June 26, 2024 | Updated | Premium Service | In this edition of The Institutional Risk Analyst, we provide notes and impressions on the IMN mortgage servicing rights (MSR) event in Dallas this week.
The first panel of the event featured a discussion with several issuers, who described how the competitive environment in Ginnie Mae servicing is being impacted by the prospective risk-based capital (RBC) rule that goes into effect at year-end. We wrote about the RBC rule in our most recent comment for National Mortgage News ("Ginnie Mae risk-based capital rule is unworkable").
Ginnie Mae officials seem to be preoccupied with the idea of MSR values suddenly falling when the FOMC cuts interest rates. History suggests that this concern is not well-considered as in 2020-2021, when prepayment rates jumped to 50% in a matter of months. What Ginnie Mae is essentially saying via the RBC rule, which requires issuers to subtract the excess servicing strip (ESS) from capital, is that they’d rather have issuers hold cash than MSRs.
It seems that Ginnie Mae officials would rather have issuers raise the net present value of the MSR in cash today than take the price risk of holding the whole MSR asset through time. The staff of Ginnie Mae do not seem to appreciate that MSR valuations increasingly reflect the value of future recapture of existing customers. As discussed below, the Ginnie Mae RBC rule is actually forcing MSR valuations higher.
Issuers that pay 6x or 7x price multiples for MSRs are doing so because of the proposed RBC rule. Only with assumed recapture rates of 50% of total prepayments do these valuations make sense, but that's tomorrow's problem. Of note, one speaker at the IMN event reported that more auditors are willing to accept the optionality of future loan recapture for the purposes of GAAP valuations of MSRs. This change alone has been forced by the RBC rule proposal by Ginnie Mae and is probably good for a 20% boost in MSR valuations.
Bill Greenberg of Two Harbors (TWO) repeated his view that people are wrong about "stress" on the MSR in a falling rate environment. The scenario that people think is most stressful, namely a falling rate environment, is actually not because there is so much cash sloshing around the system.
The more stressful scenario, says Greenberg, is a rising rate environment where issuers must post more margin on the hedges that they can get in cash from financing the MSR. Since the RBC rule lowers leverage on the MSR from 65-70% to just 50%, the Ginnie Mae proposal will actually increase stress and reduce liquidity for independent mortgage banks.