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> > Residential Mortgage Servicing Rights Commentary







Robert Lee, Sr. VP
Capital Markets Group




        We continue to see significant variances in market rates among originators on both Agency eligible and non-conforming products.  Previously, mortgage market rates among the large participants have been fairly tight.  In the present market, we are seeing variances in base rates in excess of 25 basis points on Agency product and over 50 basis points in Non Agency product.  This market rate dispersion is furthering the confusion and widening the variances of opinion about collateral behavior on the MSR assets. 

       We have witnessed some unprecedented volatility in the current MSR market and the respective opinions on value.  Choosing base mortgage rates using secondary market rates and historical based spreads are creating extremely fast projections.  Utilizing a base mortgage rate based on Primary mortgage markets rates or incorporating the wider spreads between primary and secondary mortgage market rates would provide more muted prepayment projections.

       The current market is showing a primary base mortgage market rate that is over 100 basis points higher than secondary current coupon mortgage market rates.  Previous historical spreads between primary and secondary mortgage market rates was approximately 50 basis points.  In the current environment, if the analyst modeled using a base mortgage rate that applied these historical spreads off of the secondary mortgage rate, the result would be faster prepayment projections and lower servicing values.  Using wider spreads in the current market in calculating the base mortgage rate would equate to an approximate rate shock of 50 basis points and higher servicing values.

        Mortgage Servicing Rights (MSR’s) have dropped significantly due to the major drop in mortgage market rates creating significant increases in prepayment projections.  Earning rates have also declined resulting in reduced float income revenue streams.  Our Generic Servicing Asset portfolio (GSA) has dropped approximately 30 basis points or a full servicing fee multiple since September month end.  The months of November and December resulted in the greatest valuation declines of MSR portfolios.  January month-end results are expected to be flat to slightly higher than December MSR results.

GSA Portfoloi Price - Mult

       Properly valuing mortgage assets requires reliable and agreeable estimates of prospective borrower behavior for both voluntary and involuntary prepayments.  With the recent rally in the mortgage market, the interest rate incentive to refinance has dramatically increased.   Traditional, regression-based voluntary prepayment models are predicting dramatic acceleration of voluntary prepayments, however, these models were all calibrated in a real estate market with rising or flat real estate values.  A modeler should take caution when relying on regression based results at this time and should consider the restrictive impact of other loan attributes such as adjusted LTV.  In today’s falling real estate market, the ability of borrowers to refinance with CLTVs over 80% has significantly muted the market participant’s expectations for future voluntary prepayments.  This makes valuing illiquid mortgage assets such as mortgage servicing rights (‘MSRs’) and illiquid agency CMOs very daunting.

       Simply plugging in the current interest rate levels and relying on a prepayment model or market consensus prepayment projections to generate the collateral cash flows produces highly questionable asset valuations.  In some cases, prepayment projections may be too fast given the limited refinance opportunities for ltv and credit impaired borrowers.  On the other hand, prepayments may not be fast enough for top tier agency eligible borrowers that may qualify for mortgage rates some 100 basis points lower than where they initially took out their mortgage loan.

        We believe that the regression based prepayment models and the market consensus prepayment projections (Bloomberg or BMA medians) offer only a starting point from which to value the MSR assets.  In reviewing some of the prepayment projections, we noticed some discrepancies, for one, some of the medians included prepayment projections that have not been updated in months; yet are still being used in the calculation of the market consensus medians.  At other times, the variety of viewpoints can be significant with expectation of prepayment projections beyond a fifty percent variance.  With a little imagination, one can realize the variance of opinions on values based on prepayment projections alone. 

       Given the state of the market and the variety of views in and around collateral performance, the modeling of anticipated behavior requires the need of a solid analytical approach with a thorough understanding of market consensus expectations to accurately value assets.



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