The MSR market is hot … yet continues to be filled with idiosyncrasies

“Demand is high and values are up, so it’s a good time to sell,” could be one potential summary statement about the current state of the residential mortgage servicing rights (MSR) market. On the other side of the market, many buyers and holders of the MSR asset are saying, “yields are attractive and MSR financing is readily available, so it’s time to buy” or, “I need to keep those customer relationships, so I’m going to retain the servicing instead of releasing it.”

Those perspectives were underlying themes in Managing the Challenges of MSR Liquidity, a session on May 21 at the National Secondary Market Conference of the Mortgage Bankers Association. These themes surfaced continually in a panel discussion about an essential but small market within the residential mortgage industry – a market thriving with activity and filled with idiosyncrasies.

The panel for the session featured three representatives from advisory firms that value and trade MSRs for clients, as well as a representative from a bank that provides MSR financing. Among the panelists was Mark Garland, managing director of analytics at MountainView Financial Solutions, a Situs company.

Bidding activity is at a high point across Fannie Mae, Freddie Mac and Ginnie Mae MSRs. According to the panelists, this is visible in the number of bidders and in the bid levels.

“We recently traded a deal where 30-year conventional fixed-rate product went above a 5.5 multiple, and that would have been unimaginable six months ago,” said Garland, referencing the percentage of unpaid principal balance paid in relation to the average servicing fee that can be collected. “We also traded a Ginnie Mae deal that went above 4x, and that doesn’t sound as big, but it is a huge number.”

In explaining the current pricing levels and market activity, the panel reminded the audience of both active market participants and new market entrants that this is a thinly traded and somewhat opaque market in which a myriad of factors can easily cut values by 20-50%. A simple illustration of this point was a comparison of the To-Be-Announced (TBA) Mortgage-Backed Securities markets, where hundreds of millions of product is traded daily and where pricing is easily found through electronic reporting services, to the MSR market, where just $100 billion of product might trade in a year and where pricing is purely model based and further influenced by the selling counterparty.

Garland more specifically defined the MSR market as having 20-30 potential buyers on bulk deals and about 10 potential buyers for co-issue deals in which the servicing and loan are sold at the same time.

Among the high number bidders in the market is a somewhat even mix of operators and investors. Private equity funds and real estate investment trusts entered the market 6-7 years ago and continue to have a significant presence, while holders of the asset with legacy platforms continue buying to take advantage of their operational efficiencies. An increasing number of banks are also returning to the market, and their focus so far has been on Fannie and Freddie product.

In addition, the increased availability of MSR financing has made it easier to both buy and retain servicing. Warehouse lending facilities of $75-150 million are offered by a few banks, and there is some uncertainty about whether $500 million of financing recently provided by Freddie Mac would become more commonplace.

On the point of retaining servicing, the value of customer relationships seems to approaching historic highs at both banks and non-banks, according to the panelists. More loan officers are communicating a desire to retain the servicing in an effort to recapture clients at refinance opportunities, while bankers wish to maintain multiple financial relationships with their clients.

On the opposite side of this “customer first” approach, some banks are choosing to prune their servicing portfolios of customers who have only mortgages.

Other banks, according to Garland, have been selling servicing with deep-discount coupons – product with limited refinance incentive and that does not appreciate in value as rates go up. “Frankly, the horse has run, and now it’s much harder to hedge that servicing,” he explained. “Some banks have said, ‘Look, I want to keep what’s closer to par and sell deep discount, which so happens to be getting the best prices we’ve seen in the marketplace.’”

In closing remarks, the panelists commented on the importance of having complete data if you want to attract the highest number of bidders and the highest bid levels. FICO scores and loan-to-value ratios are among the critical data, and banks will require this data at a minimum for stress testing.