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 expense 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.

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