In an Uncertain World, Here are Some Things You Can Count On…….or Why Retaining Servicing Rights Now
We spend a lot of time assisting clients with understanding the nuances of MSRs and developing an appropriate MSR roadmap unique to their businesses. This includes understanding the use of leverage and tax consequences when deciding whether to retain servicing or release it to an aggregator. Even in more normal times, there is a fair amount of subjectivity involved when arriving at loan level retain/release decisions. In fact, we have noticed lately that some questionable advice is being made on this subject by so-called experts eager to sell their new model, but that is the topic for another day.
No one knows where capital markets will shake out after the coronavirus threat subsides. However, it seems logical to suspect that spreads between Treasuries and mortgages will return to historical ranges and that actions by the Fed (especially the robust purchases of MBS seen in recent days and likely to continue) will lead to lower primary mortgage rates. Such rates to the consumer have remained high recently relative to the secondary MBS rates and the 10yr in large part due to industry capacity constraints. Regardless of the exact progression of rates, it would seem likely that lower mortgage rates are on the horizon as our great country digs out of the economic mess created by social distancing shutdowns. Hence the following are worthy of your consideration:
·Servicing portfolios with good loan quality generate material positive cash flow on a monthly basis, the ideal complement to loan origination activities over time.
In years such as 2020 where total origination volumes and profits are expected to be robust, the tax wedge associated with retaining MSRs is huge and should not be ignored.
Prepayment speeds are always material to MSR valuation and while rates could and likely will go lower in the near term, the relative risk associated with retaining servicing for the balance of 2020 is lower than normal.
Keep in mind that absolute prepayment speeds do not rise in a linear fashion as mortgage rates fall for several reasons, including burnout caused by industry capacity constraints. Also, smart operators have figured out how to use consumer-direct units as a portfolio retention tool, in many cases dramatically blunting the actual runoff rates net of recapture.
For IMBs, the liquidity risk associated with retaining and owning MSRs is real and must be managed. However, available financing is plentiful at this point in the cycle and not only helps manage the liquidity drain associated with not collecting the SRPs but also enhances ROE on the asset, frequently overlooked.
Not all servicing is created equal and working capital demands for servicing advances will rise in the coming months due to elevated (hopefully temporary) unemployment levels. For servicing such as GNMAs which are scheduled/scheduled remittance type, T&I and even P&I advances must be anticipated. While working capital implications for IMBs should not be overlooked these should be manageable for most companies.
Our advice in a nutshell? Consider upping your MSR retention percentage now and up it again if mortgage rates plumb new lows in the coming months. Odds are that aggregator pricing may cause your retention to increase naturally in the loan-level analysis because SRPs will likely be reduced in response to high volumes, etc. Again we are talking about adding a high-quality asset with an excellent cash-on-cash return profile, don’t be afraid to embrace it!
MorVest Capital is an advisory and brokerage firm focused on assisting clients with liquidity and capital solutions. We provide MSR brokerage services and state of the art MSR valuations and other analytics to bank and non-bank clients. MorVest is considered the leading industry expert on MSR finance and functions as both an advisor and principal on MSR facilities. MorVest provides MSR specific advisory services to a growing stable of outstanding mortgage companies.
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