Managers of mortgage servicing must understand the detailed financial and operational impact of the new accounting rules.
Reporting on productivity and efficiency - as well as on net income of the mortgage servicing operations - must be adequate to detect problems that can affect economic returns and overall market value.
Management will need to constantly evaluate its servicing asset performance and determine if it is maximizing the value of the underlying cash flows. If a company decides that the risk-reward ratio of retaining servicing is appropriate, actually performing the servicing is not necessarily the solution. Companies may decide to retain servicing rights but explore ways to achieve higher returns by outsourcing or subservicing.
While most companies have wanted to perform their own servicing function, the desire for greater returns could change their minds. Outsourcing may provide companies with ways to retain this lucrative asset and be able to compete in the bidding for servicing assets, especially if their own internal costs are not competitive.
The new financial reporting for servicing rights will not improve a company's ability to retain servicing if the company does not have the capital and liquidity required. The volatility of the balance sheet may also affect an entity's standing with its creditors.
Notwithstanding the capital requirements, companies should still evaluate the economic value of retaining servicing versus the outright sale. Companies need to constantly model this formula to determine how best to maximize shareholder value.
With servicing assets on the balance sheet and the corresponding volatility of earnings, this analysis should be completed as often as the market for servicing rights changes. There is no rule of thumb for the sale or retention of servicing.
New markets are likely to emerge as a result of capital demand to retain servicing. Whether the capital demand is for debt or equity remains to be seen, but new lending sources are emerging. Some form of securitization of servicing rights could develop as a method of raising capital.
The ability of a company to remain versatile, making constant changes to employ new, more efficient processes and managing the volatility of the servicing asset will often also affect the decision to retain or sell servicing and whether to perform or outsource the function.
These issues are not new but are now more evident because the servicing asset is exposed on the balance sheet with a focus on its change in value and financial performance.
The successful servicers of the future will understand the financial aspects of their business better than ever. Companies will use many techniques to manage and maximize profitability, including selling less- profitable or higher-risk segments of the portfolio, hedging interest rate risks, and focusing all operating procedures to ensure that costs are as low as possible.
Mr. Oliver, a partner at KPMG Peat Marwick, is co-director of the company's mortgage and structured finance group. Mr. Fitzsimmons is senior manager of the group.
