An Accountant’s Perspective on the Mortgage Industry

by 07 Nov 2012

To Retain or Not to Retain, That Is the Question…

No, not water, nobody wants to retain water! I’m talking about mortgage servicing rights!  This seems to be the question on the minds of more independent mortgage banks’ management teams.  Is there anybody out there who isn’t thinking about getting agency approval and entering the brave new world of servicing? Ok, you’re right, it’s not such a new world, just one that most independent mortgage banks left years ago, and are now considering returning to.

Why the Reconsideration? It seems the servicing release premium (SRP) isn't what it used to be, which brings to light the need to consider the cost benefit of selling a loan servicing released versus servicing retained. This is not a simple consideration, and not a decision that should be made quickly or without significant fact gathering. Of course we're all interested in the bottom-line impact on net profit (hello, accountant over here), so management must consider the immediate direct revenues and costs as well as the indirect and ongoing costs that will be incurred; but at the same time management can't overlook the operational changes and risks that are added when retaining servicing. There are numerous factors to consider, and if management hasn't played the servicing game before, they should seek the advice of trusted advisors and get opinions from peers in the industry who have gone before them. Questions to be answered:

  • To retain or not (in general and on a per-loan basis)?
  • Which agency best suits your needs?
  • How long will it take to get agency approval?
  • How hard is it to get agency approval?
  • Will we have to cover payments not made by borrowers?
  • Should we service or hire a sub-servicer?
  • How will the pending Dodd-Frank regulations impact the economics of retaining?
  • What happens to my balance sheet when we start retaining and recording mortgage servicing rights ("MSRs")?
  • What happens to the MSRs on my balance sheet when interest rates and other factors change?
  • How does all of this impact my compliance with minimum net worth, liquidity and other financial ratio requirements of regulators, lenders, and investors?

Since I'm limited to one page here, I'll jump to the balance sheet questions, as the balance sheet is near and dear to my heart. When a company sells a mortgage and retains the servicing rights, it must record the value of the servicing asset (or, in some cases, the servicing liability) at its fair value at the time that the loan is sold. Then management has an option. The MSRs can be amortized over the expected life of the loan, or an election can be made to carry the MSRs at fair value with changes in value running through current earnings.

Many companies find it easier to carry MSRs at fair value when using a third party to calculate the valuation. This requires a fairly simple adjustment to the newly calculated value, as opposed to the sometimes complex and time-consuming calculations needed for tracking amortization when assets are being added and removed every day.

Other companies however, don't like the potential volatility they are introducing to their balance sheet when electing fair value and therefore choose to amortize the MSRs. If the MSR value declines, a loss is recognized for the reporting period. REMEMBER – there are rules upon rules that must be considered when building accounting policies for MSRs. Here again, a consultation with a trusted advisor is likely in order if it is new territory for management.

Finally, what does this new asset do for a company's net worth? Generally speaking, it increases net worth. HUD, Fannie, Freddie and Ginnie currently recognize servicing assets as acceptable assets (with the caveat that they are properly reported according to Generally Accepted Accounting Principles). Note however that some warehouse lenders may not. Their covenant calculations may include an adjustment to pull them out when determining tangible net worth, which would mean that you've traded the cash you would have received selling a loan servicing released for an illiquid asset that does not increase your net worth for borrowing purposes.

"We Know What We Are, But Know Not What We May Be."~HAMLET

I wish you luck and wisdom as you traverse the new landscape of Mortgage Banking!

For more information, please contact Jeanette Emmons of WithumSmith+Brown, PC at 908.526.6363 x3344 or email [email protected]