Bank of America Facing Mortgage Servicing Losses

Bloomberg’s “Handling Home Payments Loses Profit Luster as Bad Loans Pile Up” reports that Countrywide lost $2.2B on loan servicing in the first half of 2008, following a $441M loss for all of 2007. Bank of America doubled its loan-workout staff to 5,600 as the business is becoming substantially more labor intensive. Ordinarily, the business produces steady profits with little risk. But when the mortgage delinquency rate crosses over 2%, the tables are turned. By September 30, delinquency rates reached 6.99%.

Servicers usually charge between 2.5% and 3.5% of the mortgage balance for administrating billing and collection. Servicers must continue timely payments to investors (advances), even when borrowers are late or delinquent. Advances continue until the servicers determine the loans are not salvageable. This negative cash flow along with added labor costs to negotiate mortgage modifications has turned servicing temporarily from an asset to liability. After GMAC’s Residential Capital advanced more the $2B to investors on behalf of delinquent borrowers, no one is interested in buying the unit.

Bank of America (BAC), Wells Fargo (WFC) and JP Morgan Chase (JPM) service almost half of the $11.5T mortgage market. Citigroup (C) follows with 7%. Analysts have questioned the wisdom of Wilbur Ross paying $1.8B for American Home Mortgage and Option One Mortgage’s servicing units when their loans are performing so poorly. Ross counters that most of the money went toward advances which he plans on recovering.

Ross has a history of building empires from bankrupt companies and my bet is he will be right again. Obviously, the increased labor cost will not add any value to the servicing units. But, at least the major banks can easily finance the advances if they are only temporary as Ross indicates. And the computer systems and operations that Bank of America and Ross recently acquired would be difficult and expensive to replicate.

It looks like the trend of mortgage servicing moving to stronger hands will continue. The servicers will need increasing access to credit in a market where any type of real estate credit is almost nonexistent. Five years from now Bank of America could have a cash cow rising from Countrywide’s ashes. Do you think Ken Lewis knew all along how large Countrywide’s losses would be before the goose will start laying her golden eggs?

As the megabanks morph into low margin utilities, highly efficient mortgage servicing on a grand scale will become just as important as credit card processing. And in good times mortgage services is much less capital intensive.

Disclosures: Author is long BAC, C and WFC.

Comments

[HBWOW:]

Ken Lewis simply believes bigger is better no matter what. I would like to know all the details of his use of $5 Billion of the "Bailout" funds to invest in a bank in China, mainly his authority for such outrageous use of the public's assist monies.

Jan 11 11:02 AM

[Crocodilian:]

"Do you think Ken Lewis knew all along how large Countrywide’s losses would be before the goose will start laying her golden eggs?"

Clearly not. My guess is that he was looking at the competitive landscape-- seen from 2007, there clearly were far too many banks and financial institutions to serve America.

My guess is that he correctly saw consolidation coming, but missed just how deep the financial crisis would be.

If BofA can survive the financial crisis intact, the consolidation play will work well. Its BofA's core competence, all the way back to their NCNB days. In that light, I see the Countrywide business as being easier for BofA to manage -- it basically is a traditional banking function.

Merrill is the more worrying piece-- keeping overpaid stockbrokers happy in a financial apocalypse has nothing much to do with traditional banking competencies, and we've already seen signs of tension at Merrill.

Jan 11 03:36 PM

[Augustus:]

You have got the servicing fees jacked up to be about 10X what they really are. Rates are usually 1/4% to 3/8%.

Jan 11 06:15 PM

[Kenny G:]

"Ken Lewis simply believes bigger is better no matter what. I would like to know all the details of his use of $5 Billion of the "Bailout" funds to invest in a bank in China, mainly his authority for such outrageous use of the public's assist monies. "
your comment really makes sense HBWOW!

Jan 12 01:47 AM

[Victhom:]

Lewis should spin-off some asset like MERRILL DIVISION....LENDER DIVISION....and GET GOOD INSURANCE DIVISION.... and the Bank division....this will creat value for shareholders instead to create a "Conglomerate" like CITI that was prove unefective and costly....creat 4-5 divisions will create value....and more synergies and less tensions....inside business...exemple...B... BOYS from Merrill would be more than happy to run the business with support of BAC....than be controlled by regular bankers....

Jan 12 01:48 AM

[Smalltownba...:]

Don't bet on Ross. More than 75% of American Home Mortgages' servicing portfolio in February 2007 was Option ARM product. I think he bought the weakest part of the company.

Jan 12 08:08 AM

[Chris B:]

The requirement that servicing companies make advances to investors even when loans are not performing is a large part of why these loans have not been worked out yet. Why should the investors take a 15% haircut by reducing the principal and payments on their loans when the servicing company will pay them regardless? Why not just let the servicing companies go broke at your expense, and work out the loans later if it's still necessary?

The turning point in the mortgage crisis will occur when the servicing companies all go broke or start walking away from contracts. Then the mortgage owners will be accountable for getting the most returns out of their loans and preventing foreclosures. You can bet that with those incentives, negotiations for loan restructurings will begin in earnest.

Jan 12 11:26 AM

[levin70:]

Why not just let the servicing companies go broke at your expense, and work out the loans later if it's still necessary?

ChrisB. The reason is because the advance payments occur only so long as the servicer shows the loans in non-default status (as defined by the service agent agreement). Once the loans get put into non-accrual and default status, the servicer stops advancing against the loan and is then able to file to receive its advances back from the investor.

Kind Regards

Jan 12 03:08 PM

[ozcutty2:]

BAC stocks plunging. Expect more drama soon. I think the gov will have to step in with another one of its 300billion gaurantees ala Citigroup.

Jan 12 06:01 PM

[desicon:]

Going by CITI example bigger is not better. Global diversification did not insulate CITI from mortgage industry failure. The key business issue in banking is risk management. When banks get bigger they tend to loose control. Economy of scale and cross division synergy does not really happen in banking. Consumers go a la carte for their financial and credit needs. I think BAC stock valuation will be discounted for the large unfathomable risk due to the amalgamation of Merrill and Countrywide.

Jan 12 06:34 PM