Consolidation of mortgage servicing is likely to accelerate this year, one of the nation's leading mortgage investment bankers said.
Elizabeth K. Workman, managing director of Harrison, N.Y.-based Cohane Rafferty Securities Inc., said that if interest rates creep up throughout the year, as many economists are predicting, demand for servicing rights will increase. This demand should in turn lead to higher prices.
Ms. Workman, addressing the Mortgage Bankers Association's national mortgage servicing conference last week, said the average amount of servicing rights being sold in each package has increased in the last few years as well, a trend that could benefit larger servicers. She said the larger servicers have been purchasing portfolios mostly in excess of $5 billion.
As the year progresses, it is likely that more small and midsize servicers will be looking to sell assets as a way of dealing with the relatively new concept of actively managing interest rate risks. Ms. Workman said.
These risks have come to the forefront because of FAS 122, an accounting rule established by the Financial Accounting Standards Board in 1995 that changed the way mortgage servicing rights are capitalized.
Jeffrey L. Briggs, loan portfolio manager of Wendover Funding Inc., said that the accounting change was the most significant event in the mortgage banking industry since the advent of mortgage-backed securities in the 1970s.
Before FAS 122, lenders had to include only purchased servicing rights on their balance sheet. Now servicers must capitalize originated servicing rights as well as purchased servicing. FAS 122 was implemented by some mortgage bankers in 1995, but most did not do so until last year.
This year, lenders have to deal with another accounting change, FAS 125, which requires that excess servicing rights be capitalized as well.
Mr. Briggs said that since the amount of servicing exposed to prepayment risk has increased, mortgage banks that want to retain their servicing must adopt hedging strategies-buying financial instruments that should increase in value when interest rates decrease.
But he pointed out that such hedges are costly and are not a foolproof way of offsetting losses that occur when rates decline and servicing runoff increases.
"The perfect hedge for prepayment risk is you sell your servicing," he said, as members of the audience chuckled. "That's not a very attractive option for most servicing people," he continued.
Still, there are enough servicers who are clearly uncomfortable with hedging. According to figures provided by Ms. Workman, more than a third of the servicing sales Cohane Rafferty advised last year were done for risk- management purposes, while about 40% of the sales were to bolster profits.
In 1994, the year before FAS 122 was adopted, almost all sales through Cohane Rafferty were made to enhance earnings.