Valuing mortgage servicing rights is tricky in normal times. The foreclosure documentation mess threatens to make the process even more difficult.

"It's just another whammy to the mortgage banking industry and the mortgage servicing assets," said Brett Schaffer, the president of Phoenix Capital and Phoenix Analytics Services, which provide mortgage servicing rights advisory and valuation services. "The servicing remains highly illiquid at historical standards. It's kind of hard to wonder … how much more illiquid it will become, but certainly this will add to it."

Schaffer and other industry experts say it's premature to determine how big of a hit the "robo-signing" scandal will have on servicing valuations. Much depends on how long it takes for servicers to address the problem.

"If this gets resolved in fairly short order within a month or six weeks and … there isn't any critical flaw in the mortgage servicers' practices in general, then I don't think it has really any impact," Schaffer said. "On the other hand, if it is determined that there is a material flaw and there is going to be long-term foreclosure halts, then it probably would have a material impact on those particular firms. It's not just a blanket statement for the market."

The latest industry saga erupted late last month, when Ally Financial's GMAC Mortgage said it was halting evictions and foreclosure sales in the 23 states where the process is handled by courts as it investigates problems with the way documents were executed. The issue was brought to light in the depositions of an employee who revealed that he routinely signed thousands of documents a month without verifying the information or having a witness present, which is required by law.

JPMorgan Chase  and Bank of America Corp. have since discovered similar problems with their documentation process. JPMorgan Chase has frozen foreclosures in 23 states, while BofA has stopped foreclosure sales across the country. The disclosures have set off a flurry of investigations by attorneys general. Lawmakers in Washington are calling for a federal probe.
The extent of the damage to valuations will vary depending on the servicer and the makeup of its portfolio. Where the homes are and how far behind the borrowers are on payments will be factors. In general, servicing portfolios with a high proportion of delinquent loans will lose the most value.

"It's going to be a problem for the [companies] that have a high exposure for highly delinquent loans because by extending the time lines they are going to have to borrow more capital to advance the position and they are going to have to incur higher costs because of the servicing and the higher touch," said Robert Lee, a senior vice president at Mortgage Industry Advisory Corp. in New York.

Servicing costs are going to rise regardless of how long it takes for the issue to be resolved, as companies hire employees to work through the documents and the foreclosure process is delayed. "You're going to have higher expenses. You're going to reduce your profit margin," Lee said. "With a lot of these delinquent loans, the servicer has to advance the payment. Now they are delaying the time line. They have to advance them and then it's nonrecoverable."

But the impact of those higher costs on mortgage servicing asset values may be minimal, Lee said, because many servicers have been conservative in their estimates. "Servicing rights themselves right now are weaker than where the cash flow values are," he said. Lee estimated the hit to most portfolios' value from the fallout of the documentation scandal will be less than 10 basis points. (Servicing values are expressed as a percentage of the unpaid principal balance of the loans in a portfolio.)

And it may be too soon for servicers to alter their estimates. Industry observers don't expect to get much detail in the coming third-quarter reports, since the issues only came to light a week before the end of the period.

The uncertainty hanging over MSR valuations could make it more difficult to sell portfolios — but, considering the current strain in the market, not much more difficult than it already is. "There just aren't sales going on," said David Stephens, chief financial officer and chief operating officer at United Capital Markets, a firm that provides MSR hedging services. "If you wanted to be a buyer and somebody needed to be a seller, you could do the deal with reserves" to cover the costs to the buyer of documentation errors. "But you would not be a seller today, particularly not the big guys."

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