Digging up profits from dead S&Ls.

Digging up profits from dead S&Ls

Lots of people have looked in vain to profit by snatching up the real estate and other assets of dead savings and loans. But Herman Churchwell finds profit in a little-publicized facet of the S&L industry mess

Many buyers ready to profit from the savings and loan industry mess have been sorely disappointed. They've been waiting for the government's Resolution Trust Corp. to sell the S&L assets at "giveaway" prices, but these hoped-for hidden values for the most part haven't materialized.

Not so for Herman Churchwell, the chairman and chief operating officer of Hamilton, Carter, Smith & Co., a Century City-based investment bank. As Churchwell sees it, many of the bargain hunters have overlooked one of the best deals available from the RTC: loan servicing rights.

"In the RTC mess the most valuable assets are loan servicing rights," says the bespectacled Churchwell in a mild Southern twang which belies an intensity with which he approaches his business.

The RTC is the government agency set up under the Financial Institutions Reform, Recovery and Enforcement Act of 1989 to seize failed savings and loan associations and dispose of their assets.

Mortgage servicing includes the collection of mortgage payments, interfacing with customers, the payment of taxes and insurance premiums on behalf of customers, the preservation of assets and if necessary, the institution of foreclosure proceedings.

The RTC has retained Churchwell's firm to advise it on the disposition of such rights on loan portfolios of $100 million and less. On loan portfolios of more than $100 million, Hamilton, Carter is one of a handful of brokers approved by the RTC to bid for the right to sell such loan servicing rates.

Most of the potential buyers of RTC assets have concentrated on buying mortgage loan portfolios and real estate. Many analysts have become skeptical whether much of real value can be found there.

These rights may not be the most glamorous business, but they differ from other assets held by failed thrifts in that their quality has not suffered with the deteriorating fortunes of the S&Ls holding them, according to Churchwell. "The overall quality of residential servicing coming from the RTC institutions has been good and does not vary much from what is on the market otherwise," he explains.

He describes the advantages of these rights as "tangible assets with an income stream and defined characteristics." That allows the financial institution which books the loan to sell the servicing rights to someone else. As compensation the holder of loan servicing rights receives an annual fee now in the neighborhood of .375 to .44 percent of total loan value, Churchwell indicates. In addition to this regular income stream, holders of these rights also receive assumption transfer fees paid by a house buyer.

Of course, the rights come with some risks, including delinquencies and early prepayments. Early prepayments will tend to increase when interest rates go down, making refinancing attractive to home owners despite prepayment penalties. An unexpected rise in early prepayments cuts into future service fee income which may not be completely offset by penalties.

Expected delinquency rates and prepayments are factored into what buyers will pay for such rights. The going rate for rights held by the RTC is in the range of 1.5 percent of the total loan value, which may be adjusted according to the delinquency and prepayment risk, Churchwell points out.

Although rights being auctioned by the RTC may not carry a discernibly greater risk than privately held rights, the RTC may have to sell its rights at a slight discount, Churchwell acknowledges. Unlike most private sellers of servicing rights, the RTC will not issue any representation or warranty of any kind. Churchwell says he cannot estimate how much effect this would have on the price.

In winning its contract from the RTC, Hamilton, Carter competed against virtually every major Wall Street firm, Churchwell says. As a boutique with extensive experience in the mortgage servicing rights field, Hamilton, Carter may have had a more solid track record in this esoteric area. Last year alone the company marketed $27 billion of loan servicing rights and evaluated rights worth $150 billion, Churchwell indicated.

Hamilton, Carter shares the business with Smith Barney Harris Upham & Co., which handles portfolios larger than $100 million.

"Smith Barney tends to handle more complicated issues; they deal with fewer RTC institutions but they handle a greater outstanding principal balance," Churchwell says.

Unlike Smith Barney, Churchwell's firm is staffed leanly. Half of its staff of roughly 25 are in the contemporary-styled Century City office and the others in Chicago, Dallas and Washington, D.C.

The fact Hamilton, Carter may be handling less complicated issues does not mean its task is not daunting. The valuations it must make require the same kind of due diligence undertaken in a corporate mergers and acquisitions setting, Churchwell suggests. Beginning with face-to-face interviews with a servicing institution's management, Hamilton Carter then collects data on the loans being serviced to enter into a database. Data includes such items as the size of the portfolio, the age of the mortgages held in the portfolio, the interest rates of the mortgages, the deliquency and foreclosure rates of the mortgages, the geographic location and the type of mortgage (fixed, adjustable). In all there are between 20 and 30 factors thrown into the database.

One of the objectives of this analysis is to assess the servicing performance at each institution.

"If the thrift is inefficient in its servicing, it could represent a higher risk of loss for the purchaser," Churchwell says.

After all the data is processed, Churchwell will have a report prepared with his recommendations to the RTC.

If the RTC gives Hamilton, Carter a go-ahead, the firm will then put the servicing rights out to competitive bidding from 35 brokers. The RTC will then choose the victor on the basis of the broker's fee and the pricing level the broker maintains it can obtain.

With each contract Churchwell says he will generally deploy 5 to 7 people to do the analysis.

Because of the conflict of interest, Churchwell's company is disqualified from bidding on contracts on which it has advised the RTC, but it is one of the 11 approved brokers to bid on Smith Barney auctions.

This on top of its active role as a broker of loan servicing rights in the private market makes it a major player in the brokering of these rights.

Sellers of such rights include savings and loans, banks and mortgage bankers. The same institutions may also be buyers of another institution's servicing rights when they wish to diversity their portfolio geographically or they seek to capitalize on an expertise in certain kinds of mortgages, such as fixed interest rate mortgages.

For the most part, however, S&Ls have left the market as buyers of late as they await finalization of a regulation concerning the treatment of loan servicing rights for purposes of the capital guidelines they must comply with under FIRREA, Churchwell says.

A native of Memphis, Tenn., Churchwell studied accounting and business administration at Hendricks College in Arkansas. He returned to his hometown in 1971 to join a mortgage banking firm.

Mortgage bankers typically originate the mortgage loan and then turn around to sell it to the secondary market as quickly as possible. The usual buyers are Ginnie Mae and Fannie Mae, which assemble a portfolio of mortgage loans and securitize them. That means they issue debt instruments to the public which are backed by the underlying mortgage portfolio. These debt instruments have the usual features associated with bonds, such as fixed interest rates and the like.

Churchwell left Memphis to become an executive vice president at a larger mortgage banker based in Chicago. In 1984, he was hired by Bank of America as a vice president to head their loan servicing operations in Orange. At the time the bank held roughly 260,000 loans with a value of $16.5 billion, Churchwell said.

Churchwell sees his move to Hamilton, Carter in 1986 as a partial career change. "I no longer manage a portfolio, but I can take advantage of the relationships and knowledge of the industry I picked up during 14 years as a mortgage banker," he says.