Just a *brief* update on the MSR market from the BWFT trading desk:
In this note:
- With the current Risk back drop, what should you pay for MSR?
- MSR Valuations have come off materially/Excess valuations remain robust
- How much lower can mortgage rates go – Our opinion
- Attention Investors – Lock in Funding
1. With the current Risk back drop, what should you pay for MSR?
Top of mind for most MSR Investors is what the new pricing dynamics should be for MSR given the current backdrop for macro risk. From our perspective it comes back to:
a) do you hedge (and what do you hedge) – look at OAS?
b) what is your recapture rate?
c) What is your investment horizon.
MSR hedgers are likely to pay more for MSR as would those who have strong recapture capabilities. For those that have a longer-term investment horizon, the current backdrop provides a potentially compelling investment opportunity.
2. MSR Valuations have come off materially/Excess valuations remain robust
With short term rates hovering around 30 bps and the forward curve pricing even more easing, the float component to MSR has been under tremendous pressure. MSR valuations from the January high are down approximately .75 of a mult, or more. Most of this move is attributable to float. On the other hand, Excess valuations have held up much better given the drop in yield (see above).
3. How much lower can mortgage rates go – Our opinion?
For the sake of this somewhat pedantic analysis, we need to start with a few assumptions.
• Call average loan size 300,000.
• Call cost to originate 9,000 (approx. $ from MBA)
Let’s add up the details:
Cost to originate: Cost to originate 3% (9/300). If the duration is 4, then cost component is ~75 bp.
+ Originator margin: Originators will temporarily run at negative gain on sale, but historical low operating levels have been ~35 bp.
+ Servicing of ~ 25 bp
+ Guaranty fee ~44 bps
= 1.79.
1.875 is what we would call the lower threshold on the primary rate given all the information that we currently have. For that $300,000 loan made new at 2.75%, 30yr fixed the payment is $1,225. Should rates drop to 1.875% that new payment is ~$1,090. The savings of $134/mo would take over 5.5 years to pay back if we assume 3% consumer cost to close. How many borrowers know for sure they plan to be in their current home for over 6 years? How long do mortgages get as a result? ….and, MSRs? (recall late 2018 when we were debating whether 6cpr/100psa was still the long-term floor?)
Implications:
If primary rates are bounded from below, producers of MSR that do not retain should look to sell – this MSR will likely be on their books for a long time. On the other hand, for those that do not sell, buying and holding should look advantageous. BWFT provides liquidity through our buyers in both GOVT AND CONVENTIONAL MSR, currently providing compelling bids.
4. Attention Investors – Lock in Funding
Is it time to look at that other risk? For those that have msr or excess on balance sheet, BWFT believes that locking in advantageous funding as we meander lower in interest rates is something investors should look at.
Do we mention locking in funding rather than defending refi risk? BWFT spends an enormous amount of time and energy particularly in the area of MSR-line funding risk.
All MSRs should be positively convex here. For our part we believe that monetary policy adjustments by cutting rates is NOT the solution. We believe instead that concerted fiscal stimulus and tax relief should be undertaken in an unprecedented and deliberate manner. Our strong belief is that the recent market turmoil will be transitory.
Contact Information
Alan Qureshi, Managing Partner
aqureshi@bluewater-fintech.com
Travis LaMar, Managing Director, Capital Markets
tlamar@bluewater-fintech.com