***

Thomas O'Donnell

Equities analyst,

Smith Barney & Co.

New York

It's really a two-sided business: originating and servicing. When origination income declines, the servicing portfolio should provide an offsetting revenue stream. It becomes more valuable in a rising rate environment. That happens because the mortgages to which it's attached don't disappear as quickly.

Economies of scale count in the mortgage lending and servicing business. If you have a servicing platform in place, it's like a factory. The more you run through the factory, the cheaper it is on a per-item, per- mortgage basis.

Economies of scale are definitely in place. I think that has been shown by Countrywide to a great extent. Countrywide has a $149 billion portfolio, and that portfolio is standing them in good stead.

The reason you want to have size in a servicing portfolio is that in the mortgage banking business, when rates are low and originations are high, you do very well. But then when rates are high and originations fall off, it's very tough for companies to be profitable and even sometimes to survive.

Countrywide has shown that. In recent quarters we've had a tricky rate environment, and Countrywide has done well because of the combination of their origination and servicing businesses. A big company like Countrywide is large enough to use capital markets, their borrowing costs are lower than smaller companies, and they have capital to help get them through tougher times. They also have low operating costs both to originate loans and to service them. And it all comes from economies of scale because it's a big, successful company.

Size does count, but a well-run smaller company can also survive and do well. It's not cut and dried; big companies also get into difficulty. Size alone does not ensure success.

***

Terrance Hodel

President,

North American Mortgage Co.

Santa Rosa, Calif.

There was a Peat Marwick study that concluded companies that service under $20 billion in loans have an average cost lower than companies servicing over $20 billion. I don't know that there's any advantage to being huge. It doesn't show up in the statistics that larger servicers are any more profitable or cost-effective than smaller ones.

There certainly are economies of scale when you're talking about the difference between 2 billion and 5 billion and 8 billion. And there are certainly big servicers that claim that having 100 billion is much cheaper than having 20 billion, but I'm not privileged to their numbers. All I can see are the published numbers, which don't support that theory.

We sell servicing about an amount equal to our production every year. Our servicing stays pretty much flat. It has trickled down over two years from maybe 15 billion to 13.6, but it's basically flat. We happen to believe that other people want the servicing. It's worth more to someone else than it is to us, and we're happy to let them have it.

***

Thomas J. Healy

Director, mortgage banking strategies group,

CoreStates Capital Markets

Fort Lauderdale, Fla.

I disagree with "Get big or get out" on two fronts. First, the "Get big or get out" syndrome is predicated upon economies of scale, and economies of scale can many times be elusive. It's possible to be a billion-dollar servicer in one state with one investor and only a handful of products and make money. As companies grow, however, they expect economies of scale, but all of a sudden they find themselves servicing in 40 states with 50 different investors and 57 varieties of arms and a whole variety of products, each of which adds another cost element. All these unusual features - different investors, different loan types, different products - add cost. So whereas the growing company might have expected economies of scale, sometimes this complexity factor offsets any economies they might have achieved.

If you're small and keep your focus on a niche and you do that niche better than anyone else, I think you can make money. Cornelius Vanderbilt said, "I put all my eggs in one basket, but I watched them like a hawk." If you're small, you want to limit yourself to a fairly narrow band of investors and product types and watch your costs like a hawk.

I talked recently to a $20 billion servicer, and they told me with a straight face that if only they could get to $30 billion they would have economies of scale. I'm not so sure if you don't have it at 20 billion that you're going to get it at 30 billion.

To survive in the long run you need to be a low-cost producer, but that doesn't necessarily mean you have to be big. It means you have to be good.

***

Geoffrey A. Oliver

Partner and co-director, mortgage and structured finance,

KPMG Peat Marwick

Washington

There is certainly some truth to "Get big or get out," but I don't think it applies to every company. If your source of new servicing business is buying it in the marketplace, you're competing against the largest companies. Because of a number of factors, they clearly have an opportunity to outbid you.

The second key point is: How big is big? There is a minimal size - probably in the billion to 2 billion range - that is on the low end of the spectrum, but I don't believe you have to be a $100 billion player to be in this business. We see a number of clients that are very profitable at a fairly small size, though not much below the $1 billion mark in servicing.

There is a size point below which it becomes very difficult to have all the resources, technology, investment capability, bidding power, etc., to be in business. It's not impossible, but it certainly makes it very difficult.

A third point is that it depends a lot upon what kind of business you're in. If a company is a $2 billion servicer and originates $500 million per year and can do it profitably, then realistically speaking it can do just fine in replenishing its servicing portfolio with its new production. We have seen companies be profitable at that, and they don't need to compete against the big guys to go out and buy servicing in the marketplace.

If you're in the purchase market, whether you're buying servicing on a flow basis or a bulk basis, and you're going to compete against the big guys out there, then you're at a competitive disadvantage, if that's what you're depending upon for your source of new servicing business. But if you can originate the loans and correspondingly sell the loans and retain the servicing, and meet your needs that way, then being a big servicer doesn't necessarily have any impact. That's really the key issue.

***

Mark Marple

Director, mortgage servicing products,

MGIC

Milwaukee

Strategy matters; size doesn't. The overall trend in the mortgage banking industry has been to focus on servicing cost per loan. It's something relatively easy to measure and has received too much focus, whereas net profitability per loan has not received enough focus.

Some people say size matters because the way some individuals are compensated is that size becomes all encompassing: The larger I am, the better the economies of scale and the lower the costs per loan. And sometimes that, rather than net profitability per loan, drives the strategy.

Size gets overemphasized because people tend to look at cost per loan too much and don't look at net profitability enough. And that's what's driven the size concept.

The reason we have so many people chasing A-quality (fixed-rate, agency-type) servicing is because it has a low cost of service.

If I were a small or medium-size servicer focusing on net profitability, I would look for servicing that's not the norm. I may not be able to compete in the A-quality servicing market; I might want servicing that has more delinquency. Not everyone is chasing that market. I might want to focus on adjustable-rate servicing or on all the different varieties that the industry has created.

These other types of servicing come with larger margins but also with higher costs. If an individual or firm is focusing on costs per loan, he tends to ignore them because they would increase his cost structure.

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