It can still be profitable to be in the mortgage servicing business.
KPMG Peat Marwick focused its 1995 annual mortgage servicing performance study, Morserv, on the characteristics of the more profitable mortgage servicers, and reached that conclusion.
KPMG found that companies with higher profitability were profitable more because of the characteristics of their portfolios than the number of loans in them.
Many times a mortgage company bases who it considers a competitor only on portfolio size - and thus ignores many of its competitors. Also, many servicers do not consider companies who perform servicing activities differently as competitors, yet they compete for servicing in some of the same markets.
KPMG evaluated the return on investment for the more profitable, the average large mortgage servicer, and the average midize mortgage servicer.
On a pretax basis, the return on investment was 19% for the most profitable companies and 11% and 12% for the midsize and larger mortgage servicers respectively.
Clearly, the industry should focus more heavily on what drives overall servicing profitability rather than only on direct cost to service. KPMG identified a class of participants whose profit was better than the average and that were considered top performers based on profitability.
These participants' average profit per loan was $350 in 1995, compared with slightly more than $200 per loan on average for the remaining participants.
One interesting fact to note was that for the larger servicers (also known as industry players), average profitability was only slightly higher than for the smaller servicers. This disproves the industry's mind-set that bigger is always better.
There was not a dominant type of servicer in the more profitable grouping; rather, it was a combination of larger national servicers and midsize niche servicers.
The largest insight gained from the more profitable servicers was that there were several ingredients to becoming profitable and that size plays a different role than many previously thought.
Many companies and analysts believed that direct cost was the only factor to consider in evaluating a servicer's performance. KPMG found that revenues were an equally important source of profitability.
The higher-profit servicers proved that higher revenues had a greater impact on profit than did lower cost. Total cost per loan (which includes indirect costs and foreclosure losses) for the more profitable servicers of $105 was only $10 per loan less than the average.
Net servicing fees and float income were the two largest contributors to increased revenue. Net servicing fees were nearly 5 basis points higher than the average for the more profitable servicers, and this group had $30 per loan more float income than the average participant.
As costs have continued to decline over the past few years, so has their importance to overall profitability. The consolidation of mortgage servicers over the past few years has narrowed the range of direct servicing costs that were acceptable. The industry appeared to be identifying the base cost of the mortgage loan servicing business.
The more profitable servicers identified by KPMG realized some reductions in direct cost per loan compared with 1994. Individually, the range of direct costs for the more profitable companies was within $8 per loan and ranged from $39 to $47 per loan. The overall average direct servicing cost per loan declined from $67 in 1993, to $57 in 1994, to $47 per loan for 1995.
In 1986, KPMG's servicing study concluded that the competitive range of direct servicing cost per loan appeared to be between $70 and $90 per loan.
This year, companies that incur direct costs in what was considered acceptable levels in 1986 are those that should be assessing the strategic issues of whether to get out of the servicing business entirely, subservice the portfolio, or invest in portfolio growth, process changes, and technology to drive the costs down to a competitive level.
Productivity has also dramatically improved over the last 10 years. Only a few years ago, productivity of 1,000 loans per direct full-time equivalent employee was considered an admirable goal. The 1995 average direct productivity of 1,100 loans per full-time equivalent shattered that idea. The best performer and one of most profitable companies surpassed 2,000 loans per direct full-time equivalent.
Although the more profitable servicers' direct cost per loan of $45 was only slightly better than the data base average of $47 per loan, the components of direct costs were different from those of the average servicer. The more profitable servicers tended to incur higher operating expenses than the other participants because of outsourcing. Paying fewer people higher salaries was another strategy used by some of the more profitable companies.
The dual forces of a lower percentage of personnel cost component of direct cost and a higher personnel cost per full-time equivalent led to 20% higher productivity for the more profitable servicers over the average participant.
Companies are now managing the "on-balance-sheet" asset more than they addressed the "off-balance-sheet" asset because of the increased awareness of stockholders, Wall Street, and senior management. The asset is more volatile than many are willing to accept and management could benefit from assessing their tolerance of the impact this asset has on the income statement.
However, without the appropriate data, this analysis cannot be performed accurately and completely. Not only does the accounting impact of servicing rights need to be addressed and managed more closely, but the economic impact of servicing rights should also be closely managed in order to compete in the industry.
In order to manage the asset properly, profitability data such as net servicing fees, float income, ancillary income, and total cost to service should be available to management at the product and, in many cases, the loan level detail.
Mr. Oliver is a partner and co-director and Ms. McDonald is senior manager in the Mortgage and Structured Finance Group at KPMG Peat Marwick in Washington, D.C.