Smaller nonbanks facing “come to Jesus moment” as MSR values dip 

FHFA issues advisory mandating third-party valuations of MSR assets

The year ahead for the mortgage-servicing rights market is shaping up to be a lucrative play for investors, lenders and others looking to purchase MSR assets. 

Independent mortgage banks (IMBs) leaning on MSR sales, however, now face a supply-demand imbalance, market observers say. That imbalance favors buyers and is expected to be a drag on MSR pricing that threatens to squeeze margins for already struggling IMBs — particularly the smaller players, regardless of whether they sell or retain servicing.

Driving home the concern over MSR pricing declines is a recent advisory bulletin issued by the Federal Housing Finance Agency (FHFA), which overseas Fannie Mae and Freddie Mac. The bulletin, issued quietly in mid-January, states that “although seller/servicers assign values to their MSRs, the enterprises [Fannie and Freddie] should have their own processes to evaluate the reasonableness of seller/servicer MSR values.”

“Seller/servicers and other market participants [including independent mortgage banks, or IMBs] may value MSRs based on differing model assumptions, levels of sophistication and strategic objectives,” the FHFA bulletin continues. “These differences can cause volatile MSR values. 

“For these reasons, the enterprise should not accept MSR valuations provided by seller/servicers without an independent evaluation.”

Nick Smith, the founder, managing partner and CEO of Minneapolis-based Rice Park Capital Management, sees the FHFA advisory bulletin as a positive development.

“People generally don’t like regulation and don’t like being held to certain standards, but they also don’t like the consequences of crashes, [which] hurt everybody,” said Smith, whose private investment firm is an active MSR portfolio buyer on behalf of institutional investors and others. “Insofar as the regulatory bodies are trying to create more stability and ensure that big players in the MSR market are responsible, stable, and have appropriate capital and liquidity, I think it’s great.”

FHFA in an email response to a HousingWire query about the advisory bulletin offered the following insight:

“This is the first such advisory bulletin FHFA has issued on this particular topic [MSR values],” FHFA’s email response states. “In terms of timing, FHFA has a statutory responsibility to ensure the safe and sound operations of its regulated entities. 

“Advisory bulletins describe FHFA’s supervisory expectations for safe and sound operations in particular areas and are used in the agency’s examinations of its regulated entities.”

MSR prices and the come to Jesus moment

Smith said the MSR market currently, based on unpaid principal balance (UPB), is about $14 trillion in total size, “which translate into about $200 billion of market value.” He added that the MSR market, according to his firm’s projections, is expected to grow by an additional $1 trillion UPB by 2025.

Rice Park Capital acquired some $30 billion in MSRs [UPB] in 2022, Smith said. The firm is in the process of raising $500 million from investors to acquire additional MSR assets in 2023, he added. 

Smith stressed that IMBs account for the vast majority of all MSR sales, and the numbers show their role as buyers in the market is diminishing, though they remain active sellers.

“We see the market opportunities as pretty compelling and are raising money into that opportunity,” Smith said. “Independent mortgage companies on a net basis bought $1.6 trillion in MSRs in 2021, and in 2022 they bought net $440 million [based on UPB].”

Most of the IMBs that we’ve spoken to I don’t believe fully appreciate the potential implications of the impact of MSR pricing as it may relate to their own margins.

Brett Ludden, Managing Director at Sterling Point Advisors

In addition, Smith stressed that, “Wells Fargo announced it intends to downsize [its mortgage footprint], and that’s likely going to create even more [MSR] supply.” 

“So, that creates a gap,” he said, “where there’s more MSR being offered than it appears there’s investment capital to match up against it.”

Smith said he doesn’t “envision a price crash” in the MSR market this year, adding that overall prices are still relatively stable — although well off the high points reached this past summer. He does believe, however, that a supply-demand imbalance exists in the market now, which “means that investors are going to be able to be very selective about what they buy, and they can buy a lot.”

A good market for investors, the buyers, however, usually means sellers, like IMBs, particularly smaller IMBS, are likely to suffer some margin compression as MSR prices moderate. If these IMBs retain servicing, the values of their MSR portfolios will decline in that environment as well, according to Brett Ludden, managing director and co-lead of the financial services team at Virginia-based mergers and acquisitions advisory firm Sterling Point Advisors. If they sell loans without retaining servicing, the value of the loans sold to aggregators also will decline if MSR values decline.

“Most of the IMBs that we’ve spoken to I don’t believe fully appreciate the potential implications of the impact of MSR pricing as it may relate to their own margins,” Ludden said. “If [MSR] prices keep dropping, at some point, there are a number of [mortgage] aggregators who probably have pretty high pricing on their MSR portfolios [currently] that allows them to offer very competitive pricing in the industry. 

