Fitch: Brexit Means More Pain for U.S. Mortgage Servicers

Already tired of hearing about Brexit? Sorry, there’s more–particularly if you’re a mortgage servicer.

Fitch Ratings, New York, reported the likely drop in U.S. mortgage rates following Brexit could hurt valuations for some U.S. residential mortgage servicers.

This comes on the heels of previous mortgage servicer rights valuation declines that already took place in the first quarter of this year.

Fitch said not all U.S. residential mortgage servicers could be impacted equally. Its analysis said MSR-holding entities with more interest rate sensitive portfolios would be likely to feel the Brexit effects in terms of earnings and the ability to finance MSRs. This would most likely manifest in accelerated refinance-driven servicer portfolio runoff. Fitch noted, however, that it does not include MSRs in its calculation of core capitalization ratios for mortgage servicers, so from this perspective the rating impact would be limited.

Independent non-bank servicers that do not have associated origination platforms (or where originations lack sufficient scale) and service mostly performing loans are most exposed to MSR volatility stemming from a lower rate environment where prepayments may be higher, Fitch said.

The report noted non-bank servicers are generally less active than banks in applying financial hedges against MSR valuation volatility risk, due in part to the required infrastructure to effectively employ a comprehensive hedging strategy.

“Servicers that also originate mortgages have a type of ‘natural hedge’ from the additional revenue brought in by the production of new loans, which may help offset MSR valuation declines,” said Fitch Managing Director Roelof Slump. “The ability of the originator/servicer to ‘recapture’ borrowers that are refinancing is crucially important. Also, some non-bank servicers specialize in servicing underperforming loans that tend to be relatively less responsive to mortgage market rate movements and therefore have less MSR valuation volatility.”

Prepayment rates would be most significantly influenced by Brexit, Fitch said.

“Holders of MSRs use either the ‘amortization’ or the ‘fair value’ method to calculate their MSR values,” Slump said. “The amortization method results in less volatility in earnings than the fair value method. If the latter method is chosen, the MSRs are measured at fair value each reporting period and the changes are reflected in earnings in that period. This can be impactful when mortgage rates move dramatically and MSR holdings make up a significant portion of an entity’s assets.”