MSR Market Monthly Update - September 2024

Finally, inflation data signals that the Fed’s anticipated rate reduction action is coming very soon, and probably during their meeting in September. Mortgage rates have already dropped by about 48 basis points since July 31, 2024, and 65 basis points lower since the end of Q2. The industry has already experienced some robust refinancing activity since July 2024 which could continue as the market awaits the Fed’s announcement. The real estate industry is anticipating robust mortgage/housing activity once the Fed’s announcement becomes a reality.

The impact from lower mortgage rates and float income rates will have a varying impact on fair values. For certain, MSR fair values are expected to retreat from the previous month’s values. However, those changes will vary depending on portfolio vintages and other portfolio characteristics such as agency and GNMA mix. The MSR bulk market activity continues to show some pricing resilience despite recent declines in rates, however, MSR holders must remain diligent as the MSR market and values enter a period of declining rates and as the industry navigates through the Fed’s decisions and how MSR values are impacted.

Mortgage escrows are currently the second largest contributor to the overall MSR value as float income rates remain high. Escrow float income makes up about 10%-20% of the overall MSR revenue. However, depending on the Fed’s decision on rate cuts and the frequency of such cuts, MSR holders should anticipate some negative impact on the overall value in the range of 3-8 basis points. At the same time, anticipated increases in borrowers monthly escrow payments during 2024 and 2025 should offset some of the declines in values attributed to lower float income rates. Borrowers monthly escrow payments have increased by an average of about 15%-20% per year since 2022 and we should expect another 5%-15% during the next 18 months. The increases will have a positive impact on MSR values; However, the increases will further impact borrowers’ financial burdens that could potentially lead to higher delinquencies, particularly in regions where property values are very high. As an example, Florida borrowers have experienced a 15%-25% increase in their monthly mortgage payments due to higher hazard insurance premiums. The increases could also lead to higher escrow advances that servicers must prepare for which could impact operations, especially since most mortgage operations are generally already under financial stress.

Mortgage prepayments, though historically very low, continue to reflect steady and persistent upticks with 2020-2023 vintages that were virtually nonexistent prior to Q2 2024. We remain diligent and continue to monitor prepayments and delinquency trends, and we estimate that they will remain relatively low and manageable for the remainder of 2024. However, with mortgage rates heading closer to 6.00%, we estimate that agency loans’ prepayment levels will probably start rising at a faster pace and could increase over the next six months by 20%-40% from a current national average of about 5%.

Second mortgages and HELOC loan originations continue their growth, as well as non-QM originations. Recent indicators reflect 20%-30% quarterly growth in originations of such mortgage products. We anticipate this growth to continue through the remainder of 2024 and into 2025. Many lenders have already included such loan products in their product offerings. Investors continue to invest in non-QM MSRs and securities providing reasonable yields and returns. Growth in certain products within this segment, such the DSCR loans, as the real estate market has been shifting towards investment properties offering investors attractive solutions that the GSEs don’t currently offer. Performance trends for such products have been relatively positive and are expected to remain stable into the foreseeable future.

Recent MSR bulk and co-issue activities continue to reflect price resiliency and healthy demand for legacy loans and current production; However, Bulk MSR prices for 2023 and 2024 production have weakened since late Q2 due to lower mortgage rates. Although the MSR bulk market is expected to remain healthy and robust for the remainder of 2024. Co-issue pricing continues to remain competitive as low production persists for prime products. However, there are still opportunities that lie within less desired products such as low FICO scores and higher LTVs.

Recent bulk MSR trading values reflect levels of 5.0x – 5.30x multiples of servicing fees for agency loans, and it is possible that if loan production does not pick up significantly in the next two months, we could see higher bulk MSR prices during Q4, 2024 as buyers push to replenish their declining portfolio principal balances. Many potential sellers remain on the sidelines while there are large servicers interested in replenishing their portfolios’ fast declining principal balances. If mortgage rates continue to decline, sellers may opt to lock in their MSR gains before further mortgage rates deterioration.

As mortgage rates retreat, we continue to advocate for our clients to capitalize their retained MSRs at moderate values to avoid potential balance sheet exposure. Fair values are stable and are not as volatile or sensitive as market values are. Aggregator prices are market prices and represent the aggregators’ willingness to pay premium prices that are much higher than fair values for newly originated loans. There is a risk in using those same price levels to capitalize retained MSR assets at those high prices. Our weekly MSR grids are fair value based and the values are designed to mitigate potential market volatility and will ultimately produce higher returns if lenders choose to sell their MSR in the future. Capitalizing retained loans at higher multiples of servicing fees could result in potential future losses stemming from selling bulk MSR.

As of August 31, 2024, the current 30 Year base mortgage rate is 6.3696%, which represents about 48 basis point decline from July 31, 2024, mark. We anticipate existing portfolio fair values to decline by 2-7 basis points from their 7/31/2024 marks, depending on the underlying portfolio characteristics and vintage. While overall values should remain strong, most of value volatility will be concentrated within the 2023 and 2024 vintages as they are more sensitive to rate changes compared to 2020 – 2022 vintages. Almost all of 2020-2022 vintages have already reached maximum potential values and we should anticipate those values to soften as mortgage rates trend closer to 6.00%.

We also remind clients that while MSR fair values in basis points remain steady and strong, MSR dollar values are eroding at a faster pace because 2020 -2022 production have very low interest rates, therefore, as borrowers make their regular monthly payments, current scheduled principal payments make up approximately 40-60% of total principal runoff which includes portfolio payoffs. Most lenders are currently retaining only about 10%-30% of their production which barely covers the principal balance that ran off. This is the primary driver that is causing the dollar value of portfolios to continue to decline while the basis points values either flat or increase.

For portfolios that have a mix of Conventional and Government loans, we anticipate Fair Value changes as follows:

• Conventional loans between -2 to -5 bps change from July 31, 2024, marks.
• Government loans between -2 to -7 bps change from July 31, 2024, marks.
  • GNMA loans are experiencing a continuous uptick in delinquency rates which generally began in Q2, 2022. Due to the increase in delinquencies, we continue to monitor those trends and are consequently more cautious with our current GNMA fair value estimates.

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