North American Mortgage Co. says it has been selling servicing on some of its new loans for as much as 180 basis points.
To anybody who cut their teeth in the mortgage business when 100 or 125 points was the standard price for portfolios of 30-year fixed loans, 180 points may seem astounding; servicing on a typical loan of $100,000 would fetch $1,800 up front, a pretty good balm for thin profit margins on loan originations.
Thomas J. Healy, a director with Meridian Capital Markets, Fort Lauderdale, Fla., says, however, that servicing valuations have changed significantly in the last year or two and that North American's price is merely at the high end of a very strong market.
"I think 180 points is incredible, but real," he said. "I do know of at least one other case of a seller getting seven times the servicing fees. You have to wonder how much risk is being built into that number." With servicing fees of 25 basis points a year now standard for conventional 30- year fixed-rate loans, a multiple of seven amounts to 175 basis points, or $1,750 on a typical loan.
Mr. Healy added that some megaservicers could afford to pay higher prices for servicing rights because their cost of performing the servicing tasks is so low. And some servicers with excess capacity could also bid high because they incur only marginal costs in adding loans.
Indeed, one executive familiar with servicing deals said that North American, based in Santa Rosa, Calif., was probably selling some of its newly generated servicing to archrival Countrywide Credit Industries, Pasadena, Calif. He said Countrywide, one of the megaservicers, appeared to be the only buyer, or one of the few, offering such high prices.
But Mr. Healy said another secular factor was likely influencing servicing values: a long-term change in prepayment behavior. "The appreciation in real estate values between World War II and the 1980s is behind us, the boomers have all boomed out, and the surge of two-wage- earner families is past," he said.
"If you buy this rationale, you should expect to have fewer loans prepay than in the past. Also, the tremendous pent-up demand has somewhat faded" since the refinancing boom of 1993, Mr. Healy said.
Another source of higher prices, he said, was that buyers are now using measures of value other than a net-present-value formula for cash flows from servicing. "They're looking at return on assets or return on investment instead of internal rate of return," he said. "By these measures, servicing rights look better."
Mr. Healy said this was because servicing rights have little impact on a lender's balance sheet and thus can produce relatively strong returns.
"The very large players, commercial banks, are driven by returns on assets or equity, and they want to see what's going to happen to their return next quarter," he said. "That's a major part of it. So far, banks have not seen the volatility that can accompany a servicing portfolio, since they entered the market when rates were fairly low."
If there were to be a major decline in rates, he said, banks might well change their minds about servicing as writedowns surge. But he emphasized that he was not expecting any significant decline in rates.
Mr. Healy also noted that changes in the accounting rules for servicing rights have made it unnecessary for lenders to sell rights just to recognize their value on the books. With this source of supply reduced, a seller's market has developed.
But if 180 points is at the high end of the current price spectrum for servicing, what is more normal?
Gerry Risi, a Meridian executive vice president, said multiples of 5.5 to 6.5 times the servicing fees were fairly generic. That translates to between $1,375 and $1,625 per $100,000 loan.
Why the wide spread?
"Every buyer has its own magic formula by which it determines value," Mr. Risi said. "If they believe they are strong in cross-selling, they will assign greater value to ancillary income."
Bernadette Kogler, a senior manager in the mortgage practice at KPMG Peat Marwick, Washington, said some acquirers were assuming as much as $100 of ancillary income per loan, largely because of perceived cross-selling opportunities. She said this was in contrast to a more normal $30 per loan of ancillary income.
She also noted that, while costs per loan might be $50 a year, servicers with excess capacity may assume an incremental cost of as little as $10 a year.
Meridian's Mr. Risi noted that all buyers, as a starting point, must use present-value models to value cash flows. This allows them to determine the dollar value today of cash flows that are expected in the future.
"To what degree they tweak the variables, these can vary from buyer to buyer," Mr. Risi said. "Beauty is in the eye of the beholder when it comes to servicing."
Mr. Risi also noted that servicing transactions of modest size were still fairly common among midsize companies and that pricing in these deals was likely to be closer to the low end of the range.
Mr. Risi also said multiples on adjustable-rate servicing were much smaller than on fixed-rate loans, more like two and a half to three times the servicing fee. The difference, he said, reflects a much higher prepayment expectation on ARMs. "Balloon mortgages fall into the same category," he said. "ARMs and balloons tend to get grouped, their pricing tends to get mixed."
