RSM McGladrey Conference

We See It: Working Together

Industry and Consulting Conference

August 19, 2003

Valuation of Mortgage Servicing

Recent Events:

FHLMC

FNMA

Cendant

Homeside

Countrywide

Valuation of Mortgage Servicing

FHLMC

� Independent outside auditors replaced

� Company understated pretax earnings by$6.9 billion in 2002 and recent previousyears

� Top three executives “ousted”

Valuation of Mortgage Servicing

FNMA

� Institutional investors concerned thatbillions of dollars of losses have beenobscured by accounting complexity

� Balance sheet not presented at fair value

Valuation of Mortgage Servicing

CENDANT

� $175 million after tax write down of MSRsin 3rd quarter of 2002

� Company had hedging program in place

� Write down due to incorrect OASassumptions in valuation model

Valuation of Mortgage Servicing

HOMESIDE/NATIONAL AUSTRALIA BANK (NAB)

� NAB acquires Homeside in 1998� NAB announces $450 million write down in July 2001� NAB announces additional $1.75 billion write down just

three months later� MSR’s purchased in fall of 2002 by Washington Mutual at

an apparent bargain price

Valuation of Mortgage Servicing

COUNTRYWIDE

� Countrywide announces $1 billionimpairment and amortization

� Stock price soars

Valuation of Mortgage Servicing

WHO WE ARE AND HOW WE CAN HELP

� Wilary Winn LLC formed in May 2003 to provide adviceto financial institutions in the middle market

� We provide independent fee-based analysis and advice

� We have actively managed billions of dollars of asset-backed securities through several interest rate cycles.

Valuation of Mortgage Servicing

MORTGAGE SERVICING RIGHTS (MSRs)

� MSRs are a modified interest only strip

� Many types of underlying loans

� Revenues and costs vary significantly bytype of MSR

Valuation of Mortgage Servicing

TYPES OF MSRs

� Conventional Conforming� GNMA – FHA & VA� Jumbo� Bond� Recourse and non-recourse

Valuation of Mortgage Servicing

MAJOR VALUATION COMPONENTS

� Servicing fee percentage� Expected loan life� Discount rate� Costs to service� Foreclosure losses

Valuation of Mortgage Servicing

MAJOR COMPONENTS OF REVENUE ANDEXPENSE

� Servicing fees paid monthly based on unpaid principalbalance

� Ancillary fees and servicing costs are generally based ondollars per loan

� Additional costs for delinquencies, foreclosures andadvances

� Additional benefits for float and impounds (escrows)

Valuation of Mortgage Servicing

VALUATION OF CONFORMING CONVENTIONAL

%

Value Change Change

Base 1.20

Prepayments increase 30% 1.05 -0.15 -12.5%

Servicing costs increase 30% 1.16 -0.04 -3.3%

Delinquencies increase 30% 1.19 -0.01 -0.8%

Discount rate increases 30% 1.11 -0.09 -7.5%

Valuation of Mortgage Servicing

VALUATION OF SUBPRIME HOME EQUITY

%

Value Change Change

Base 4.50

Prepayments increase 30% 3.89 -0.61 -13.6%

Servicing costs increase 30% 4.31 -0.19 -4.2%

Delinquencies increase 30% 2.89 -1.61 -35.8%

Severity increases 30% 3.03 -1.47 -32.7%

Valuation of Mortgage Servicing

Valuation of Mortgage Servicing

Orig.CPN Year WAC -200 -100 -50 0 50 100 200

5.0 2002 5.60 72.7 47.9 24.2 10.9 8.7 8.0 7.3

5.5 2002 6.04 72.1 59.5 38.9 19.2 10.4 8.7 7.6

6.0 2002 6.49 68.6 62.4 47.9 29.8 15.0 10.3 8.2

6.5 2002 6.92 63.7 58.3 51.5 36.8 21.9 13.3 9.0

7.0 2002 7.41 57.5 53.1 50.4 41.5 27.6 18.1 10.2

Orig.CPN Year WAC -200 -100 -50 0 50 100 200

5.0 2002 5.60 72.7 47.9 24.2 10.9 8.7 8.0 7.3

change from base (%) 567% 339% 122% 0% -20% -27% -33%

Change in mortgage interest rates

PREPAYMENT CURVE (CPR)

Valuation of Mortgage Servicing

30 Year Conforming Conventional Par Rate MSR Value

0.00%

0.20%

0.40%

0.60%

0.80%

1.00%

1.20%

1.40%

1.60%

-200 -100 -50 0 50 100 200

MSR Value

MSR YIELD CURVE AND NEGATIVE CONVEXITY

OTHER IMPORTANT VALUATIONVARIABLES

� Production channel – retail versuswholesale

� Current economic conditions in the region� Recent changes in home prices

Valuation of Mortgage Servicing

MANAGING THE RISK

� The Operational / Macro Hedge

� Hedge with positive convexity instruments

� FAS 133 implications

� “Frozen” Portfolio Approach

Valuation of Mortgage Servicing

IMPAIRMENT

� Basis versus Fair Market Value� “Excess” Servicing is treated as a true IO� Portfolio stratification must be based on one or

more of the predominant risk characteristics� FAS 140 and FAS 133 stratifications are probably

not the same� Impairment is best measured at the loan level

Valuation of Mortgage Servicing

RECOMMENDATIONS

� Mark to the model at least quarterly� Understand the major assumptions used in the

model� Run shock analyses at least quarterly� Understand the current market� Seek expert advice when needed

Valuation of Mortgage Servicing