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Servicing Portfolio Evaluation and Management - A Financial Perspective.

ONE OF THE MOST CRITICAL AND important issues to mortgage bankers today is the price, or value, of servicing traded in the secondary servicing market. Selling servicing rights has created liquidity and profit opportunities for mortgage bankers squeezed by increasing costs and cutthroat price competition. Conversely, larger, well capitalized servicers find economies of scale by purchasing servicing rights. Buying and selling servicing is a primary income source for most mortgage bankers today.

Understanding the value of servicing and the evaluation process is important to both buyers and sellers wishing to maximize returns. Cash flows can be generated over the life of the mortgage, or the mortgage can be sold servicing-released for a one-time fee. Determining the value, or price, of these cash flows is a complex process usually calculated with an analytical model requiring the user to make a number of economic assumptions about the servicing portfolio. Still, there are many who use methods from the dark ages such as "two points" or "four times servicing fee" and, in the process, create intellectual and economic risks. Understanding the valuation process can enhance profit planning and generally improve corporate performance.

The nature of the cash flows generated from residential mortgages are as complex and diverse as the products themselves. Each has its own unique income and expense components that must be determined individually before value can be calculated. To understand these servicing characteristics and obligations leads to a more complete understanding of the product and its secondary servicing market value.

Servicing Portfolio Evaluation and Management provides the reader with timely and valuable information about servicing valuation technique and methodology. The book is divided into six areas: evaluation concept; income components; expense components; cash flows; prepayments; and net present value/discount rate and risk evaluation. The objective of the book is to provide basic information about the valuation process. The authors provide the reader, whether novice or sophisticated, a better understanding of the different values and risks associated with residential loan servicing. The book presents objective and subjective valuation issues in a straight forward fashion.

Chapter one describes the valuation process and the use of portfolio stratification. It further differentiates between the economic value and market value of a portfolio.

Chapters two and three discuss the income and expense components of various servicing portfolios, such as GNMA, Fannie Mae, Freddie Mac and private investor servicing. Exhibits are utilized to illustrate income derived from servicing fees, late charges, principal and interest float and ancillary income, such as credit life insurance premiums. The authors provide valuable information to mortgage bankers seeking advice on how to invest escrow deposits along with the interest borrowers earn on escrows. The book describes strategies to identify, monitor and reduce servicing-related expenses.

The chapter on prepayments is particularly useful in helping the reader understand the basic issue of projecting prepayment assumptions for a portfolio. It describes demographic considerations, as well as loan type and rate-level issues that are critical when making prepayment forecasts.

The last two chapters lend perspective to the valuation process. They walk through the questions of what are net present value and discount rate. And more important, how does one establish a realistic return objective? The authors credibly describe risks beyond prepayment, such as credit and operational risk.

In conclusion, the book offers a rational and realistic approach to the art of servicing evaluation. It can be used as a reference book for the more experienced or a primer for the novice. The book offers valuable and time-saving information for those wishing to refine their evaluation skills or those just climbing the learning curve. The book suggests, and I agree, that the most valuable learning experience is practical experience. The book provides practical information and analytical techniques that can be applied to the valuation process.

Reviewer Doc Baldwin, is president of Baldwin Financial Corporation, Parker, Colorado.
COPYRIGHT 1992 Mortgage Bankers Association of America
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1992 Gale, Cengage Learning. All rights reserved.

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Author:Pulignano, Maureen
Publication:Mortgage Banking
Article Type:Book Review
Date:Oct 1, 1992
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