There’s nothing a mortgage banker loves more than a good old-fashioned refinancing boom—that is, unless that mortgage banker happens to work in the loan servicing department.

Yes, by now it’s no secret that, thanks to lower interest rates, America’s residential lenders are awash in refinancings. It looks as though total mortgage production could top $1.5 trillion this year, maybe even $1.6 trillion, depending on how the "purchase money" market plays out.

But about 50% to 60% of what is being produced today will turn out to be refis, which means servicers—especially the bank-owned "mega" servicers (Wells Fargo, Chase, and Bank of America)—are seeing housing receivables disappear faster than new ones can be put on the books.

Not only is this causing headaches for mega-lender/servicers but it’s creating problems for firms that want to sell servicing rights in the secondary market. (The typical servicing fee on a conventional Fannie Mae or Freddie Mac loan is 23 basis points. Government-backed loans carry a servicing fee of 44 basis points.)

It’s also causing nightmares for commercial banks that have finally made the decision to exit the servicing arena by jettisoning all their receivables only to find that the price they were hoping for has been reduced by 10%, 15% or even more.

Case in point is the recent sale by FleetBoston Financial of Fleet Mortgage Group, a $136 billion servicer that ranked eighth overall. When the sale was announced in late March, Fleet said it was selling Fleet Mortgage to Washington Mutual, Seattle, for $660 million in cash. Little else was said—officially, that is—about the transaction. Then about two weeks later when Fleet announced first-quarter earnings, it said it was taking a $225 million hit on the sale of FMG, without providing any details. However, sources familiar with the transaction say the hit was tied to a writedown on the value of the servicing.

It had been no secret in the mortgage industry that Fleet had been trying to sell Fleet Mortgage—on and off—for the past six years. By the time it finally pulled the trigger it was too late. Investors no longer were willing to pay premium prices for bulk (existing) servicing rights, and when Fleet finally sold, it was forced to accept what the market was willing to pay, and that, apparently, wasn’t enough to offset a loss. (Prior to the sale there had been rumors that Fleet would take a $100 million hit on its servicing due to accounting changes promulgated under FAS 133, a new rule that requires servicers to market-to-market its financial hedges.)

Bulk vs. Flow

Then again, the market for mortgage servicing rights isn’t always so cut and dry. For buyers of bulk servicing the depressed prices create an opportunity to pick up receivables at what could turn out to be bargain prices.

Also, while wreaking havoc in the bulk servicing market, the refi boom is causing the "flow" servicing market to flourish. Flow servicing involves the delivery or sale of newly originated servicing rights on a monthly (forward-going) basis. Because it represents a cash-flow stream carved from newly originated (low coupon) mortgages, the buyer receives the rights to loans that likely won’t prepay so easily, unless of course, interest rates plummet another 100 to 200 basis points.

According to Ted Jadlos, a principal in Denver-based Phoenix Capital, conventional mortgages that carry a note rate north of 7.25% run the risk of prepaying due to a refinancing. "But bulk servicing with low note rates are still very liquid and can trade easily," said Jadlos, whose firm specializes in brokering the sale of both flow and bulk rights.

Tom Donatacci, a servicing broker for Cohane Rafferty Securities, Harrison, NY, notes that for servicing portfolios where the note rate is in the range of 7.5% to 8%, "there is very little interest on the buy side."

There are exceptions, though. Donatacci says niche servicing markets where the receivables are seasoned and/or carry low loan balances can still fetch a decent price. Why? For one thing, says Donatacci, older (seasoned) mortgages are less likely to prepay because the consumer has been in the home so long that many see no economic upside to refinancing. If there are five or 10 years left on a 30-year mortgage, why bother?

The same holds true for lower loan balances. Simply put, it may not pay much in the way of savings to shave 100 to 150 basis points off a low-balance mortgage.

For Jadlos, Donatacci and others who make a living selling bulk servicing the refi boom is causing problems, yes. But every cloud has a silver lining and for servicing brokers it’s the flow market. Newly originated ‘A’ paper quality mortgages that carry a note rate of 7.25% or lower (depending on the points) aren’t likely to prepay any time soon, especially if the paper was originated during the past six months. That means buyers of flow servicing are eager to purchase receivables (even if it’s for future delivery) and will pay handsomely.

"The flow market is extremely strong right now," Jadlos says. "We’re busier than we’ve ever been."

How busy? The flow market is so good right now that Phoenix Capital, which was formed four years ago, expects to broker more flow servicing transactions than ever before. "Last year about 60% of our deals were flow-related," says Jadlos. "This year about 80% of our deals will be flow-based."

Cohane Rafferty, which traditionally has been more involved in bulk than flow, also expects to have a banner year in flow. "During the first six months we’ve done more flow than bulk," says Donatacci. "It’s hard to say where we’ll wind up for the year, but right now we’re ahead on flow transactions."

In case you were wondering, the biggest buyers of flow servicing, traditionally, have been the largest servicers. Jadlos and Donatacci won’t identify specific firms but it’s no secret that Wells Fargo Home Mortgage, Chase Manhattan Mortgage, HomeSide Lending and Bank of America Mortgage have been aggressively bidding on flow deals.

The reason for their strong appetite is obvious: these bank-owned firms have spent millions, if not billions, building huge servicing platforms and need to feed their factories to make the "economies of scale" model work to their advantage.

But, curiously, Bank of America Mortgage backed out of the flow market in April without saying why. In 2000, BofA Mortgage bought between $30 billion and $40 billion in flow. Could the competition be too stiff for the cost-conscious BofA? Or is it just another sign that the company is trimming its presence in the residential mortgage market? Servicing brokers aren’t sure. A few predict BofA will be back in the market by the fall or even sooner. Others aren’t certain. If BofA does stay out of the flow market for an extended period of time, it will send a signal that it thinks valuations have once again gotten out of hand.

Besides being a contributing editor to U.S. Banker, Paul Muolo is executive editor of National Mortgage News, based in Washington.

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