When it comes to forecasting MSR performance and valuations, much is made of the interest rate environment, and rightly so. But other loan characteristics also play a role, particularly when it comes to predicting involuntary prepayments.
So let’s take a look at what 2023 mortgage originations might be telling us.
Average credit scores, which were markedly higher than normal during the pandemic years, have returned during the first part of 2023 to averages observed during the latter half of the 2010s.
The most credible explanation for this most recent reversion to the mean is the fact that the Covid years were accompanied by an historically strong refinance market. Refis traditionally have higher FICO scores than purchase mortgages, and this is apparent in the recent trend.
Purchase markets are also associated with higher average LTV ratios than are refi markets, which accounts for their sharp rise during the same period
Consequently, in 2023, with high home prices persisting despite extremely high interest rates, new first-time homebuyers with good credit continue to be approved for loans, but with higher LTV and DTI ratios.
Between rates and home prices,borrowers simply need to borrow more now than they would have just a few years ago to buy a comparable house. This is reflected not just in the average DTI and LTV, but also the average loan size (below) which, unsurprisingly, is trending higher as well.
Recent large increases to the conforming loan limit are clearly also contributing to the higher average loan size.
What, then, do these origination trends mean for the MSR market?
The very high rates associated with newer originations clearly translate to higher risk of prepayments. We have seen significant spikes in actual speeds when rates have taken a leg down — even though the loans are still very new. FICO/LTV/DTI trends also potentially portend higher delinquencies down the line, which would negatively impact MSR valuations.
Nevertheless, today’s MSR trading market remains healthy, and demand is starting to catch up with the high supply as more money is being raised and put to work by investors in this space. Supply remains high due to the need for mortgage originators to monetize the value of MSR to balance out the impact from declining originations.
However, the nature of the MSR trade has evolved from the investor’s perspective. When rates were at historic lows for an extended period, the MSR trade was relatively straightforward as there was a broader secular rate play in motion. Now, however, bidders are scrutinizing available deals more closely — evaluating how speeds may differ from historical trends or from what the models would typically forecast.
These more granular reviews are necessarily beginning to focus on how much lower today’s already very low turnover speeds can actually go and the extent of lock-in effects for out-of-the-money loans at differing levels of negative refi incentive. Investors’ differing views on prepays across various pools in the market will often be the determining factor on who wins the bid.
Investor preference may also be driven by the diversity of an investor’s other holdings. Some investors are looking for steady yield on low-WAC MSRs that have very small prepayment risk while other investors are seeking the higher negative convexity risk of higher-WAC MSRs — for example, if their broader portfolio has very limited negative convexity risk.
In sum, investors have remained patient and selective — seeking opportunities that best fit their needs and preferences.
So what else do MSR holders need to focus on that may may impact MSR valuations going forward?
The impact from changes in HPI is one key area of focus.
While year-over-year HPI remains positive nationally, servicers and other investors really need to look at housing values region by region. The real risk comes in the tails of local home price moves that are often divorced from national trends.
For example, HPIs in Phoenix, Austin, and Boise (to name three particularly volatile MSAs) behaved quite differently from the nation as a whole as HPIs in these three areas in particular first got a boost from mass in-migration during the pandemic and have since come down to earth.
Geographic concentrations within MSR books will be a key driver of credit events. To that end, we are seeing clients beginning to examine their portfolio concentration as granularly as zipcode level.
Declining home values will impact most MSR valuation models in two offsetting ways: slower refi speeds will result in higher MSR values, while the increase in defaults will push MSRs back downward. Of these two factors, the slower speeds typically take precedence. In today’s environment of slow speeds driven primarily by turnover, however, lower home prices are going to blunt the impact of speeds, leaving MSR values more exposed to the impact of higher defaults.
The rapid decline of Silicon Valley Bank and Signature Bank affirms the strong need for daily interest rate risk measurement and hedging. All financial institutions should have well documented management and board limits on these exposures.
