What is good for Main Street may not be good for Wall Street, at least in the case of mortgage refinancing.
Cendant Corp. announced Wednesday it would take a third-quarter charge of $175 million after taxes, or 17 cents a share, because of a "very unexpected" wave of mortgage refinancings last month, said Richard A. Smith, the chairman of Cendant Real Estate Services.
"We thought this refinancing market would be curtailed earlier in the year," and Cendant estimated the value of its mortgage-servicing portfolio to reflect that, he said. However, the pace of mortgage refinancing remains high, and "the prepayment speeds in our model were not reflecting what was in the market."
Even though the company originated a lot of new loans, it says it will not benefit from them in time to prevent a writedown this quarter.
"With the type of drop we've seen since August, there isn't time to generate new loans to offset that decline," said Terry Edwards, the president of Cendant Mortgage.
Cendant shares dropped 13% Wednesday on the news. By midday Thursday the stock had dropped another 6.22%, to $10.55 a share.
Many analysts thought that Cendant, with its diversified portfolio of travel, lodging, and real estate businesses, had a comfortable buffer against shocks from the mortgage business. Only $2.2 billion, or less than 7%, of its $32.1 billion of assets as of June 30 were mortgage servicing rights. That represents the net present value of the portfolio of loans Cendant services but does not hold.
However, millions of homeowners are refinancing their mortgages at rates as low as 5.5% and pulling out cash for cars, college, and other uses. Their windfall is causing a storm for mortgage companies that were counting on steady revenues from those loans to continue for months. When that future revenue stream falls steeply, as it did for Cendant last month, companies must write down that change in future value against present earnings.
As little as a year ago Cendant estimated that an average borrower would retain a home loan for between five and seven years. Now Mr. Edwards says that estimate has been reduced to "just under four years."
Borrowers who once considered a rate drop of 1 percentage point the threshold for refinancing are now refinancing on dips of as little as 40 basis points, Mr. Edwards said.
To reflect that volatility, Cendant is adopting a new valuation model for its servicing portfolio, but the company is not sharing many details about it. The model will reflect a "higher frequency of refinancing," but it will not include any changes in delinquency rates, because delinquencies have not increased, Mr. Edwards said.
Cendant says it will continue to estimate the impact of interest rate changes on its portfolio every week. These so-called shock tests identify portfolio risk and allow managers to hedge accordingly.
The company will also continue to review its valuation models and portfolio risk in a weekly "hedging review," Mr. Edwards said. "It's not an issue of being asleep at the switch."
Today most home mortgages are bundled and sold as mortgage-backed securities to investors, including Fannie Mae, pension funds, and insurance companies. Lenders continue to collect payments, for a fee of about 0.4%, and pass the balance on to the bondholders.
Falling interest rates have upset that balance.
The Mortgage Bankers Association reported that last year 57% of all mortgage originations were to refinance an existing loan. This refinancing rate exceeded previous highs of 50% in 1998 and 52% in 1993, according to Marina Walsh, a financial analyst with the trade group.
Fees connected with the churn helped the average lender's servicing income per loan last year increase 23.4% from the previous year, to $369, the MBA estimates. Servicing costs per loan rose 8.2%, to $79.
On the surface it appears that mortgage servicing was still profitable last year, but there is more to it than that, Ms. Walsh said. Bankers must subtract the normal amortization of loans and delinquencies, which are rising. They also must write down the future income that they expected from loans that are refinanced and absorb the manpower cost of handling payoffs and selling new loans.
As a result, the MBA estimates that the average lender lost $44 per loan on servicing, compared with a profit of $111 per loan in 2000.
Cendant's portfolio as of June 30 increased 19% from a year earlier, to $2.2 billion. The writedown announced Wednesday is likely to push that figure below $2.2 billion, but the company has not said by how much.
The Parsippany, N.J., company is not the only lender struggling to hedge against a declining mortgage portfolio.
Last year National Australia Bank Ltd. wrote down about $3.6 billion against HomeSide Lending Inc., its U.S. mortgage lending unit. Last month it announced the sale of the rest of the business to Washington Mutual Inc. for $1.3 billion plus assumed debt. Even then NAB took an additional $104 million loss on the sale.
Even community lenders are struggling to manage refinancings. Second Bancorp Inc. of Warren, Ohio, took a second-quarter charge of $900,000, or about 5 cents a share, to write down the value of the mortgage servicing rights on its books.
With more than 50 companies in the mortgage servicing business, it's likely that other writedowns will be announced in the weeks ahead.
