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How fine-tuning MSR valuations can help lenders improve decision-making

Lenders cannot afford to wait until month-end or quarter-end to understand what is happening with their servicing portfolios

Over the course of the last year, the mortgage industry has seen increases in origination volumes and decreases in released servicing bids. This has caused servicing portfolios to grow to represent the largest single asset on many lenders’ balance sheets, making it critical to keep a pulse on the value of servicing rights.

Lenders reported significant origination volume in the first quarter of 2021, but as rates change and the market shifts to a more purchase-driven origination environment, lenders need to carefully monitor margins and profitability. If we’ve learned anything in the past year, it’s that operational flexibility and accurate servicing valuation are key to lending profitability.

Historically, mortgage servicing rights (MSR) have been valued once per month or once per quarter. With the recent increase in market volatility, lenders cannot afford to wait until month-end or quarter-end to understand what is happening with their servicing portfolios. Fortunately, with advanced technology and the proliferation of APIs, lenders can now apply the same forms of daily reporting and metrics to their servicing rights as they do to their loan originations.

Recently, solutions have become available that enable lenders and servicers to tackle pricing and portfolio management on various fronts. Companies ranging from small credit unions to large mega-servicers can benefit in multiple ways from having a detailed MSR valuation embedded in their daily processes. Using more accurate MSR valuations, originators can fine-tune pricing so they can be competitive without leaving money on the table or being undersold for less-than-timely MSR grids.

In addition, updating MSR values more frequently and leveraging them in pipeline analytics can help lenders produce month-end or quarter-end financial statements with a consistent MSR valuation throughout the process. Armed with this data, lenders can make smart decisions on whether to retain or sell servicing and introduce full loan-level transparency into their portfolio.

Determining MSR Values Beyond the Grid

An asymmetry in pricing can cost lenders and servicers dearly. Lenders often get a monthly or quarterly report from an MSR broker and use that simplified grid to determine valuation and decide whether to retain or release future loans based on this grid at a moment in time.

“Historically, the industry has tried to boil down MSR value by using grids or simplified assumptions, but that approach can be far from accurate,” said Rob Kessel, managing director, Black Knight Secondary Marketing Technologies. “If you don’t understand what different parameters drive servicing values, you’re not going to price loans correctly and incentivize production that you actually want.”

The challenge with using grids is that most loans do not fall directly on the grid line – they fall somewhere in between. For example, if a grid breaks down adjustments applied to servicing rights by $100,000 increments, it does not precisely tell you what happens with a $250,000 loan that falls between the tiers.

When a lender runs a discounted cash flow with broker assumptions, the number of basis points can vary in that gray zone between grid tiers. If lenders only use grids and simplified assumptions, they might inaccurately price the loans or make poor retain/release decisions.

Retaining the wrong loan can lead to not only poor MSR valuations in the future, but also to cash getting tied up in potential advances or early buyouts. Servicers could, theoretically, be overpaying upfront for a loan and inadvertently capitalizing the asset at a different value than what an MSR broker would value it at in the future.

Increasing Accuracy with More Granularity

There are several ways to solve the critical valuation dilemmas for lenders and servicers – each starting with simplifying complex data and providing more granularity and transparency. Access to integrations with MSR brokers, daily MSR pipeline and portfolio reports, data, and metrics can help lenders and servicers make smart decisions and remain competitive.

Black Knight, for example, offers a range of solutions that leverage Optimal Blue’s industry-leading product, pricing and eligibility engine and hedging capabilities, as well as the CompassPoint risk management, loan sale platform, and MSR valuation analytics to determine more precise servicing values.

Given the complexity and loan-value sensitivity of accurately calculating MSR valuation, Black Knight’s suite of MSR solutions connects data directly from a user’s servicing system or pipeline data to MSR broker assumption sets. Since brokers directly trade these assets, this direct connection to them is integral to delivering up-to-date data with game-changing market value accuracy.

