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Neither rate volatility nor war has stymied the MSR market

MSR values remain robust even as the world copes with heightened upheaval

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Despite the global turmoil sparked by Russia’s recent invasion of Ukraine and the volatility in interest rates that has followed, the mortgage servicing rights (MSR) market remains on track to record one of its most dynamic runs in decades, according to multiple market experts.

That’s because even as mortgage rates have fluctuated in recent days, they remain well above mortgage rates in prior months — really years — when the bulk of the MSRs were booked. That means prepayment speeds will continue to favor sellers and buyers alike. 

In addition, MSR sales are a fast and sure way for sellers — originators and other holders of the assets — to raise cash to ride out the current volatile rate environment, as well as to address longer-term earnings pressures. In the year ahead, many lenders will need to adjust operations to cope with the still-anticipated long-term uptick in rates and the resulting move away from a refinancing-dominated market and toward a purchase market, MSR experts agree.

The value of MSRs, which represent a small slice of the interest rate on a mortgage, tend to increase in a rising-rate environment because higher rates stifle prepayment speeds. 

“For a while now [the concern] was inflation, inflation, inflation and now you throw in [Vladimir] Putin and a war, it creates a flight to quality, which pushes the ball back the other direction, and rates go back down,” said John Toohig, head of whole-loan trading at Raymond James. “So, there’s a lot of noise out there — talk about a whipsaw…. In my opinion, inflation is still the bigger issue, but for now you have these two conflicting forces.”

The conflicting pressures whipsawing the market currently are disconcerting on many fronts, but they also should be kept in perspective with respect to the MSR market and the dynamics that make it tick. 

“While the [rate] environment is scary, that’s the environment we find ourselves in now,” said Michael Carnes, managing director of the MSR valuation group at the New York-based Mortgage Industry Advisory Corp. (MIAC). “It’s kind of one of those things that if you don’t like it, wait five minutes, and it’ll change — like the weather.

“In the case of mortgage servicing rights, you have to remember that a lot of these MSRS being transacted today were 100 basis points out of the money, and if they [fall to] 85 basis points out of the money [because of rate volatility], they are still out of the money and not at serious risk for repayment. … Also, you’re looking at multiple Fed rate hikes this year, and the general market consensus is that rates will continue to go higher.”

Carnes added that 2022 is shaping up to be a record year for MSR bulk transactions at prices that “are very, very competitive” — with some deals commanding a price, calculated as a percentage of the MSR loan pool involved, that is up to five times the net servicing fee.

He said MIAC is looking at eight to 10 potential MSR sales deals over the next couple months, “and that’s a lot of volume, considering we’re not the only ones transacting MSRs.” 

In fact, this week alone, Carnes said MIAC expects to close two MSR deals with a combined value exceeding $6 billion. “One of them is a smaller $500 million government [Ginnie Mae MSR] deal, and the other is a $5.7 billion agency [Fannie Mae/Freddie Mac] deal,” he said.

The Prestwick Mortgage Group, an Alexandra Virginia-based MSR advisory and brokerage firm, so far in March has put at least three MSR bulk packages on the market, according to bid documents. Two of those deals involve 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 MSR deal, also being offered by an undisclosed seller — an independent mortgage banker — involves both Fannie Mae and Freddie Mac mortgages with a combined value of $640 million.

Tom Piercy, managing director of Denver-based Incenter Mortgage Advisors, said his firm completed a dozen transactions in January involving agency MSR loan pools with a combined value of $113.2 billion, which is close to what Incenter historically has sold in an entire year. As of late February, Incenter had put out to bid at least two additional MSR deals with a combined value of $24 billion and had another $40 billion worth of MSR deals in the pipeline. 

Although the overall impact of the current volatile market conditions is not expected to derail the exuberant MSR market, it is having an impact around the edges, according to Piercy.

“The war in Ukraine has created volatility across all global markets and specific sectors of each of those markets,” he said. “Here in the U.S., we have seen the Treasury market impacted as many investors, both domestic and foreign, have invested in the safety of U.S. Treasuries, which drives those rates down.  

“As we’ve seen U.S. Treasury rates — and, more specifically, 10-year Treasuries —move down, so have MSR values, but not significantly. The reason is that we have not seen primary mortgage rates move [significantly] during this volatile period in Ukraine, so this props up optimism on forward-looking prepayment curves.”

Piercy adds, however, that the instruments used to hedge MSR assets “are more volatile, hence the slight impact to price.”

Freddie Mac reported on Thursday, March 3, that the 30-year fixed-rate mortgage averaged 3.76%, down from 3.89% a week prior. A year earlier, the average rate on a 30-year fixed-rate mortgage was 3.02%.

“Geopolitical tensions caused U.S. Treasury yields to recede this week as investors moved to the safety of bonds, leading to a drop in mortgage rates,” said Freddie Mac’s chief economist, Sam Khater. “While inflationary pressures remain, the cascading impacts of the war in Ukraine have created market uncertainty. 

“Consequently, rates are expected to stay low in the short-term but will likely increase in the coming months.”

It’s difficult to forecast with a high degree of certainty the fate of the MSR market through the balance of the year, but one MSR expert who preferred to remain on background, predicted that it will continue remain healthy at least through the second quarter of this year.

Carnes has another take, informed both by the extremely favorable pricing levels for MSRs currently and the eventual need for some lenders to bolster earnings in what promises to be a diminished yet still healthy mortgage-production environment in 2022, compared with the 2021.

“Right now, people are taking advantage of being able to sell these MSRs at levels that we haven’t seen since prior to the financial crisis [some 15 years ago],” he said. “As we get later into the year, their reasons for selling might be for earnings purposes. 

“I don’t really want to make any predictions on the staying power of this type of [MSR deal] volume that we’re seeing today. But I do believe some combination of the eventual need for earnings [stability] and the ability to sell MSRs at substantial gains will continue to keep the market strong for the duration of this year.”

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