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Mike Carnes , VP
Capital Markets Group
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Residential Mortgage Servicing Rights - Market Update
Mortgage interest rates continued their downward spiral this quarter with the 30-year fixed Freddie Mac survey rate falling to 4.19 percent as of October 14th. This is down 102 basis points and now reflects the lowest rate on record since Freddie Mac began tracking this data in 1971. The last 12-month high of 5.21 percent was achieved on April 8th. The fixed 15-year Freddie Mac survey rate (3.62 percent) and the 5-year Hybrid ARM (3.47 percent) are down 90 basis points and 78 basis points respectively over the same time period.
With rates at their current levels, the question is, “Do traditional prepayment rules still apply”? According to the Mortgage Bankers Association, the refinance share of mortgage activity recently surged by more than 20% and now makes up 83.1% of all applications. Certainly with rates this low, even those who recently refinanced may find it advantageous to do so again. The question is, “Can they qualify and are we running out of homeowners who can still benefit”? For the more severely constrained cohorts, the decline in primary mortgage rates from over 5.0% in April to 4.7% in June had little impact on voluntary prepayments. This begs the question, “Have recent capacity constraints forced lenders to prioritize closings and push the more problematic cases to the back of the queue?”
Regardless, one thing is certain, new purchase applications, despite being at their highest level since the beginning of May (following the expiration of the tax credit) continue to languish even behind last year’s dismal levels. According to the Mortgage Bankers Association (MBA), purchase activity remains well below levels seen prior to the expiration of the homebuyer tax credit and is almost 40 percent below the level recorded one year ago. According to news released by the National Association of Realtors on September 23rd Sales of existing homes were the second-lowest on record. Irrespective of the historically low rates, the number of potential home buyers is projected to stay at historically depressed levels. Weak market sentiment being fueled by market volatility and continued high unemployment is not very encouraging. High unemployment remains one of the biggest risks to sustained economic recovery and until the number of jobs begins to grow and consumers become less weary about a possible “Double Dip” recessionary period, buyers are unlikely to show necessary confidence required for a new home purchase.
Mortgage Delinquencies
According to the MBA, the delinquency rate for mortgage loans on one-to-four-unit residential properties dropped to a seasonally adjusted rate of 9.85 percent of all loans outstanding as of the end of the second quarter of 2010. While the figures remain high, the encouraging news is that this represents an improvement of 21 basis points from the first quarter of 2010. The delinquency rate includes loans that are 30 or more days past due but does not incorporate loans in foreclosure. The percentage of loans in foreclosure at the end of the second quarter was 4.57 percent which is a 6 basis point improvement over the first quarter of 2010.
The percentage of loans entering foreclosure during the second quarter was 1.11 percent, which reflects an improvement of 12 basis points over the first quarter. While the drop may not seem monumental, it is the first time since 2006 that the total inventory of homes anywhere in the process of foreclosure dropped. The percentage of loans that are 90 days or more past due or in some state of foreclosure was 9.11 percent, which reflects an impressive decrease of 43 basis points from last quarter.
The fact that 90+ delinquencies and loans in foreclosure dropped quarter over quarter is good news and points to the fact that a number of previously nonperforming mortgages have been modified and are now being classified as current. The bad news is that 30- and 60-day delinquencies are once again on the rise. After reaching a high of 3.77 percent in early 2009, and dropping to a recent low of 3.31 percent at the end of 2009, the percent of loans one payment behind is now 3.51 percent.
As a word of caution, while seasonally adjusted delinquency rates for fixed rate and VA loans saw a decrease, seasonally adjusted delinquency rates on ARM and FHA loans are still on the rise. Delinquency rates on Prime ARM loans currently stand at 13.75 percent and 13.29 percent for FHA loans.
Given the uncertainty surrounding seasonally adjusted data, looking at year-over-year changes is key. According to the MBA, the non-seasonally adjusted delinquency rate increased 71 basis points for prime fixed loans and 149 basis points for prime ARM loans from the second quarter of 2009. The delinquency rate was 107 basis points lower for FHA loans and 29 basis points lower for VA loans over the same time period. The non-seasonally adjusted foreclosure starts rate increased 4 basis points for prime fixed loans and 2 basis points for VA loans from one year ago. The starts rate decreased 78 basis points for prime ARM loans and 13 basis points for FHA loans.
Regardless of whether or not the seasonally adjusted improvement reflects a broader indicator of sustained market recovery, any sign of improvement is positive these days.
Mortgage Servicing Rights Values - GSA Pricing
On a monthly basis, MIAC simulates a hypothetical auction process by creating a select group of Generic Servicing Assets that collectively simulate the agency market cohorts at whole. Participating firms, which mainly represent large to middle tier servicers, submit Mortgage Servicing Rights values to MIAC for each cohort, reflecting what they would pay for a similar asset if offered in the marketplace today. As a participating member, firms receive beneficial market feedback that includes high, low, and median values and how member firms compare to each of these benchmarks. For the most recent month compiled, Agency Conventional 30-year cohorts with a weighted average note rate of 5.60%, an average age of 32 months, with a delinquency percentage of 5.25% generally ranged in the mid 2 to low 3 multiple range.
Mortgage Prepayment Speeds
As previously indicated, refinance applications are up substantially and should be reflected accordingly in modeled prepay behavior. That said, not everyone can refinance, which makes it increasingly important that firms incorporate revised loan to values into their valuation process. Not incorporating performance matrices such as Mark-to-Market Loan-to-Value (MTM LTV), vintage year, FICO, and geographic distribution can cause very imprecise prepay estimates. The Bloomberg caption below shows how speeds can vary widely between firms but only a true understanding of your underlying asset will produce the most reliable results.
Recent declines in secondary rates are being partially offset by a widening of the primary/secondary spreads. Although off its one year high, as illustrated in the table below, primary base mortgage rates are approximately 94 basis points higher than secondary current coupon mortgage rates. This compares to a historical average of approximately 55 basis points. In assessing a Mortgage Servicing Rights value, it is critical that one incorporates the true refinance rate as opposed to a secondary rate plus a constant spread; otherwise, one runs the risk of over inflating pre-pay speeds.
Mortgage Market Volatility
Shifting our focus from prepay speeds, weak market sentiment being fueled by market volatility and continued high unemployment continues to wreck havoc on earnings rates. High unemployment remains one of the biggest risks to sustained economic recovery. Until unemployment claims begin to show noticeable improvement, earning rates will likely remain fairly range bound. As evidenced below, attempts at recovery tend to be relatively short lived.
Conclusion:
Regardless of how conservatively or aggressively your firm chooses to value its Mortgage Servicing Rights, it’s highly recommended that you know your data and ultimately what assumption matrices must be assigned to produce reliable Mortgage Servicing Rights values. It is entirely possible that your values are either under-or over-valued and only a thorough understanding of your portfolio’s collateral attributes coupled with today’s market conditions will suffice in the determination of Mortgage Servicing Rights’ worth.
For those contemplating the purchase of servicing, consider the following: Beyond doubt, Mortgage Servicing Rights values remain at historically low levels, which creates one of the best buyer’s markets in history. From MIAC’s perspective, we believe prices for servicing have dropped to very attractive yields relative to the risk profile of the asset class. We believe the economics (forecasted cash flows) of Mortgage Servicing Rights are intrinsically worth more than current market values due to supply/demand dynamics and an overly risk-sensitive market. This holds true across all sectors including Agency and pockets within the higher touch sector such as Non-Agency and certain Ginnie Mae collateral pools.
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