An auction of $878 million of mortgage servicing rights by an unidentified New England bank is expected to attract heavy interest this week as big players in the home loan industry look to load up on servicing to insulate themselves against higher interest rates.
Rights to service loans - that is, to administer them for a fee - gain in value when rates rise, because borrowers are more likely to keep their loans than to refinance. Big companies with economies of scale often seek to beef up their portfolios when rates rise. The smaller players mitigate their losses by selling servicing and taking profits.
Many observers expect a slew of portfolio sales to materialize in the months ahead in the wake of soaring interest rates, which have ravaged lenders' origination business. The surge of deals might have occurred sooner, but some say buyers were reluctant to commit to deals because of year-2000 rollover worries and fears that there might now be a glut of offerings.
Thomas Donatacci, managing director at Cohane Rafferty Securities Inc. in White Plains, N.Y., which is offering the portfolio along with the servicing platform of the New England bank, said the portfolio is especially attractive. It boasts an average note rate of 7.31% - about 100 basis points below the prevailing market rate for 30-year mortgages - and its delinquency rate is just 0.58%, against the industry average is about 4.35%. Cohane Rafferty said it expects to negotiate a deal by mid-February and transfer the assets by April.
Though the servicing market has remained slow this month, many lenders say trading for servicing rights will surge in the next few months.
"The year 2000 should be a very profitable year for the servicing component of the mortgage business," said Mike Heid, executive vice president of loan servicing at Norwest.
A consultant who did not want to be identified said prices would have to come down before a flood of servicing deals occurs.
Recent deals at five to six times one year's servicing revenue are very risky, the consultant said. "I don't see how companies are going to be paid back," he said, blaming the high prices on supply and demand.
George Christo of Prestwick Mortgage Group in Alexandria, Va., attributed the lack of servicing deals so far to Y2K fears, which kept activity slow from September through yearend. He said today's environment should yield heavy-duty service premiums and a strong market.
"I think the sellers will be there, given the interest rate environment we are in," Mr. Christo added. He said he has reviewed some portfolios but that none are up for bidding.
Though bulk packages of servicing rights are trading at higher prices, "flow" deals for newly created servicing are selling for about 10% to 15% less than a year ago, said Michael Zimmerman, vice president at MGIC Investor Services Corp. in Milwaukee. In a flow arrangement, the seller transfers servicing rights to the buyer as soon as loans are originated.
In general, the value of servicing increases the longer a borrower is expected to stay in a given loan. Mortgage servicing companies want the loans they service to stay on the books for an extended period. When interest rates go up, runoff stops, increasing the value of servicing.
Though higher interest rates have hurt loan originations, they also protect servicing already on the books by virtually eliminating the refinancing market. In addition, the torrid economy reduces the chance of default or delinquent payment, keeping servicing fees humming along, mortgage bankers say.
Servicing rights on low-interest-rate loans are particularly appealing, because they are least likely to be refinanced. A 1998 vintage portfolio would be seen as especially valuable today.
Loans originated more recently have higher coupons than loans made during the refinance boom of 1998 and early 1999, and are therefore more at risk to be paid off early.
But Phil Bracken, executive vice president of Des Moines-based Norwest Mortgage Inc., a Wells Fargo & Co. unit, said the value of servicing on newer loans is only slightly less attractive than on 1998 loans. "With low unemployment and strong consumer confidence, we will see fewer defaults and delinquent payments, making servicing a good investment," he said.
Robert Husted, principal in the Mortgage Industry Advisory Corp. in New York, said the market is forcing some production-heavy companies to move forward with portfolio sales because profit targets from the production side fell short. He said these companies are not the usual sellers of servicing, but they need to sell portfolios to offset production losses.
First Tennessee National Corp. said in its earnings report last week that its mortgage unit sold some bulk packages of servicing last year, mostly during the fourth quarter, to realize the gains in value.
Mr. Husted said the increased servicing value for some represents "a consolation prize, not a direct offset" for the retrenchment in production.
The servicing sales could come with further consolidation in the home loan business. Several lenders predict that a number of companies may be for sale along with the servicing.
"Everybody has their price," said Mr. Husted, adding that some companies may find current servicing value irresistible.
Noting a recent news report that GE Capital Mortgage Services of Cherry Hill, N.J., may be for sale, he asked, "How many more GEs are out there?"
Another market source, speaking on condition of anonymity, said of the General Electric home loan unit: "Every down cycle they're 'for sale.' They're running the flag up to see if anyone will salute with a big price." A GE spokesman declined to comment.