It seems like the market has been focusing on:
1) Government regulation that penalizes mortgage servicing rights as part of tier 1 capital,
2) Decreasing prepayments/foreclosures rates and as a result,
3) The rise of non-bank servicers.
Mortgage servicing rights are exactly what they sound, the right and obligation to collect payments from borrowers and send them to the ultimate investor/lender. Given the often rapid changes in the end investor, the servicer provides a key service, a middle-man keep payments going where they need to maintain documentation and provider certain advances/escrow servicers when in default.
This is not a glamor business. This area has existed for many, many years as many banks kept the rights themselves when originating mortgages (e.g. JPMorgan's 1.1 trillion unpaid principal balances (UPBs) portfolio of rights). LPS & OCN are similar stocks which, even during the housing bubble, were range-bound at best. What has changed?
1) Basel III regulations do not give full weight of MSRs to count for Tier 1 capital. (
http://www.jdsupra.com/legalnews/proposed-basel-iii-capital-rules-for-m…). Previously, banks could could 100% of the value of MSRs as Tier 1 capital. Now, then can only count 10%. As capital is precious and funding requirement increase now that MSRs don't fully count, there is now an artificially higher cost for banks to be involved in servicing mortgages. As a result, banks such as Bank of America have been exiting the business (http://online.wsj.com/article/SB100014240527023039182045774485601346173…). This is forced selling, pushing down price of such rights.2) MSRs are similarly, but not exactly affected the same way as mortgages proper. MSRs are paid 25-50 bps of the unpaid principal balance - regardless of prevailing interest rates. Now, there are other nuances to be had here, as prepayments from refinancing or foreclosures do affect it, as the fees are based off of principal. Both are moving down due to low rates and accommodation from fed/us govt (many sources for this). As a result, I believe it is reasonable to think such rights are at least as valuable as before.
3) Other non-bank participants have seen this coming, with the formation of NSM and growth of OCN (http://finance.yahoo.com/news/ocwen-wins-bid-buy-rescap-190917643.html) as non-bank servicers bid for such rights.
But how far has this trend gone? The JPMorgan acquisition at top is actually in the opposite direction. Have rights become valuable enough that banks are willing to take the capital hit? Does that mean the explosive growth of companies is over? (even after only say a 6 month run?)
Your three points seem to fly in the face of JPMorgan growing its MSR business.. what was their acquisition rationale?
JPM's purchase was probably a decent move. Despite the Basel III headwinds, it's quite obvious that mortgage volume in this environment is hugely elevated (just look at any banks' earnings right now), so they picked up a ton of MSRs that are unlikely to ever prepay (thus more valuable) for a business that's booming. Smart move.
Agreed - the 3 arguments above actually a little stale (beginning was 6-9 month ago) and JPM's purchase may signal that we are in the middle of the trade, i.e. when competition resumes sinces these MSRs are quite valuable.
It seems like JPM, with its 1.1 trillion+ MSR portfolio, seeks to remain in this business (unlike BAC), and has decided to use capital in this business (and therefore vertically integrated w/ its origination/securitization/distribution business etc.)
Any insight on the evolution of MSR trading on the non-bank (hedge-fund/PE) side of the fence?
not directly, though I would think it's tougher bc you actually have to service the clients and so need infrastructure. ASPS/OCN did that before (poorly) so not an easy task
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