nearly $19 billion as of Dec. 31, with an estimated equity base of $3.5 billion. The capitalization rate on Countrywide's servicing portfolio was 1.4% of the outstanding balance of the loans, down from a third quarter capitalization rate of 1.51%, Countrywide said.
According to FBR, that accounts for the lion's share of Bank of America's $7 per share offer for Countrywide Financial Corp. In FBR's analysis, the MSR asset accounts for most of the $4 billion offer price, with about $500 million accounting for the rest of the company in the Bank of America offer.
Servicing fees are still a big revenue generator for Countrywide, which posted $1.66 billion in servicing fee revenue during the fourth quarter. That was down slightly from the third quarter, but still represented valuable cash flow at a time when the origination side of the business is struggling. Countrywide's MSR portfolio consisted of $1.46 trillion in home loans at the end of last year.
One unintended benefit of the credit tightening that has occurred on the origination side of the business is that homeowners have fewer refinancing options than they did a couple of years ago, which in many cases has slowed down prepayment rates. Wells Fargo, which has been neck and neck with Countrywide in the race to accumulate the nation's largest mortgage servicing portfolio, also posted respectable servicing results. Wells Fargo serviced $1.53 trillion in owned mortgage servicing rights at the end of last year, up 12% from one year earlier. Growth in the mortgage servicing portfolio helped Wells Fargo post a 73% year-over-year increase in net servicing fee income, more than offsetting the company's decline in net gains on mortgage origination and sales activities. Wells Fargo, like Countrywide, benefited from hedging "outperformance" pertaining to its servicing portfolio.
Wells reduced its MSR valuation by $1.9 billion, citing a more than 40 basis point decline in 30-year mortgage rates during the quarter. But the company also noted that hedging gains of $2.2 billion offset that write down.
Wells valued its servicing portfolio more conservatively than Countrywide, using a capitalization rate of 1.2%. That was 15 basis points lower than the third quarter capitalization rate and marked the lowest capitalization rate in 10 quarters.
The scene was similar at Washington Mutual, which posted a $128 million gain from changes in MSR valuation and risk management. That reflected a $390 million reduction in the MSR value offset by a $518 million hedging gain in the fourth quarter.
Snapshot: MSR Capitalization Rates at 12/31
Wells Fargo 1.20%
Source: company financial statement. (c) 2008 Mortgage Servicing News and SourceMedia, Inc. All Rights Reserved. http://www.mortgageservicingnews.com/ http://www.sourcemedia.com/