Understanding the Benefits of Servicing Released Vs. Retained
posted on Wednesday, March 31, 2021 in Mortgage Partnership Finance
This was originally published on February 24, 2017, and has since been updated.
Our partners at the Federal Home Loan Bank of Topeka illustrate below how members may take advantage of the different servicing options available on sold loans.
For many financial institutions, deciding to retain the servicing on your secondary market loans is not always a financial one. Often it is viewed as a way to better retain hard-earned customer relationships. While servicing income may not be the first consideration in that decision, it is essential to understand the financial benefits of retaining servicing.
Generate Income Over Time
The main questions many ask are, "how is servicing income obtained,” and “what is the value of that income stream?" The answer to those questions are clear when servicing is sold along with the loan. You will receive a Service Release Premium (SRP) which represents the value a servicing aggregator is willing to pay for the ongoing servicing revenues. This option is generally referred to as a “servicing released” sale. Under a servicing released sale the primary benefit to the seller is that it enables you to maximize your upfront cash revenue received.
As an alternative, “servicing retained” sales provide you with an earning asset for which you will receive income throughout the remaining life of the loan. Given that the income is received over time, it may make the value more difficult to quantify, but the income is real and worth considering. Here is an example:
- Loan Amount: $250,000
- Interest Rate: 3.55%
- Term: 30-year Fixed
- SRP: 74 Basis Points (bps)
- Duration: 8.255 Years
The 8.25-year loan duration is based on the coupon and term of the mortgage and the interest rate environment at origination; recent rate reductions will extend the duration period. The duration is influenced by expected prepayment speeds and represents the weighted average time over which the servicing fees are expected to be paid. Of course, this income could be more or less than the example, based on changes in interest rates impacting how long the loan is on the books.
In the example above, a one-time SRP payment of $1,850 (74 bps x $250,000) is paid by the buyer of the servicing. However, if the servicing is retained, the loan will generate a life-of-loan servicing fee income of $4,685.43 ($250,000 x 25 bps servicing fee) based on the estimated 8.25 yr. duration of the loan. This comparison, when done using even just your last 12 months, provides a clearer picture of the income potential from retaining servicing.
In addition, the value of the servicing fee income received over time represents an asset for your institution. This is commonly referred to as Mortgage Servicing Rights (MSRs). Please see the Wilary Winn whitepaper Accounting & Regulatory Reporting for Mortgage Servicing Rights for a more detailed discussion of MSR valuation.
Beyond servicing income, when customers make their loan payments to you it maintains an ongoing relationship and communication channel. Leverage that contact to cross-sell additional products and gain more income from the relationship. Do they need a Home Equity Line of Credit, a boat loan or an auto loan? The borrower relationship maintained by mortgage servicing creates the opportunity for revenue from other financial products.
Impact on Operating Expenses
Another important consideration related to retaining or releasing servicing is the impact on operating expenses. Many people think that the “efficiencies of scale” of large financial institutions drive down the costs associated with servicing. While this can be true, a smaller operation may also benefit by leveraging existing staffing and core system functionality.
Smaller community institutions tend to have employees working within multiple roles, which translates to lower personnel costs. This means if you already service residential loans for your own portfolio, and then begin to service secondary market loans, you may be able to maintain personnel costs and increase revenue via servicing fees. In addition to the income from retaining servicing, you can also collect the ancillary revenue such as late fees and partial release fees.
You may ask yourself, with so many benefits to retaining servicing, why do so many financial institutions continue to sell their servicing rights? A few reasons may be:
- They do not want to service loans other than their own loan portfolio
- They like the upfront income when they sell the servicing, or they do not value the potential additional profit related to the servicing fee and ancillary fee income over the life of a loan.
- They are concerned government forbearance and mitigation programs will strain staff and system resources.
- They are unsure if their core system can accommodate the servicing and investor reporting of secondary market loans.
- They do not see customer relationship value through maintaining ongoing contact by retaining the mortgage servicing.
After evaluating all of the factors—such as the potential to generate income over time, the creation of an MSR asset, and more efficient utilization of staff and systems—your financial institution may decide the best strategic decision is to begin retaining servicing on secondary market loans.
Learn more about equal access to secondary market opportunities, no matter the size of your financial institution, by using the Mortgage Partnership Finance® Program or contact one of our Mortgage Relationship Managers.