“Having better information earlier in the process boosts financial performance and competitiveness,” Kessel said. “Leveraging broker assumptions and an advanced cash flow model can help lenders execute the retain or release decision more accurately.”

Servicers can now receive a daily snapshot that shows the impact of different milestones in the servicing relationship, whether that is a payoff request or a forbearance request. With full transparency into the servicing value, servicers can better understand the asset and value drivers, and use the information to make more informed decisions.

Simplifying Complex Data for Key Stakeholders

Managing servicing portfolios requires a broad range of data, analysis and experience to make the best decisions. Lenders and servicers have varying needs depending on the size of their portfolio, interests and the role of the person reviewing the data. A tiered solution can help address each company’s specific needs – with each tier providing more detail.

Executives, for example, often desire a simplified view of the servicing portfolio data in a snapshot format. This data quickly tells why the asset has changed in valuation month-over-month, two months back, etc. It also breaks the data down into a simplistic summary level that displays portfolio performance and the rate environment at that point in time.

Black Knight offers its MSR Pulse solution, which provides an inexpensive, daily report on servicing portfolio valuation using generic assumptions maintained by third-party mark providers. This solution is a popular choice for small credit unions and independent mortgage bankers (IMBs).

“Pulse helps bring dashboard clarity to the senior executive team, even people who wouldn’t normally dive into MSR valuation,” Kessel said. “It allows key stakeholders to get a high-level, bird’s-eye view of the vital factors that impact the financial health of their business.”

Leveraging Detailed Loan-Level Intelligence

As lenders grow their servicing portfolios over time, they often want more insight into making sure they are selecting the right loans to service, and how that impacts the performance of their pipeline. Not only do they want daily broker assumptions – they also want to start getting loan-level reports so they can gain more insight into what loans are increasing and decreasing in value materially day-over-day. They want the ability to explore scenarios such as what happens if delinquencies spike, or if prepayments slow down or accelerate, etc.

Secondary marketing departments also need to understand the servicing valuation differences between high/low coupon executions, tiers of excess servicing multiples and between remittance types, since the different servicing values will drive best execution decisions in addition to retain/release decisioning. 

Any originator that retains servicing rights can use tools like Black Knight’s MSR Loan-Level Pipeline to run loan-level valuations for pipeline marks and make retain/release decisions. This solution utilizes servicer-specific assumptions and prepayment settings administered by integrated third-party MSR mark providers to provide the information lenders need to make decisions as accurately as possible.

Taking a More Hands-On Modeling Approach

Servicers that want to take a more hands-on approach to managing their MSR portfolio but are not yet ready to manage their MSR assumptions can utilize tools like Black Knight’s MSR Portfolio. This solution provides daily, loan-level portfolio valuation with specific assumptions by MSR brokers and is leveraged by large servicers as part of their daily process. This includes daily MSR valuation attribution, eliminating month or quarter-end surprises, and providing regular scenario analytics related to valuation performance given future rate and economic changes.

Mega-servicers with experienced MSR valuation personnel who maintain their own assumption sets and prepayment model settings can take it one step further by licensing analytics through tools like MSR Pro. Servicers can leverage the same model that is used by the majority of MSR brokers but take over management of the model to run their own analysis. Their analysts will then be able to tweak and change the assumptions, handle all the data mapping, and create scenarios, reports and other custom tools.

Lenders and servicers that aspire to start looking at their whole business in a series of reports, or those that want to begin investing, can make it possible with today’s advanced analytics solutions. These solutions not only provide visibility to internal stakeholders, but they also make it easy to communicate financials to the whole ecosystem of counterparties involved in lending and servicing, including warehouse lenders, broker-dealers and agencies.

“All counterparties want to know that the other party is not surprised by changes in economic conditions. Especially with lenders and servicers that have a sizable portion of their portfolio in servicing, these solutions will enable them to be better at front-running changes in value,” Kessel said. “The more servicers and senior managers understand what drives the value of that asset, the more prepared they are to make the best strategic decisions.”

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