WE’RE HEARING that after some rough sledding the last few years, mortgage servicing is once again contributing to the profitability of the nation’s biggest lenders.
Just to recap the obvious, servicers were hit with a double whammy in the wake of the housing crisis. Default rates skyrocketed. Operational costs swelled as well as lenders struggled with new regulations and litigation risk alongside higher loss mitigation expenses.
To add insult to injury, the value of the servicing asset plummeted under the weight not only of these operational challenges, but also from falling interest rates, which sped up portfolio runoff.
Fast forward to the second quarter of 2013. Delinquencies and loss reserves are trending down. Operational costs are improving. And rising rates allowed lenders to adjust the value of the servicing asset significantly upward.
Mike Loughlin, chief risk officer at Wells Fargo, put it this way in the company’s second-quarter earnings report.
“The consumer loss levels have improved rapidly due primarily to the positive momentum in the residential real estate market, with home prices improving faster and in more markets than expected.”
But rising rates really helped boost the value of servicing rights in the second quarter. Keefe, Bruyette & Woods said in a research report that MSR valuations increased by an average of 22% from the first quarter among the companies KBW covers.
KBW analyst Bose George told me that the second quarter proved to be better than expected for mortgage firms.
“I’d say that across the board, they outperformed expectations.”
The biggest surprise in the mortgage space, he said, was that even as refinancing volume began to taper off, originators were able to reprice their product pretty well and maintain stronger-than-expected profit margins. Still, rising rates and the shift to a home purchase dominated market will put pressure on margins going forward. Lenders will face tough competition as origination volume shrinks.
“Profitability will be weaker in the back half of the year,” George said. “The positive side is that hopefully the purchase market keeps improving.”
George said that improving credit quality and lower loss provisions are clearly a positive for firms that hold mortgage credit risk, including not only banks but also mortgage insurance firms.
“Their situation has turned around pretty dramatically over the last six to nine months,” George said of the MI firms.
The KBW report reveals a significant disparity in the valuation of the servicing portfolios of the largest lenders. Wells valued its MSR portfolio at 3.0 times the average servicing fee, JPMorgan Chase’s multiple was 2.7 and Bank of America’s multiple was 2.4. Those valuation metrics are up considerably. For Wells Fargo, the improvement in MSR values yielded a $1.2 billion boost to its balance sheet in the second quarter.
While servicing costs remained “elevated,” KBW noted that several of the top lenders reported that operational costs have come down—not surprising, given that the biggest servicers have announced
The big three also benefited from lower repurchase reserves and lower loss provisions in the second quarter.
At Wells Fargo, the nonperforming rate on its one-to-four family mortgage loans fell to 4.23% from 4.49% in the first quarter.
Bank of America said it exceeded its own expectations in reining in operational costs.
“We reduced expenses related to servicing delinquent mortgage loans at a faster rate than we originally expected,” CFO Bruce Thompson said in the company’s earnings release.
Bank of America’s “legacy assets and servicing” division employed 37,900 employees, including contractors, in the second quarter, down from 58,100 a year earlier.
The number of Bank of America’s 60-day overdue home loans peaked at 1.4 million in 2010. Now, that is down to 492,000 loans. The company said it expects that number to drop to 375,000 or less by the end of the year. Bank of America has been trimming the size of its MSR portfolio through the sale of servicing rights.
Bank of America’s said its legacy asset and servicing expense, excluding litigation costs, was $2.3 billion in the second quarter. The company expects that to fall below $2 billion by the fourth quarter.
JPMorgan Chase also saw significant improvement in loan performance. In the company’s earnings release, CEO Jamie Dimon said that real estate charge-offs in the second quarter were half what they were a year earlier.
JPMorgan Chase said that pretax income from mortgage servicing totaled $133 million, an increase of $68 million from the first quarter. The company said its servicing expense in the second quarter was $238 million lower than it had been a year earlier.
A lower headcount and lower expense related to the Independent Foreclosure Review were responsible for the decline in servicing costs.
Overall, the company estimated its return on equity from mortgage banking activities was 23%.
Ted Cornwell has covered the mortgage markets since 1990. He is a former editor of both Mortgage Servicing News and Mortgage Technology.