“And the smaller companies [IMBs] sell to those aggregators, so as MSR prices start to come down, that’s going to put pressure on the margins of smaller originators.”

Smith said the top 15 or so IMBs — the public companies or those large enough to finance MSR purchases — already get independent reviews of their MSR portfolios and should not be impacted greatly by the new FHFA requirements. However, Jeff Juliane, also managing director and co-lead of the financial services team Sterling Point Advisors, added that moderating MSR prices are likely to lead many smaller IMBs to a “come to Jesus moment.” 

More than 80% of the top 1,000 IMBs nationwide — the bulk of the nonbank market — are expected to record $1 billion or less in mortgage production over the 12-month period through June 2023, according to a forecast prepared by Sterling Point Advisors. 

Only 10% of IMBs are expected to exceed $2 billion in originations over the period — which includes leading loan-aggregators like PennymacNewRez and AmeriHome Mortgage, among others.

“At some point in time, some of those very aggressive aggregators [in terms of MSR pricing] are going to have to come down on the MSR multiples [values] … which is going to create additional margin compression for the [smaller] IMBs that are selling loans to them,” Juliane said.

Ludden stressed that a dip in MSR pricing can impact any lender with an MSR portfolio, “depending on where they’re pricing their MSRs.” 

“What we know is that there are a handful of large aggregators where there’s likely some pricing challenges to come,” he added. “But then there’s a second group, which is all of the lenders that rely on these large aggregators for pricing, and while they don’t do any servicing-retained business, they are still at risk if [MSR] pricing starts to deteriorate.”

The window to burn cash is closing

Luddon said he believes FHFA’s recent advisory bulletin focused on the valuation of MSRs wasn’t issued at this time “randomly.”

“It came out right before yearend 2022 financials have to be shared with the GSEs [the government-sponsored enterprises Fannie Mae and Freddie Mac],” he said.

As previously reported by HousingWire, Ludden projects that up to 30% of the 1,000 largest IMBs will disappear by the end of 2023 via sales, mergers, shutdowns or failures.

[Some lenders] are burning cash, and I can see why they keep selling MSRs because they have to. They have to raise cash because you can only burn cash for so long.

Keith Lind, CEO of Acra Lending

Keith Lind, CEO of California-based non-QM lender Acra Lending, the mortgage origination arm of Citadel Servicing Corp., said he wouldn’t “be surprised if the number [of IMB mergers or exits in 2023] is even higher” than 30%. He added that it was a smart move for FHFA to require lenders holding MSRs to get third-party valuations.

“What you have to understand is when you go through a volatile year like 2022 [with rates jumping 3 percentage points in a matter of months], there are likely [lenders] miss-marking their MSRs to make themselves look profitable,” Lind said.  “I’m sure, unfortunately, that is going to happen.

“I think having a third-party evaluation is a good thing. It’s just as more transparency in the market.”

Acra only sells its non-QM loans servicing-retained and recently, according to Lind, “crossed the $5 billion mark on our [MSR] servicing book [of nonconforming/nonagency loans].” That servicing-portfolio figure has not been released previously to the media, he said.

“As a private company, we get outside valuations [of our MSR portfolio] because of our board and just for full transparency,” he said. 

“It’s hard for these little guys to stay in business,” Lind added, referring to the current dour mortgage market for originators. “The free money [from the refinancing boom] is gone, right?

“[Some lenders] are burning cash, and I can see why they keep selling MSRs because they have to. They have to raise cash because you can only burn cash for so long.”

Unfortunately, Lind added, the bid-ask spread for MSR transactions right now “is probably pretty wide.”

“If you’re a forced seller, you’re probably not going to love the price that you’re getting on your MSR,” he said. “But if you’re not a forced seller, it’s a great carry-trade [a financed asset purchase].”

Azad Rafat, senior director of MSR services at San Diego-based Mortgage Capital Trading, said the average yield on an MSR servicing book is in the range of 10% to 11%.

There are big originators and other investors in the market now with plenty of cash on hand and, Lind added, “They are going to buy more MSRs because they want to steal market share.”

“I think they’re going to take that opportunity,” Lind said. “You can get financing to buy MSRs, so if you’re buying a billion dollars in market value, you’re not laying out a billion in cash. You can get 70% to 80% financing for those MSR [bulk purchases].”

Smith of Rice Park Capital stressed that he believes the market can absorb the additional supply it is seeing now without a risk of “substantial declines” in pricing.

“But I do think that there is a gap [with supply exceeding demand],” he added. “I think the selling will be orderly, but there is a gap.

“That’s why people like us [Rice Park Capital], and others like us, are lining up additional capital, so that we can be a good partner to those who need to sell and provide them with the liquidity that they need, and then at the same time provide our investors with a return that we think is pretty attractive.” 

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