NEW YORK--(BUSINESS WIRE)--Kroll Bond Rating Agency (KBRA) has released a new research reported entitled “Mortgage Servicing Rights: Rising Yields Are Good.” The report makes the following key points:
- Last August KBRA wrote about the dire state of the market for mortgage servicing rights or (MSRs) after years of zero interest rate policy by the Federal Open Market Committee. The stress in the market was caused not just by years of low interest rates, but also by the income statement volatility arising from fair value accounting for these volatile intangible assets. With the sharp increase in yields on Treasury bonds since October 2016, however, the average fair value of MSRs held by all U.S. banks has jumped sharply.
- Through Q4 2016 many large banks saw double digit increases in the valuation of their MSRs, but then took significant losses on the hedge meant to protect earnings from the volatility of these little understood payment intangibles. Adding to the confusion regarding MSRs, interest rates are not always the determining factor in short-term price swings. At the peak of “quantitative easing” by the FOMC, MSRs were trading briskly north of four times cash flow.
- By 2012, however, the more savvy buyers began to appreciate that the front-end opportunities of a distressed mortgage portfolio—the proverbial low-hanging fruit—were far better than the average for the pool. The MSRs that were once trading at 4-5 times annual net servicing revenue began to see a deterioration of market prices and liquidity. With the election of Donald Trump last November, however, the prospects for MSRs and the firms that hold them improved enormously.
- The strong rebound in pricing for MSRs seen in Q4 2016 may or may not endure in 2017. A big factor in that analysis is the direction of the 10-year Treasury, which in turn governs mortgage originations. With the uptick in the 10-year bond yield after last October, estimates for mortgage refinancing volumes plummeted and guesstimates regarding loan prepayments likewise fell, thus increasing the net present value of the estimated cash flows from the MSR. But if the 10-year bond rallies as 2017 unfolds, look for mortgage refinancing volumes to rebound and MSR pricing to fall as prepayment assumptions rise.
To view the full report, please click here.
About Kroll Bond Rating Agency
KBRA is registered with the U.S. Securities and Exchange Commission as a Nationally Recognized Statistical Rating Organization (NRSRO). In addition, KBRA is recognized by the National Association of Insurance Commissioners (NAIC) as a Credit Rating Provider (CRP)