Finding Opportunities Amid an Improving MSR Market

If difficulty breeds opportunity, there may be untold treasures awaiting mortgage servicers, who are facing challenges unlike any seen since the 2008 housing market collapse. Of course, today’s challenges were caused by a global health crisis, not by any underlying systemic issues. But regardless of the cause, today’s crisis has created enormous volatility across every segment of the industry, especially the mortgage servicing rights (MSR) market.

It’s difficult to overstate just how paralyzing an impact the COVID-19 pandemic had on MSR values. Almost all trading activity came to a sudden halt in March 2020. Servicers that could afford to hold onto their MSR assets did so, while those that were experiencing liquidity issues and had no other choice but to offload MSRs did so, but only at bargain-bin prices. Even then, there weren’t many takers.

Today, a different picture is emerging. MSR values have recovered considerably, and large trades and brokered offerings are increasing. Optimism is returning to the market. To be sure, plenty of challenges and unknowns loom ahead. But so do prospects for growth, especially for those with the right approach.

Understanding What Happened

Prior to 2020, the MSR market had experienced several years of growth and activity. Buoyed by a strong economy and job growth, many different investors were active in trading these assets because of their high returns, especially independent mortgage bankers. Yet for some time before the pandemic, low mortgage rates had already begun to depress MSR values. It was only when the pandemic hit that values went into freefall.

The pandemic continues to be the biggest element influencing the MSR market. While low rates and high origination volumes have generally been welcome news, the Federal Reserve’s strategy of keeping mortgage rates low by buying bonds has led to record refinance volume as well as an increase in prepayments. According to data released by Black Knight in January, industry prepayment activity in December was up 11.7% from the prior month and 112% higher than the same time one year earlier. These trends have prevented MSR values from a full recovery. Both bulk and co-issue MSR market activity are still significantly below pre-pandemic levels for conventional loans and even further below for FHA, VA, and USDA loans.

Several factors have helped stabilize the MSR market in recent months. For most lenders that hold MSRs, the increase in origination volume has provided some cushion against lower values. Meanwhile, lenders looking for new avenues of business are looking for portfolios that have recapture opportunities. Another hopeful sign is the likelihood that interest rates will begin to slowly rise at some point in 2021, which will reduce prepayments and boost MSR values. There’s also hope that MSR valuations and liquidity will continue to rise as the pandemic lifts and borrowers who were in forbearance plans begin to recover.

Recently several large MSR deals have generated optimism. Ocwen Financial, for example, is investing in about $250 million in Fannie Mae and Freddie Mac MSRs with Oaktree Capital Management. In mid-January, Ocwen and Freedom Mortgage successfully bid on a $25 billion Quicken Loans portfolio. Meanwhile, the National Credit Union Administration is proposing to allow credit unions to buy MSRs from each other—although at the time of this writing, the proposal’s fate is unknown. In early January, MountainView announced it is brokering $3.5 billion in MSRs for Fannie and Freddie loans, most of which were originated between 2015 and 2016.

Independent mortgage bankers are leading the way. By the end of December, independent mortgage bankers comprised a majority of the market—56%—for owned single-family agency mortgage-backed securities, according to an analysis by Inside Mortgage Finance. All totaled, independent bankers were servicing more than $4 trillion of agency loans at the end of 2020, which was up 8.1% over a three-month period.

Where the Market Is Headed

MSR values are set based on the expected future cash flows from the underlying mortgage asset, so any risks to that cash flow—whether it’s the borrower paying off the mortgage ahead of time or failing to pay at all—will decrease the value. Right now, both of those risks remain high and will likely stay that way for some time, at least if rates remain low and the chances of borrowers becoming delinquent on their loans are present.

Even though foreclosure rates remain low despite the economic fallout from the pandemic—mostly because borrowers facing financial difficulties have been offered forbearance plans—the number of delinquent loans in December was up 79% from one year prior. Borrowers in default mean a reduction in cash flow and the value of the MSR asset. It also means the cost of servicing that asset grows, as it takes extra work to service delinquent loans while staying compliant with servicing rules that took place after the 2008 market collapse.

These risks are heightened for servicers that borrow money to purchase MSR portfolios, because the lender could make a margin call if cash flows fall. Major economic events can impact multiple servicers holding MSRs this way, which can lead to a system-wide crash in values. This is one reason why banks reduced the amount of MSRs they owned after the 2008 housing collapse.

Meanwhile, there is significant anxiety about the economy and what will happen to the large number of borrowers who will eventually be coming out of forbearance plans. According to the Mortgage Bankers Association, nearly 5.5% of all homeowners were in forbearance plans in early December. While this was a decrease from 8.5% six months earlier, new forbearance requests have been growing. Currently, an estimated 16 million people have claimed unemployment benefits or assistance through the Pandemic Unemployment Assistance fund for self-employed workers.

Yet another factor impacting the MSR market has been the level of financial support that’s been offered to servicers since the start of the pandemic. While housing agencies have offered help to servicers so they can make advance payments, so far, the federal government has held off on providing direct support, as private financing has largely been available to servicers. This could change, of course, if the crisis and its damage to the economy worsens.

New Opportunities for Servicers

Because MSR assets are difficult to value—and even more so today—buying and selling MSRs invariably involves risk. New entrants in the MSR market face other risks, as it takes significant time to gain approval from the GSEs to service loans in addition to the time spent ensuring the right operations are in place to manage them.

Typically, there are several strategies for reducing risk. One is to balance MSR investments by increasing purchase and refinance originations. Another is to sell pieces of the servicing work to sub-servicers. For the second option, obviously, it helps to partner with a company with experience in MSR and portfolio acquisitions as well the day-to-day management of large servicing. It can also help to find a partner that supports your business model and provides options when it comes to deciding whether to hold or sell servicing rights, and perhaps one that could potentially buy MSRs from you when you’re ready to sell.

The most trusted sub-servicers are those approved by all the housing agencies and Federal Home Loan Banks and have a history of using technology to streamline the servicing process. Lenders can use these vendors for both servicing and subservicing while retaining the option to subservice or sell MSRs on either a bulk or flow basis. The benefit of this strategy is that lenders can reduce operating risk that can arise when dealing with aggregators while realizing greater cash flow.

The value of technology when it comes to managing MSRs and keeping costs down cannot be overstated. Whether loans are paid off early or go into default, reducing the cost of servicing loans translates to greater profitability. A high-quality subservicing partner will typically have a technology platform that offers real-time visibility into loan status and performance through a secure lender portal and be able to leverage exception-based processing to identify data anomalies during loan boarding and over the life of the loan. These technologies have been shown to reduce servicing error rates by as much as 80% and borrower complaints by 50% or more.

A servicer’s technology should also extend to borrowers by letting them manage their loans online through any device, including mobile apps. These tools typically enable borrowers to schedule payments, request loan and tax documents, and receive help from customer service agents. In today’s environment, it’s important that borrowers have digital control of their loans and are offered complete transparency regarding their loan status and conditions.

For companies that hold MSRs or are thinking about investing in them, there is a lot to think about over the coming year. The bottom line is that there is likely more volatility in store, in addition to new challenges that we cannot anticipate. For any MSR market participant, it’s worth paying attention to the big picture and getting the right help when needed. After all, there will always be market hurdles—as well as rewards for those that overcome them.

Source: https://themreport.com/uncategorized/03-04-2021/finding-opportunities-amid-an-improving-msr-market

Donovan Larsen

Donovan is a columnist and associate editor at the Dark News. He has written on everything from the politics to diversity issues in the workplace.

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