Measuring risk on complex mortgage-backed securities and loan portfolios that have embedded prepayment and credit risk is challenging. RiskSpan has a one-stop risk measurement solution for all mortgage-backed securities, structured product, loan and other related assets including data management, proprietary models and risk reporting.
Our bank clients enjoy the benefit of daily risk measurement to ensure they are well-hedged in this volatile market environment.
For a limited time, under full non-disclosure, RiskSpan will offer a one-time analysis on your securities portfolio.
Please reach out if we can help your institution more fully understand the market risk in your portfolios.
There are many lessons to learn through the SVB failure. While technology (the internet) enabled the fastest run on a bank in US history, technology can also be the solution. As we just saw US Government securities are risk-free for credit but not interest rate movements. When rates rose, security prices on the balance sheet of SVB declined in lock-step. All financial institutions (of all sizes) need to act now and deploy modern tech to manage modern risks – this means managing duration risk on a daily basis. It’s no longer acceptable for banks to review this risk monthly or weekly. Solutions exists that are practical, reliable and affordable.
The most highly attended conference in recent years brought together leaders from government, capital markets, and tech institutions to discuss the current state and future of the securitization markets.
SFVegas remains the optimal environment for fostering healthy dialogue aimed at making markets more efficient and transparent by creating innovative, new solutions. RiskSpan is delighted to be engaged in this dialogue.
Here are our key takeaways from the conference.
Sticky inflation and high interest rates are creating a macroeconomic environment that is particularly conducive to bringing new residential mortgage products to market. Market demand for HELOCs and other second-lien products is driving innovation around these offerings and accelerating their acceptance. ARM production is growing rapidly and is at some of the highest levels in over a decade.
Product Innovation is moving forward with both consumers and investors in mind. Consumers are in search of access to better financing while investors seek new ways to participate in these markets.
Data is driving the dialogue. New scoring tools (FICO10T and Vantage Score 4.0), new ESG-related data and better disclosures are creating a much more transparent investment process
Cloud-native applications continue to make analytics processing cheaper and differentiate how investors and their counterparties seek relative value. Efficiency in data management and analytics separates winner and losers.
Accelerated adoption of AI-driven solutions will drive market operational efficiency in the coming years. The adoption and use cases are just beginning to be uncovered.
New Investors, New Ideas
New investors are bringing fresh capital to the market with new ideas on how to maximize risk-adjusted returns. Investors backed by private equity are seeking new returns in virtually every category of structured markets: MSRs, BPLs and CLOs. Interest in these classes will only grow in the coming years as more investors seek to maximize returns in private assets.
The international investor community remains strong as global asset allocation is shifting towards the U.S. and fewer opportunities exist in overseas markets
RiskSpan sits at the intersection of all of these trends by helping structured finance investors of every type to leverage technology and data solutions that uncover market opportunities, mitigate risks and deliver new products
Great conference! Get in touch with us to learn more about how RiskSpan help clients simplify, scale, and transform their structured finance analytics!
Learn how to create a new Snowflake database and upload large loan-level datasets
The first episode of RiskSpan’s Snowflake Tutorial Series has dropped!
This six-minute tutorial succinctly demonstrates how to:
- Set up a new Snowflake #database
- Use SnowSQL to load large datasets (28 million #mortgage loans in this example)
- Use internal staging (without a #cloud provider)
This is this first in what is expected to be a 10-part tutorial series demonstrating how RiskSpan’s Snowflake integration makes mortgage and structured finance analytics easier than ever before.
Future topics will include:
- Executing complex queries using python functions in Snowflake’s SQL
- External Tables (accessing data without a database)
- OLAP vs OLTP and hybrid tables in Snowflake
- Time Travel functionality, clone and data replication
- Normalizing data and creating a single materialized view
- Dynamic tables data concepts in Snowflake
- Data share
- Data masking
- Snowpark: Data analysis (pandas) functionality in Snowflake