Second of two parts

Mortgage servicing had its day in the sun in 2000, driving revenues for many of the industry’s biggest players as originations sagged to a three-year low.

Often used as a hedge against cycles in the mortgage origination market, last year mortgage servicing rights provided a much-needed return for large investors, many of which responded by gobbling up even more servicing business.

Wells Fargo Home Mortgage led the charge, increasing its portfolio by a whopping 60% to $452.5 billion and leapfrogging from the third position to No. 1, according to rankings by National Mortgage News. In fact, out of the top 10 servicers, only one reported a drop in its servicing and market share.

Rounding out the top five were Chase Manhattan Mortgage, up 16% to $361.6 billion; Bank of America, up 14% to $335.8 billion; Countrywide Home Loans, gaining 16% to $284.9 billion; and HomeSide Lending Inc., surging 24% to $187.5 billion. All figures represent servicing portfolios as of Dec. 31. Fleet Mortgage Group, the eighth-largest servicer last year, registered the only drop — 9%, to $136.3 billion.

Over all, the top 10 expanded their servicing portfolios by an average of 21%, but more important, they now control approximately 46% of the market, up from 40% in 1999. Wells Fargo alone holds 8.85% of the servicing market.

“The market will continue to consolidate, and I expect that what has happened over the last five years will continue and accelerate,” said Craig S. Davis, president of Washington Mutual Home Loans in Seattle, the sixth-largest servicer last year. “We view this as a size-and-scale business, and the key to customer management is scale on the servicing side — and that is a key component of our strategy.”

Leo E. Knight Jr., chairman and chief executive of National City Mortgage in Miamisburg, Ohio, agreed. “Quite honestly, in both servicing and origination there will be continued consolidation,” he said. “Without scale, it’s pretty tough to compete. It seems to be a continuing evolution where a small lender grows to midsize and then sells out to a larger player.”

In its aggressive move last year to bulk up on servicing, Wells Fargo completed several large deals, including a two-week binge in the fall for GE Capital’s $78.6 billion portfolio and $35.7 billion of First Union’s $52 billion portfolio. The purchases put the Des Moines-based lender far ahead of the No. 2 servicer, Chase, which trails Wells by almost $100 billion.

“You’re going to see a continuation of the servicing consolidating into what will be 10 primary servicers, with a big concentration in the top five,” said Stanford L. Kurland, president and chief executive of Countrywide Credit Industries Inc. of Calabasas, Calif. “It’s just part of the economics of how to maximize the potential of your customer base and how to be an effective originator.”

Steve Rotella, chief operating officer of Chase Manhattan Mortgage, said he also expects consolidation to continue —- because in the servicing business, it is clear that size makes a difference. “The same is true on the production side, but it’s not as obvious a factor as it has been on the servicing,” he said.

Yet the servicing market in 2000 also produced what several sources called a disturbing trend of money-losing transactions as aggressive pricing drove deals past the point of profitability.

“I wonder who’s going to service loans going forward,” said Doug W. Naidus, chief executive of MortgageIT.com. “I don’t think anybody can do it profitably, and I don’t think anybody wants to do it anymore.”

Saying the servicing market is currently in a crisis, Mr. Naidus said he has watched as major national servicers, one after another, have sold out or stopped servicing altogether. He said everyone is losing money as they succumb to constant pressure to be aggressive in boosting volume.

“I’m really worried about the efficiencies and the way loans are being priced in the secondary market,” he said. “In the loan servicing industry, there’s going to have to be some economic change to keep people in the business.”

Further complicating the business, nearly all executives said FAS 133, an obscure and complicated accounting rule that went into effect earlier this year, could wreak havoc on the servicing values and earnings statements.

Walter C. Klein Jr., president and chief executive of First Nationwide Mortgage in Frederick, Md., called FAS 133 a “tough accounting rule” and said its implementation may speed up consolidation in the coming years.

Valuations can now swing by multiples as rates rise or fall, he said, requiring far more complex hedges than previously required. “Only those that can or want to stay in servicing will do so,” Mr. Klein said.

“It’s a complicated transition,” added Mr. Kurland. “It has the potential to create greater volatility in earnings from servicing.”

The rule, formulated by the Financial Accounting Standards Board, makes it more difficult for mortgage companies to qualify for the highly valued hedge accounting method, which allows them to offset gains or losses in the value of loans or servicing rights.

Mortgage companies must comply with the standard if they use hedge accounting, which allows businesses to offset any rise or fall in the value of an asset, such as servicing rights, by a corresponding rise or fall in the value of a hedge investment. Without this benefit, their earnings could become more volatile.

FAS 133 requires an investment in people, quantitative capabilities, and risk management that plays to the strengths of big companies, said Mr. Rotella of Chase.

“It’s causing some companies to think about their ability to meet the requirements, along with other complexities in the business, and that is causing them to at least look at their position in the market and in some cases say, ‘We can’t do this, we don’t want to do this,’ ” he said.

The big players, however, appear undaunted by such skepticism.

Mr. Kurland said Countrywide is “the most efficient and best servicer in the industry,” adding that servicing is an important part of the company’s business model. “We are maximizing our potential to cross-sell to our customers,” he said.

Similarly, Mr. Rotella said Chase maintains “a very balanced organization between production and servicing,” which has helped it develop “the best sales organization in the country.”

Yet he acknowledged that changes in the business are making it more difficult for the smaller lenders to compete.

“The combination of the need for size and scale, the need for investment in technology, and the need for sophisticated risk management with the changes in accounting policies is causing consolidation in the mortgage business to accelerate,” he said.

Erick Bergquist and Tom Fernandez contributed to this article.


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