At a high level, the impact on valuations of servicing rights can be put in two categories: What
That has mixed implications in the current market.
"It might look good on the surface to a servicer, because you might earn a greater float on your larger escrow balance," said Mike Carnes, a managing director at the Mortgage Industry Advisory Corp. "But the question is: How does it impact a borrower's ability to afford a home?"
The float factor
Servicers may be able to earn money from funds they hold in escrow in between payments, depending what the rules for a particular jurisdiction are. That can add value to mortgage servicing rights when more funds are added to the account to cover higher insurance premiums or taxes.
"It can be very advantageous to have that float. You might assign value to it that can vary by portfolio, geography and so on and so forth," Carnes said.
However, more than a quarter of states have rules around escrow accounts that might require some distribution of the float benefit to the borrower.
This can diminish the net benefit of float, which can influence the value of the underlying mortgage servicing rights when there are very low prevailing interest rates and a state's interest on escrow rates doesn't adjust for market conditions.
Rates weren't at this level at the time of this writing and escrow values were still very attractive but during a period like the pandemic there were some instances of this. In those circumstances, some mortgage companies may be more likely to encourage borrowers to waive escrow.
Servicers may charge a fee for this, but may waive it as an enticement to opt out if the economics to retain escrow aren't attractive. Escrows tend to be attractive in long-term valuations. However, the economic value of holding those accounts can be diminished in a low rate environment.
Escrow is mandatory for government loans but not necessarily for agency and other mortgage products. The Consumer Financial Protection Bureau also has rules around how servicers must manage these accounts.
Bank of America has attempted to assert in the court system that its charter as national bank preempted New York's rule to return escrow interest to the borrower. The case went all the way to the Supreme Court, but was
Different business models may make a difference in what value gets assigned to float. That value may be incorporated into financing arrangements that a nonbank has with a depository institution.
Affordability issues
While higher escrow balances may help servicers in some instances, the pressure higher insurance rates can put on borrowers is a concern.
"Rising tax amounts due and the tumult in the insurance industry are among the top couple of concerns most of us have," said Michael Merritt, senior vice president of customer care and default mortgage servicing at BOK Financial. "I think any time we're talking about what keeps us up at night, this is one of the topics that comes up.
"Taxes in some of the areas are the bigger driver, but what we're really seeing is with the insurance, it's almost like a wave," he added. "For a long time, the pressure was on the coasts, driven by large storms, but we are starting to see that become broader."
It's unclear whether the rise in insurance premiums, or difficulty even getting a policy in some areas, was boosting default or delinquencies in any significant way at deadline, said Selma Hepp, chief economist at Corelogic.
However, she does see it as a driver of relocation.
"Because people have so much equity, if they feel the crunch, they usually end up selling their home. They don't go into delinquency," Hepp said.
That can influence prepayment behavior.
"Any time you increase somebody's payment there is an increased risk of voluntary or involuntary prepays," Carnes said.
That may stem not only from difficulty in being able to afford new rates when policies come up for renewals with higher costs but also in situations where borrowers end up underinsured.
"You do have a requirement in your mortgage note to keep effective policy coverage so if that doesn't happen, the lender takes out like a lender-placed policy, which is more designed around replacement of the value of the loan," Merritt said.
Borrowers can opt not to get their own insurance, in which case they'll end up with lender-placed coverage.
"That may not be the best decision because of the lack of some of the protections," Merrritt said, noting that the incidence of this has risen to an unusual degree. "Lender placed policies were never intended for widespread use, so this is an interesting trend."
While lender-placed insurance provides some protection for the mortgage company, it can weaken the borrower's finances in the event of a disaster because it may not cover things like the contents of their home.
"That's one of the emerging things I think the servicing side of the business is really looking at," Merritt said.
To address this, mortgage businesses may emphasize borrower communications, potentially cluing them in earlier to a consumer hardship, planned move or other situation that could affect servicing, said Merritt.
That's not only important to managing prepayment or default risk and customer service, but it may have some compliance sensitivity given that escrows have been a theme in recent CFPB complaint reports.
Hepp said there recently have been some anecdotal instances where servicers missed insurance payments they were supposed to make on borrowers behalf. Higher premiums, servicing transfers or some combination thereof may be making this more likely.
The upshot
Valuations of mortgage servicing rights for internal or reporting purposes is to some degree a numbers game, but ultimately there are human motivations at play.
A behavioral model that accounts for how borrowers might respond to the current environment could help ensure valuations account for this.
"If your model is not properly able to account for those things, then you might be then you might be incorrectly assessing value relative to your peer MSRs," Carnes said.
