JUL 8, 2013

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What We're Hearing

Rate Rise Gives MSRs a Boost

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WE’RE HEARING companies with a large volume of mortgage servicing rights on their books may have some bragging to do as they report second-quarter financial results.

That’s because rising interest rates are lifting the value of MSRs they put on their books earlier in the year.

Tom Piercy, managing member at Interactive Mortgage Advisors, told me that the financial and reporting conditions for June 30 financial results “absolutely support some pretty significant increases” in the valuations of MSR portfolios. IMA provides valuation analysis for MSR portfolios and also brokers the sale of MSRs.

And even better news for servicing investors is that the marketplace is backing up higher estimates for servicing values.

“The bidding results that took place in the second quarter of 2013 were the best we have seen in five years,” Piercy said.

Rising rates reduce the prepayment speeds expected from mortgage loans, and that makes them more valuable by extending the expected life of the revenue stream.

But it’s not just rising rates that are helping to strengthen the MSR market. In the wake of the foreclosure crisis, MSR values plummeted as servicers struggled with the operational challenges of managing surging foreclosure volumes.

To top it off, the refinancing wave the followed the housing crisis also put downward pressure on servicing values.

But when servicing values fell dramatically, that attracted the attention of bottom fishers with capital to deploy. Those private equity sources believe the MSR asset has been undervalued, and they are in the market today hoping to capitalize on the prospect that MSR values will keep rising. That private equity capital has brought renewed liquidity to MSR markets, Piercy said.

This “nontraditional” capital that has come into the MSR market has led to a significant increase in the number of parties bidding on MSR auctions. Last week, IMA was preparing an auction that was expected to attract 10 to 12 bidders, he said. He said MSR sales have been consistently attracting 8 to 10 bidders lately.

Piercy said that the two major components of MSR values are prepayment speeds and default curves. With interest rates rising and default rates declining, that may bode well for servicing values for some time to come. Some of the new sources of private equity capital that have entered the MSR space were attracted in part by the conservative underwriting standards that apply to newly originated loans today.

“The feeling was that the default rate was going to slow considerably because of the tight credit box,” Piercy said.

Servicing rights typically are valued as a multiple of the servicing fee on the loans. During the crisis and ensuing refi boom, MSRs were trading at multiples as low as two to two and a half times the servicing fee, well below their historical averages.

Now, Piercy said that he is consistently seeing multiples north of 4 for newly originated product. Just four months ago, a multiple of 3.5 was more typical for conventional product, he said.

Private equity investors aren’t the only ones who have noticed that servicing values are rising. In recent years, some lenders that traditionally sold loans on a servicing-release basis had started retaining MSRs.

But now that the market value of that asset is rising, some of those new servicers have started to sell the asset again. Piercy said other originators that have been retaining the asset may also modify their strategy in response to the improvement in MSR prices.

Should we expect rates to keep rising? Freddie Mac’s weekly rate survey found a trough in the conventional, 30-year mortgage rate at 3.35% in early May, a stunning low for people who’ve been following mortgage rates as long as I have.

(According to Freddie Mac, the 30-year rate rose to 4.46% in late June, and that was the highest average rate in nearly two years.) A bump in the 10-year Treasury rate last Friday could put some additional upward pressure on mortgage rates this week.

Piercy declined to predict where rates are headed, but he said he thinks there remains some need for monetary stimulus to aid the economy, and that suggests the recent spike upward may taper off.

“I certainly don’t think we are on a trend that’s up. I think we may see some flattening here.”

Ted Cornwell has covered the mortgage markets since 1990. He is a former editor of both Mortgage Servicing News and Mortgage Technology.

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