Cut the Servicing Fee

Big lenders have been lobbying for a long time to reduce the minimum servicing fee on conforming loans, and we believe the time is right to take that step. Traditionally, the government-sponsored enterprises required a 25 basis point minimum fee, in large part to ensure that if servicing had to be transferred to another lender, a sufficient cash flow would be available to support loan administration, collections and default management.

But as mega-servicers have gotten bigger and technology has made servicing more efficient, many lenders have complained that the current requirement exceeds the cost of servicing loans. And it has a side effect that has come back to haunt lenders: the servicing strip on their balance sheets, which behaves much like an interest-only security, significantly increases the volatility of their quarterly earnings reports.

That's because mortgage servicing rights have become a huge asset for some lenders. Just look at the balance sheet of Wells Fargo, which owned $7.9 billion of MSRs as of Dec. 31. Because MSRs fluctuate in value dramatically with interest rate changes, falling more rapidly as rates decline than rising when rates rise, the cost of hedging is a significant one for lenders. And the impact of hedging weakness can dramatically diminish a mortgage company's earnings power, even if its operational strength remains intact.

Volatility is out with corporate parents and with investors. Companies find that Wall Street and investors reward steady, predictable growth rather than big ups and downs. For that reason, many lenders are eager to wring out some of the volatility associated with holding a big MSR asset on their books.

Reportedly, Fannie Mae and Freddie Mac are giving serious consideration to reducing the minimum servicing fee, which would have the effect of shrinking the MSR valuation on the balance sheets of big lenders. After three years of big impairment hits related to MSR valuations, many lenders are understandably eager to see this change take effect for new loans.

We'll leave it to the experts to determine exactly how low the servicing fee should go. But we applaud the willingness of the government-sponsored enterprises to consider making this change.

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