Servicers See a Silver Lining

2003 was the worst of times and the best of times for the mortgage servicing industry, according to data culled from the MBA's annual cost study.

First, the bad news: servicers lost more money per loan than ever before, due to heavy amortization and impairment costs. The MBA cost study shows that, on average, servicers experienced a net financial loss of $166 per loan in 2003, up sharply from a loss of $100 per loan in 2002.

But, at the same time, servicing managers can take some credit for boosting their operational results. Excluding financial factors such as amortization of servicing rights and gain or loss on servicing values and hedges, servicers actually made money on an operational basis. And they improved their operational margin for at least the fourth year in a row, according to the MBA.

Lenders participating in the cost study reported net servicing income - that's right, income - of $353 per loan in 2003, up modestly from $348 the year before. But the data show direct servicing income has been growing steadily in recent years, so that by 2003 servicers enjoyed net servicing income that was almost 25% higher than it had been in 2000.

Marina Walsh, director of industry analysis in the MBA's research department, said that one reason net servicing income has been rising is that average loan sizes are getting larger. That means the dollar volume of the contractual servicing fee, calculated as a percentage of the loan, is also rising. By segregating out direct net servicing income from net financial income, the MBA is helping lenders understand better the drivers of servicing profitability.

"Direct servicing net income is supposed to represent what servicing managers can control to some extent," Ms. Walsh said.

She told MSN the net financial loss servicers experienced last year was a little bigger than she might have expected, possibly reflecting the number of large lenders that participate in the cost study. But with portfolios churning from refinancing activity, higher-than-expected amortization and impairment costs were inevitable last year.

"It's pretty big, but that's not a surprise," Ms. Walsh said of the net financial loss on servicing. On the origination side of the business, lenders reported cutting loan production substantially in 2003 from the year earlier. But that too reflects market conditions to a large extent, Ms. Walsh said. Heavy lending volume driven by refinancing activity stretched the industry's capacity but also fueled efficiencies related to economies of scale.

As in the previous two years, the MBA said that favorable warehouse interest spreads and secondary marketing gains offset losses from writedowns to the MSR portfolios and amortization costs associated with servicing runoff.

The net cost of originating a single-family mortgage loan fell to $739 in 2003, a 26% decline from just one year earlier. But that improvement might wane if interest rates rise. Still, economies of scale seem to be paying off in loan production as well as in loan servicing. Lenders that originated 50,000 or more loans last year had lower loan production costs than smaller lenders.

Despite the improvement in loan production costs, both loan warehouse income and secondary marketing income declined in 2003 from the 2002.

Ms. Walsh said that the decline in warehouse interest income was small, declining by just $6 per loan last year. She said this might reflect the increasing popularity of 15-year loans, which have lower interest rates than 30-year loans and therefore lower spreads during warehouse financing. Net warehousing income averaged $516 per loan last year.

The decline in secondary marketing income, which fell to $1,528 in 2003 from $1,609 in 2002, probably reflects the impact of rate volatility during the summer of 2003, Ms. Walsh said. "I think a lot of banks were burned in terms of hedging their pipeline. That could have eaten into their secondary marketing income," Ms. Walsh said.

The MBA said that 190 companies participated in the annual cost study and estimates that those firms produced 68% of the industry's total origination volume last year. In 2003, the average participating firm reported pretax financial income of $60.7 million, a new record.

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