To Sell or Not to Sell. The Ups and Downs of Servicing Rights
As interest rates have dipped and more CUs have opted to sell their mortgages onto the secondary market, they have faced a dilemma: will they or won't they sell the servicing rights?
Mortgage servicing rights are contractual agreements where the rights to service an existing mortgage are sold by the original lender to another party who takes over the administrative duties for a fee. Common rights included are the rights to collect mortgage payments monthly, to set aside taxes and insurance premiums in escrow, and to forward interest and principle to the mortgage lender.
Credit unions have traditionally opted to keep their servicing rights if they sold their mortgages, according to Robert Lee, senior vice president with the Mortgage Industry Advisory Group, a leading mortgage consultancy.
"Primarily, credit unions have wanted to keep their servicing rights because they want to keep the relationship with the member," Lee explained. CUs have wanted to be in position to interact with a member who's paying on a mortgage that they originated, he noted. In addition, if a member has become a member to take advantage of the mortgage, continuing the servicing offers additional opportunities to cross sell other products.
Also, since the housing crisis, Lee explained that the market has been generally undervaluing servicing rights from credit unions.
"It can be very hard now to get a good price for mortgage servicing rights," Lee said, adding that "credit union mortgages are of such good quality that they usually sell at a premium. But the market has been so weak since the housing crisis began that credit union MSRs have not been valued as highly as they should be."
Lee explained that a number of different factors feed into mortgage servicing rights value, including credit quality of the borrower and the likelihood that a borrower will prepay an existing mortgage by refinancing. Both delinquent borrowers and early paying borrowers hurt MSR value but in different ways, he explained. Delinquent borrowers hike servicing expenses as those borrowers require more work to service their accounts, while borrowers who prepay or refinance their mortgages cut the servicing income their mortgage would otherwise generate.
MSRs from credit union originated loans might also have been hurt by the relatively good quality of mortgage loans, Lee noted. Credit union mortgage loans have had very strong quality in comparison with others, but in the wake of the housing crisis, almost all lenders are writing higher quality loans, he said.
But if there's a strong case for keeping MSRs, why do some CUs sell them? Lee said a variety of different factors can lead to a credit union deciding to sell the MSR along with the mortgages.
First, sometimes mortgage buyers in the market insist upon buying the servicing rights and will offer a better deal for the mortgage loan if it comes with those rights, and that can be a positive reason to possibly sell the rights, Lee explained.
Lee explained that mortgage servicing rights are an asset, but one whose value and price can fluctuate rapidly due to market conditions or prepayment expectations. Further, while servicing a small portfolio of mortgages might not be too expensive, Lee said the costs can mount as operational aspects of the servicing become more complex and labor intensive.
Credit unions that are determined not to sell their servicing rights might also consider outsourcing the servicing, Lee said. This can cut into their income potential but make them significantly easier to manage.
He also said some credit unions with large MSR portfolios sometimes hedge against the risk that interest rates could fall below the average rates of their mortgages, leaving them open to the possibility of being refinanced. The downside of hedging, ?he said, is that it tends to be both complex and expensive.