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Rising Rates Boost MSRs

At the end of the third quarter, the prevailing rate on 30-year, fixed-rate mortgages was about 50 basis points higher than it was at the beginning of the quarter. That's welcome news for loan servicing managers, who have probably tired of explaining "impairment" to corporate chiefs after a three-year refinancing binge.

And by all accounts, the third quarter shaped up to be a pretty good one for the mortgage industry at large. Not only did big servicers get to recoup some value for their mortgage servicing rights, but the loan origination side of the business did pretty well, too. That, in large part, is because of the substantial pipeline of loan applications that spilled over from the more robust lending environment of the second quarter into the third quarter.

But this wouldn't be a newspaper if we didn't dwell for a second on the downside of good times. Rising interest rates will make servicing rights shine, of course. But rising rates usually spell trouble for the home loan industry in the long term.

That's because rising rates will choke off new loan volume. In recent years, companies have dramatically expanded their capacity to make home loans, with the industry's biggest players routinely breaking their own records for loan origination volume. That has fueled high portfolio turnover but it has also, because of rising home values and increasing leverage, fueled dramatic increases in the size of servicing portfolios. Total mortgage debt outstanding, the most reasonable bellwether of the market, now exceeds $8 trillion. While the double-digit MDO growth of recent years may be over, most of the experts we talk to continue to believe that mortgage debt will grow at a pace greater than that of the economy as a whole.

Still, some of that growth may test the patience of servicing managers. Interest-only loans and adjustable-rate mortgages with payment options pose new challenges, both operationally and financially, for the servicing industry. Those segments of the market are booming. And with high housing costs continuing to dominate much of the American housing market, we suspect that innovative loan products that sometimes stretch traditional underwriting standards will continue to prove popular in the market.

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