What's It Worth? Hard to Say with Servicing

Article excerpt

The latest refinancing wave lifted mortgage production and profits to dizzying heights in the first quarter, but some observers say the way big lenders report their financials makes it difficult to judge how well they are really performing.

Specifically, the lack of a standard valuation yardstick for mortgage servicing rights has analysts and others wondering if the downside of lower interest rates -- prepayments, which cut short servicing fees -- has been fully reflected in the bottom line.

As a result, even though Countrywide Financial Corp.'s net income surged 95%, to $326 million, chairman and chief executive Angelo Mozilo spent the first part of the first-quarter earnings teleconference April 29 defending the mortgage giant's servicing business, which lost $554 million in the quarter.

Mr. Mozilo said what the other megaservicers say: Today's extraordinarily low interest rates are bound to hurt servicing values, but income from originations is more than making up for the losses.

No one argues with the first part of that statement. In February Fitch Inc. put $18 billion of Countrywide's debt on review for a possible downgrade, saying that it feared the Calabasas, Calif., company had overvalued its servicing portfolio, at 115 basis points of outstanding loan balances.

The value is considerably higher than Countrywide's peers. For instance, Washington Mutual Inc., the nation's top servicer, says its servicing rights are worth 88 basis points.

"Every company has different ways of formulating valuations," said Thomas Abruzzo, a Fitch analyst. "Right now, though, interest rates are at modern-day historic lows, and that's going to hurt servicing rights' values. That's it."

Mr. Mozilo said, "As expected, servicing took a big hit." As far as he is concerned, though, Countrywide's assessment of its servicing rights is "far below their intrinsic value."

Last Wednesday, the day after his company announced its earnings, Mr. Mozilo was in New York addressing a UBS Warburg financial services conference. In response to a question, he defended the higher assessment Countrywide accords its servicing rights, saying it stripped out all price padding, such as a cross-selling premium, before arriving at the 115-basis-point figure.

"We don't count our ability to recapture a loan that prepays, and we also don't count our ability to sell our customers home equity loans," he said. "We put into our valuation only the income we have under contract with borrowers."

But Countrywide said the main reason its servicing deserves a higher valuation than competitors' portfolios is that its loans prepay slower.

Countrywide, whose $502 billion loan portfolio places it third, behind Washington Mutual and Wells Fargo & Co., had a 42% constant prepayment rate in the first quarter. (That means 42% of its portfolio would prepay over the course of the year if refinancings continued at the same pace.) Mr. Mozilo said Wamu's prepayment rate in the quarter was 62%, though a spokesman for the Seattle thrift company put it at 41%.

Countrywide keeps prepayments under control because "our portfolio has fewer jumbo loans, fewer adjustable-rate mortgages, fewer bulk acquisitions, and more government loans," Mr. Mozilo said.

He also said his company has lower servicing costs than its competitors, which helps boost the worth of its portfolio. "We have one servicing platform -- it's unified and integrated. Wamu has six platforms from different acquisitions, and there is no way you can tell me that Wamu can service a loan as cost-efficiently."

Countrywide has put a lot of energy into validating its mortgage servicing rights assessment, for good reason. The rights "are a big part of our balance sheet, so we have to make sure they're valid," Mr. Mozilo said.

It is hard to argue with an executive whose company nearly doubled its profits year over year, but not everyone is convinced. …