Incenter’s Piercy, Dowell and Hamrick: Optimizing MSR Trades While Minimizing Risks

Tom Piercy and Bob Dowell are Managing Director and Managing Director, Analytics, respectively, of Incenter Mortgage Advisors, Denver, which provides trading and advisory services for mortgage servicing rights and whole loans. Contact them at tpiercy@incenterms.com and bdowell@incenterms.com.

Pamela Hamrick is President of Incenter Diligence Solutions, a provider of due diligence and document management services for the mortgage industry. She is reachable at pamela.hamrick@incenterms.com.

Mortgage servicing rights trading has remained brisk thus far in 2023. To help buyers and sellers capitalize on this important strategy while minimizing their risks, MBA NewsLink interviewed Tom Piercy, Managing Director, and Bob Dowell, Managing Director, Analytics, with Incenter Mortgage Advisors and Pamela Hamrick, President of Incenter Diligence Solutions.

MBA NewsLink: How would you characterize the MSR trading market so far this year?

Tom Piercy: It’s been robust so far–similar to what we saw in 2022, when volumes were exceptionally high and values increased in sync with higher interest rates. Lenders continue to offer large MSR portfolios of 2020 and 2021 mortgage originations, and the rights to service them are attractive to buyers because of their low prepayment risk. Buyer demand, in turn, is motivating sellers who want to increase their cash position or pare back MSR portfolio size by unloading some assets.

Trading itself is also changing. Technological advances are enhancing participants’ ability to optimize trading results, and act with more speed and agility. Throughout this process, though, due diligence is important for lowering buyers’ and sellers’ short-term and long-term risks.

Bob Dowell: MSR hedging has become increasingly vital. Fair Value accounting allows the MSR asset to be written up in line with interest rate increases, which have been significant, but MSRs must be written down when rates move down. Lenders are recognizing that loan origination profitability does not compensate for any writedowns in this current environment and hence, MSR hedging is the best alternative to lock into value and not take a writedown. When lenders have not switched to Fair Value accounting, hedging has allowed these asset holders to make that change. This gives them an immediate boost to earnings as they switch accounting methods, and also reduces earnings volatility.

NewsLink: What is different about risk management in the MSR trading arena?

Pamela Hamrick: Many different parties have jumped into MSR trading—from lenders and servicers to institutional investors and private equity firms. They’re entering a market with less defined due diligence and reporting processes than they’d find on the whole loan trading side. Whole loans, for example, can be traded utilizing a reliance letter. That standard doesn’t exist in the MSR trading world, and every buyer will have different criteria and risk tolerances, as well.

There are multiple risks associated with the history of the loans that buyers want the rights to service. These loans may have been originated long ago, when underwriting guidelines were different. Underlying files may also have mistakes and omissions that have been carried forward for years. During acquisitions, they could have been transferred from servicer to servicer with no-one noticing.

Uncovering those kinds of issues on the servicing side is particularly critical. Buyers do have the recourse of moving rights back to the seller, but everyone wants to avoid that hassle factor, not to mention the costs and lost opportunities.

NewsLink: What else do buyers need to account for?

Pamela Hamrick: When buyers are evaluating the quality of asset pools, the metrics that they prioritize will vary from lender to lender, or servicer to servicer. But gaining quick visibility into these characteristics within a defined trading window can be extremely challenging. One pool could combine loans from many different originators—with the documentation structured and reported differently from mortgage to mortgage. Data that is instantly visible on one document could be less obvious in another. Buyer diligence often involves plodding through hundreds of pages of “information blobs,” or an amalgamation of all these disparate loan documents. This is a significant hurdle to overcome. Many lenders or servicers simply don’t know what they have.

As a result, advance standardization of loan packages into one format is becoming a part of preventive due diligence. This is enabling buyers and sellers to identify, fix and cure problems on an ongoing basis, versus when they are under pressure (and could lose a deal) because of a narrow trading window.

NewsLink: What else is driving the focus on due diligence?

Pamela Hamrick: When parties are buying or selling MSRs, they are looking to improve their organizations’ financial performance. That always necessitates the right level of advance due diligence. A buyer, for instance, needs to rule out any issues with a file that could ultimately hamper their ability to collect if a borrower later defaults.

Lenders, and particularly banks, are under much tighter scrutiny now. They need to ensure that every loan has all the elements that regulators require for CCAR and other purposes. For example, it’s better for an originator to discover and cure missing or inaccurate loan data upfront, rather than have problems selling the servicing rights in the future.

Tom Piercy: There are timing issues with nearly every transaction from the seller’s point of view. Buyers need to perform within a certain timeframe in order to be able to work with them. One of the impediments to this process is sluggish timing on due diligence. Some buyers are now including more than one diligence provider in their arsenal to allow them to be proactive in purchasing the MRS assets, so that they can act with agility.

NewsLink: Switching gears, what excites you most about the evolution of MSR trading over the past few years?

Bob Dowell: The same level of digitization that has improved loan origination has been happening with less notice on the back end. Last year, the rights to loans with an underlying value of $1 trillion were bought and sold, and that helped to lift our industry. Technologies are expanding potential participants’ access to the marketplace. You haven’t asked about AI but that’s certain to influence both trading and diligence in the future, as well. We’re looking forward to the next chapter.

(Views expressed in this article do not necessarily reflect policy of the Mortgage Bankers Association, nor do they connote an MBA endorsement of a specific company, product or service. MBA NewsLink welcomes your submissions. Inquiries can be sent to NewsLink Editor Michael Tucker at mtucker@mba.org or Editorial Manager Anneliese Mahoney at amahoney@mba.org.)