By Mike Carnes, Managing Director, MSR Valuations Group
One may think it is counter-intuitive to be discussing recapture at a time where primary mortgage rates are still hovering above 7%, but recapture is still playing a role in MSR pricing. With new production MSRs at historic lows, MSR participants see developing recapture capabilities as a mechanism to replace MSR portfolio run off and add incremental value to their MSR book. With the recent appreciation in house prices over the past several years, borrowers have ample equity as collateral. The recapture incentives are roughly divided into two categories. As market volatility permits, higher note rate MSRs (4.5% or higher) are being targeted for rate term refinance, while higher note rate but still out-of-the-money borrowers are being targeted for Cash Out Refinance. In instances where refinance is less likely, lower note rate MSRs are being targeted for Home Equity Lines of Credit (HELOCs). And although the lower first lien note rate borrowers are locked in, they can attain liquidity with the HELOC product.
One might be skeptical that a 4.5% mortgage would be a target for refinance, but firms specializing in recapture are having increased success with a cash out strategy for a 4.5% or higher borrower. Certainly, with consumer price inflation, many borrowers need to create liquidity from home appreciation. However, many borrowers believe that there is a strong probability that 5% – 6% rates can materialize. Borrowers trading a 4.5% for a 7% cash out mortgage, are likely contemplating a future refinance within a narrow horizon, based on the presumption that the Fed will lower rates as many anticipate they will. As the adage goes, “you marry your home, and you date your rate” so why not take cash out now and lower your rate later.
There are important caveats to consider however:
- Higher loan-to value (LTVs) and higher debt-to-income ratio (DTIs) have been demonstrated to cause higher default probabilities. The MIAC CORE™ involuntary/voluntary behavioral model captures this phenomenon with precision. The increased credit risk has negatively impacted MSR values. Many of the regulatory entities are likely monitoring the delinquency status for both potential over-valuation of MSRs and liquidity concerns of nonbank MSR holders.
- Depending on the MSRs being sold, some firms do NOT want to sell to firms specializing in recapture and/or desire to carve the non-solicit rep and warrant out of the purchase agreement. This is especially true with higher weighted average coupon (WAC) collateral which slowly but surely is finding its way into more and more transactions. A higher execution level (i.e., one that includes recapture benefit) has caused many firms to cave to this pressure, figuring the price was too great to ignore.
Current Pricing Levels:
Anyone feeling as though they missed the prime opportunity to sell MSRs last year is once again contemplating a sale. The US Treasury 10-year has risen approximately 75 bps since year-end 2023. Smaller, clean, low coupon Agency portfolios, categorized as less than $500M, might trade in the 4.75 to 5.00 multiple ranges. Slightly larger, but still lower coupon Agency offerings of $500M – $2B range, can garner prices ranging from 5.00 to 5.30 multiple. In a best-case scenario, Agency trades more than $2B, but preferably higher than $3B, can execute in the mid to high 5 multiple ranges. Like always, note rate, geography, average balance, borrow credit, pay history, and average escrow balance will determine the level at which a portfolio trades, or even if a portfolio trades.
Source: CNBC
Ginnie Mae MSRs are no exception when it comes to fairly attractive execution levels. Auditors can disagree to their heart’s content when it comes to the appropriateness of including recapture into a GAAP Fair Market Value, but there is no denying that recapture plays a significant role in how a portfolio is priced in transactions. A bidder might model the forward recapture behavior as involving several future refinancings. Hypothetically speaking, a servicer can refinance a borrower an average of 2.4 times over the term of the borrower/servicer relationship. This would present multiple opportunities to earn additional trading gains and theoretically increase the value of the underlying MSR through lower rates or higher balances.
What does this mean for execution price? For the right portfolio it means that Ginne Mae MSRs can trade in the mid to even high 4x multiple range, but sellers should beware. Not all portfolio sizes or credit profiles will qualify a portfolio to achieve that price, potentially resulting in a high/low bid range as much as a 1.5x multiple. It’s not that buyers of larger portfolios don’t see value in smaller offerings; it’s a matter of opportunity cost. A large buyer who might close four to six deals per month might view a smaller offering as an opportunity cost. The buyer may not want to fill up a transfer spot with a $300M deal when it can be filled by a $3B deal, so it’s critical that firms internally price their MSRs commensurate with comparable benchmarks.
In addition to the standard representations and warranties that traditionally accompany a sale of MSRs, sellers should be aware of other rep and warrant considerations, such as any loan secured by a mortgage property in the state of New York that regardless of its current pay status, was the subject of prior foreclosure action. In instances where a state’s regulatory environment favors borrower rights above lender rights, the risk and resulting expense of any elongated foreclosure action results in additional rep and warrants that might include potential repurchase should that borrower relapse and once again get 90+ days behind on their payment. Regulation pushed to the extreme can have unintended consequences in the form of fewer firms willing to do business in areas where risk can exceed the reward.
Before contemplating any MSR valuation or brokerage exercise, consider the following:
- In business since 1989, MIAC has been providing asset valuation services for 35 years
- MIAC’s team of MSR valuation experts is led by seasoned industry experts with a combined 50 years of MSR valuation and brokerage expertise
- MIAC’s MSR valuation team is made of up 11 professionals with the shortest tenured individual at nearly 7 years
- Not including other asset types, in 2023 MIAC valued residential MSRs totaling $64.65 Trillion in unpaid principal balance (UPB) for over 200 institutions
- In 2023, MIAC valued commercial mortgage MSRs totaling $1.7 Trillion for approximately 40 institutions
- In 2023, MIAC brokered $57.6 Billion and since 2021 has brokered or functioned as a buyside advisor for $560.2 Billion in MSRs
Author
Mike Carnes, Managing Director, MSR Valuations Group
Mike.Carnes@miacanalytics.com
Disclosures: MIAC prepared this material for informational purposes only. MIAC obtained this information from multiple sources believed to be reliable as of the date of publication; MIAC, however, makes no representations as to the accuracy or completeness of such information. MIAC has no obligation to update, modify or amend this information or to otherwise notify a reader thereof in the event that any such information becomes outdated, inaccurate, or incomplete.
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