Stability? Servicing Values Continue to Flirt With All-Time Lows

You were expecting burnout this year? Thought the percentage of home loans originated to people refinancing an existing loan would finally start to fall? Once again, you might be jumping the gun if you thought the value of mortgage servicing portfolios was poised to rise early in 2003.

The industry's leading economists expect refinancing to account for almost 60% of loan originations this year, about the same as last year. That means a substantial portion of your portfolio is going to turnover, just like last year and the year before. And that continues to put a damper on the market for MSR portfolios.

With few trades actually reaching the market (Hamilton, Carter Smith & Co., Beverly Hills, Calif., was testing the market on current coupon deals as this issue of MSN went to press), lenders are looking for other ways to gauge the value of their portfolios.

Mortgage Industry Advisory Co., New York, has created an index of "Generic Servicing Asset" values to do just that. MIAC's index found that MSR values once again hit an all-time low in March as a result of low interest rates and prepayment pressure. Not a surprise, given that dealer consensus prepayment speeds were setting all-time highs for almost all asset classes.

According to MIAC's index, MSR values on most conventional loan portfolios for both 15-year and 30-year products fell below two times the servicing fee. The value of the MSRs on 30-year agency loans in March was a mere 1.7 times the servicing fee, according to MIAC.

Long gone are the days when MSR portfolios traded at multiples of nearly seven times the servicing fee.

The good news is that things improved a bit in April. The MIAC index showed that MSR prices rebounded a bit from their March lows despite continuing sub-6% mortgage coupon rates. But MIAC notes the index of servicing values continues to show "a downward oscillating trend over the last five months."

And if industry economists are right, the pressure might not come off of servicing values anytime soon. The Mortgage Bankers Association of America predicts that loan originations will total $2.6 trillion this year, with refinancing accounting for nearly 60% of that volume. Fannie Mae recently went a step further, predicting that loan origination volume may top $3 trillion this year, shattering even last year's $2.5 trillion record.

For mortgage values to stabilize and rise, and hedging risk to moderate, 30-year mortgage rates will have to edge up above the 6% level. An average 30-year rate of 6.5% wouldn't do much to dampen home sales activity, but it would do a lot to ease the pressure on loan servicing shops. However, most economists predict that mortgage rates will stay below that threshold for the rest of the year.

Still, rates will likely go up eventually. While that should reduce hedging pressure on loan servicers, it doesn't take the worry out of interest-rate risk management. Investors in MBS will have to start thinking about extension risk - as the duration of mortgage assets increases, some investors may find themselves holding securities backed by low-rate mortgage loans as prevailing interest rates start to move up. That could drive down the price on mortgage securities.

If it's not one thing, it's another, as "Saturday Night Live" newswoman Rosanne Rosanna-Danna used to say.

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