Who really owns it? Now tell the truth.

If you think the accounting scandals at Freddie Mac were noteworthy, read on. In the area of mortgage servicing assets which involves trillions and trillions of dollars, and in many cases represents the lion’s share of equity on a mortgage banker’s books, Freddie Mac seems to have created for itself a perfect license to steal by transferring this wealth from the mortgage banker’s books to its own without paying for it. It accomplishes this miracle by telling the federal courts what it apparently won’t tell its sellers/servicers.

Here are some questions and answers regarding mortgage servicing assets that should raise a few eyebrows, especially among mortgage banking attorneys, some facts that you won’t find in Freddie Mac’s Seller/Servicer Guide. Incredible as they may seem, I challenge any reader to prove any of these statements wrong.

Let's test your knowledge and have some fun:

Q. When a mortgage company sells a loan to Freddie Mac “servicing retained”, exactly what does it retain?

A. Absolutely Nothing.


Q. If this is so, then who owns the retained servicing spread?

A. Freddie Mac.


Q. Doesn’t Freddie Mac purchase loans on a “net yield” basis (note rate less the servicing spread)?

A. Allegedly, yes.


Q. Doesn’t owning the servicing spread in addition to the net yield mean that Freddie Mac owns the gross yield or note rate?

A. Yes


Q. If Freddie Mac only purchased the “net yield” how can it own the gross yield?

A. Because Freddie Mac says so.


Q. Does it say this in the Freddie Mac Seller/Servicer Guide?

A. Can’t find it.


Q. Can’t two loans of equal size and equal net yields have very different servicing spreads, for example, 50 basis points on one loan and 30 basis on another?

A. Yes


Q. So, Freddie Mac pays the same price for both loans yet owns the servicing spreads as well even though one provides a larger income stream than the other?

A. Yes


Q. Then, what is the true value of a Freddie Mac servicing contract?

A. It depends. To Freddie Mac it is the value of the servicing spread which it bought for the price of the net yield and can sell (and often has) for a nice premium. To the servicer it is zero.


Q. Why is it zero to the servicer?

A. Because the servicing contract is unilaterally written by Freddie Mac, can be terminated at any time by Freddie Mac for any reason, material or immaterial, and has no residual value upon termination.


Q. Doesn’t Freddie Mac differentiate between termination for cause and termination without cause?

A. Yes


Q. In a termination without cause, doesn’t Freddie Mac pay the servicer a termination fee equal to the present value of the remaining servicing annuity?

A. So it professes. However, upon information and belief, Freddie Mac has never terminated any service contract without cause.


Q. So, if most or all terminations are for cause, they must be for serious matters such as fraud?

A. Absolutely not. Cause is anything Freddie Mac says it is, material or immaterial. For example, Freddie Mac’s official position is that a one dollar shortage in a Freddie Mac custodial account is sufficient grounds for termination for cause. So is not having a paid tax receipt in a loan file (even though the taxes were in fact paid on time).

Q. So, if a company either created or purchased a Freddie Mac related servicing portfolio worth millions of dollars, and Freddie Mac discovered a one dollar shortage in a custodial account, Freddie Mac could terminate the contract for cause, sell the portfolio to another party and keep the proceeds?

A. Yes.


Q. Of course, the federal courts would never tolerate such insanity?

A. Wrong. Freddie Mac has already successfully argued this before the federal courts. All it has to do is say that it “perceives” risk.


Q. How can a terminated servicing contract have no residual value.

A. Simple. A servicer must execute a separate servicing contract with Freddie Mac wherein Freddie Mac “compensates” the servicer to service the loan. The “compensation” is in the form of the servicing spread (owned by Freddie Mac) which Freddie Mac allows the servicer to withhold from the borrower’s payment. If Freddie Mac terminates the contract, the servicer no longer services and therefore is no longer entitled to “compensation.” The servicer has no “equitable interest” in the servicing spread belonging to Freddie Mac and therefore has no residual value.


Here are some questions for the accountants:

Q. Is not the servicing spread the primary basis upon which a servicing asset is based followed by WAC’s and WAM’s?

A. Yes


Q. Then why does the accounting profession (FASB) mandate that servicing spreads i.e. the present value of the expected servicing income stream, be capitalized and amortized by mortgage servicers on their books?

A. Nobody told them who the real owner of the servicing spread is.


Q. Does Freddie Mac reflect on its books the gross yield (note rate) or net yield (note rate less servicing spread) on mortgages purchased?

A. Serious question. If it is the gross yield then aren’t trillions of dollars of servicing spreads are being double counted by being on the books of both Freddie Mac and the servicers. If it is the net yield, then on what basis can it claim to own the gross yield?


Q. Is it possible that Freddie Mac does not own the servicing spread as it claims???

A. Ask Freddie Mac