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MSR sector is a raging bull in a bear mortgage market

Mortgage servicing rights deals still offer plenty of upside in a rate-driven downturn in the broader housing market

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Fast-rising interest rates, up 1.5 percentage points over the past three months, have thrown a wrench into the mortgage origination and private-label securitization markets. Refinancing is plummeting, purchase activity is softening, and rate volatility is making secondary market deals harder to price efficiently across prime and non-prime/non-QM deals. 

In the face of all that dour news for the housing market, there is one bright spot — a sector that benefits from rising rates. That is the market for mortgage servicing rights (MSRs). 

As rates rise, MSR prepayment speeds drop — a byproduct of diminished refinancing activity. That, in turn, amplifies the value of MSRs because they pay out over a longer period.

“The focus on inflation and the attempts by the Fed to control inflation through their rate hikes has created upward pressure on mortgage-related financial instruments,” said Tom Piercy, managing director of Denver-based Incenter Mortgage Advisors. “As such, we begin to see prepayment curves adjust [downward] for both current par [mortgage] originations and the below current-par-rate vintages of 2020 and 2021.  

“This impacts origination volume negatively [particularly on the refinancing side] but provides for substantial pickup in value of MSR assets across all vintages.”

For Incenter, that “pickup” has translated into MSR transactions in January involving agency bulk offerings worth a combined value of $113.2 billion, which is close to what Incenter historically has sold in an entire year. (Agency deals involve Fannie Mae, Freddie Mac and/or Ginnie Mae MSRs.)

For February, Incenter traded just under $60 billion in agency MSRs, Piercy said, including two bulk deals involving Fannie Mae and Freddie Mac MSRs valued at $12.5 billion and $11.5 billion.

“There were no publicly offered deals through the firm in the month of March,” Piercy added. “We anticipate April to be another active month as we do have three deals in the queue for public offering.” Those are in addition to an already announced $7 billion bulk offering of Fannie and Freddie MSRs.

Incenter is not alone in tapping into the red-hot MSR market. The Prestwick Mortgage Group, an Alexandra, Virginia-based MSR advisory and brokerage firm, in March put at least three agency MSR bulk packages on the market, the two largest as part of a strategic partnership with San Diego-based Mortgage Capital Trading (MCT), according to bid documents provided to HousingWire. 

Two of those deals involved servicing rights on pools of Fannie Mae loans with a combined value of $610 million — a $242 million deal being brokered for an undisclosed Michigan bank and the other a $368 million offering by an undisclosed Pennsylvania bank. The third was a $640 million offering by a nonbank of Fannie and Freddie MSRs.

In addition, Prestwick has at least three additional nonbank MSR transactions in motion with bid due dates in April — a $1.6 billion Fannie and Ginnie Mae offering; a $520 million Fannie offering; and a $1.8 billion Fannie and Freddie package also being offered in conjunction with MCT, according to offering circulars.

“We’ve already seen about as much bulk [MSR] activity year to date [in 2022] as we saw all of last year,” said Michael Carnes, managing director of the MSR valuation group for New York-based Mortgage Industry Advisory Corp. (MIAC). “…In the category of seller risks, the possibility exists that certain buyers could blow through their entire 2022 [MSR] acquisition budget.

“I’m not suggesting that it has happened yet, but looking through my crystal ball, I’m viewing that as a possibility. As someone who’s transacted these deals for 30 years, I do know some of these buyers get refreshed budgets at the beginning of the year and have to go back to their investors for approval to get more, and they may very well be granted that approval, but it’s a consideration nonetheless.”

MIAC year to date through March had brokered at least five agency MSR bulk offerings valued in total at $8.8 billion, according to bid documents, including a $6.2 billion transaction in January and a $1.9 billion deal in March. MIAC has three additional agency MSR deals already on the market in April valued in total at about $6 billion.

“We’re also releasing a $1.8 billion [MSR] deal and a $3.6 billion deal,” Carnes added. “The 1.8 billion should come out later this week, and then we may push the 3.6 billion offering into next week. 

“So those are all coming to market within the next week and a half. …The volumes are just incredible.”

Carnes said the buyers in the market for these MSR packages include banks putting their deposits to work and well-capitalized nonbanks. 

Data provided by New York-based mortgage-data analytics firm Recursion, shows that year to date through the first week of April some $255 billion in agency MSRs were transferred between institutions, with nonbanks being both the leading purchasers and sellers.  

Banks acquired about $66 billion in agency MSRs sold by nonbanks ($54.1 billion) and other banks ($11.9 billion), Recursion’s data shows. Nonbanks acquired $188.6 billion in agency MSRs sold by other nonbanks ($179.1 billion) and banks ($9.5 billion).

The top MSR buyers over the period, according to Recursion’s data, were J.P. Morgan Chase, $39.7 billion; Lakeview Loan Servicing, $39.4 billion; Mr. Cooper, $30.6 billion and Carrington Mortgage Services, $24.5 billion. 

The leading MSR sellers over the first three months of 2022 included United Wholesale Mortgage, $25.9 billion to J.P. Morgan and $16.5 billion to Matrix Financial Services Corp.; Rocket Mortgage, $25 billion to Lakeview and $5 billion to Carrington; Freedom Mortgage, $22.2 billion in MSRs sold to three separate lenders, including $7.1 billion to Rocket; and Homepoint, $12.8 billion transferred to Freedom — which also was the leading MSR purchaser in 2021 at $143.4 billion in MSRs acquired. 

The MSR package sizes reflect the value of the underlying book of mortgages being serviced, not the actual sales price. In addition, the Recursion servicing-rights data reflect the agency-recorded transfer period and balance, not necessarily publicly announced sales volumes and dates.

“The tide is turning because you’re looking at origination revenue declining due to higher rates and lack of inventory,” Carnes said. “But as an offset to that, you’re seeing MSR values rise, and some firms are choosing to lock in those gains, while other firms are choosing to hold onto them [the MSRs] and rely on that revenue to help keep the lights on so to speak.”

Carnes and Piercy said, however, that there is a floor for the prepayment rate on mortgages that ultimately will affect the upward momentum of MSR values. Lower-rate mortgages at 3%, they explained, are no more likely to refinance (repay) if the prevailing rate is at 4.8% versus 5.3%, for example.

“Yes, we could see pricing begin to hit its ceiling when looking at just prepayment curves,” Piercy said. “For instance, most 2020 and 2021 conventional vintage [MSR packages involving mortgages at 3% rates or lower] have seen lifetime [prepayment] speeds drop to as low as 6% or 7% and more typically 8%. 

“The standard life of a mortgage asset without [rate-driven] refinance pressure is typically 8% over the history of data, simply due to relocation, divorce, death, etc.” 

That doesn’t’ mean MSR values are declining for those MSR offerings involving legacy loans, it just means “the rate of value-add starts to level off after a period of time, after interest rates [on older mortgages] are so far below prevailing market rates,” Carnes added.

“You hit a floor on what people will assume for their prepays because you’re going to what’s called normal turnover,” he said. “That said, I believe the next couple of quarters will be very strong for transactions.”

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