Andrew Davidson & Co. Inc. (AD&Co) proudly sponsored the Information Management Network (IMN)’s 10th Annual Mortgage Servicing Rights (MSR) Forum, held November 21 - 22, 2024 at the New York Marriott at Brooklyn Bridge. Our servicing expert Richard Cooperstein moderated and I spoke on the panel “Leveraging Trended Data to Enhance Your MSR Portfolio’s Mortgage Prepayment and Credit Modeling.” This panel focused on enhanced consumer data, its impact on delinquencies and prepayments (as shown in our white paper), and the process to bring the data and analytics into decision-making.

Other panels at the event discussed a variety of topics, including the interest rate outlook, macroeconomic factors, climate factors, and their effects on prepayments, escrow, originations, delinquencies, new versus seasoned MSRs, MSR supply and demand, and rate hedging strategies and functionality. The panel discussions underscored the need for a deeper understanding and management of the interest rate and credit risks embedded in the federal mortgage servicing asset. Recapture and the importance of good customer service were recurring themes throughout the conference.

Cautious Optimism for the MSR Market

The overall sentiment regarding MSR assets was a cautious optimism: Despite being a complex asset class, the MSR market remains strong, and people want to buy. Many panelists took the view that due to full employment, a strong GDP, and expectations about the economy and a large and increasing deficit, interest rates in 2025 would see at most a modest decrease before rising again. However, this view was not universally shared, with some pointing to a potential economic downturn and increased defaults being hinted at by delinquency trends in auto credit being close to pre-Covid levels, and the subset of Covid forbearance mortgages that will ultimately default.

For borrowers who already have low mortgage rates, there is limited room for modification; it is interesting to note that one servicer mentioned having some mortgages in foreclosure even with low LTV. Meanwhile, some borrowers bought homes in 2023 hoping to ultimately refinance into lower rates, but the opportunity has not arisen (and might not anytime soon). Finally, due to climate factors and inflation, insurance in some areas is becoming increasingly unaffordable or unavailable. In some regions, such as Florida, some condominium owners are facing massive assessments. One servicer noted that with the current high home prices, most consumers facing high insurance increases can sell their homes. However, there is evidence that when insurance premiums rise to the level of 30-40% of principal and interest, delinquencies also begin to rise. AD&Co’s Climate Impact Suite (currently in beta testing) distinguishes between the effect of climate change on home prices (through Climate Conditioned HPA) and the effect of high premiums on borrower behavior (through Climate Conditioned LDM), with the first effect feeding into the second; if the CLTV remains low, high premiums lead to increased turnover, but if the CLTV becomes high, delinquencies increase.

Uncertainty and the Importance of Prepayment Forecasting

In general, and especially with the new administration coming in, uncertainty was a key theme throughout the forum. It was suggested more than once that the economy may have some curve balls. Regardless – and as always – the ability to forecast prepayment speeds is key for valuing MSR’s. Prepayments determine the total base fee collected on a mortgage, as well as the earnings on escrow and payment float, which have become larger and increasingly important components of MSR valuation due to higher interest rates.

For current coupon mortgages, much depends on the interest rate forecast. For low-rate mortgages, however, it's important to understand the economics of turnover (especially when no rate incentive exists) and predict which borrowers are more likely to prepay at a low rate, such as 3%. The overall low prepayment rate among this set could potentially rise due to a pent-up demand to move, especially with more firms pushing for employees to return to the office.

Many panelists spoke about recapture, which was a prominent theme of the conference: recapture refers to the situation in which the servicer retains the borrower by servicing the new loan as well. Some servicers account for recapture in their valuation, and some use models for predicting recapture rates. The necessity of providing excellent customer service arose in multiple panels as essential for increasing recapture and selling ancillary products while also reducing delinquencies and defaults.

"Know Your Data and Your Portfolio"

One panelist observed that, in the current environment, it is now more important than ever for servicers to “know your data and your portfolio”. The topic was addressed during the AD&Co-moderated panel “Leveraging Trended Data to Enhance Your MSR Portfolio’s Mortgage Prepayment and Credit Modeling”. David Doyle of Sagent first discussed some of the challenges in understanding the strengths and risks of potential MSR acquisitions, while Gauhar Turmuhambetova of BlackRock outlined the challenges of using dynamic credit bureau data in the valuation of securitized products. Bindiya Jain of Experian described the granular loan-level insights available on their platform and specifically within their mortgage performance dataset. Then I shared research that illustrates how Experian’s trended data attributes may be used to improve mortgage prepayment and delinquency forecasts beyond what may be inferred from a traditional credit score. I also demonstrated through AD&Co’s MSRKinetics application how these improved forecasts would affect the base fee and cost components of MSR valuation for sample GSE and FHA loans, as well as their weighted average lifetimes and duration profiles.

Overall, IMN’s MSR forum provided a rich opportunity to engage with participants in the MSR industry, learn about their views and needs, and explore potential synergies.

Tune in to Michelle Stepien Breier's interview with Alex Levin & Matteo Caracciolo-King as they discuss their latest Pipeline article “AD&Co Updates its Home Price Index Model.” The interview highlights key points from the article as they share recent updates to the HPI3 model. If you’re intrigued and eager to learn more, hit play or click the link to read the full article! 

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With the increasing volumes of Synthetic Risk Transfer (SRT) and Credit Risk Transfer (CRT) along with the discussion of BASEL III, we thought it would be useful to re-issue our comment letter to FHFA on the capital treatment of Credit Risk Transfer. 

CRT is not quite the same as either equity or debt from a capital perspective; however, capital rules often attempt to categorize them this way and then add ad hoc adjustments. Our comment letter addressed an appropriate framework for understanding the risk reduction impact of CRT transactions.
 

Recently, senior credit modeler, Daniel Swanson had the pleasure of speaking with Rob Kessel from the Panoramic Capital Academy podcast titled, “Modeler’s Perspective on Prepayment Modeling.”  This podcast is part of the curriculum in Panoramic Capital Academy's capital market course, an accredited 14-week class for capital market professionals, including hedging mortgage pipelines and valuing mortgage servicing rights (MSRs).  The discussion covered topics like data gathering, how to forecast speeds in an ever-changing world, validating results and how modeling evolved to include more loan-specific variables.

Click here to listen. 

About Panoramic Capital Academy and Consulting

Panoramic Capital Academy and Consulting offers an advanced mortgage capital markets training program, providing accessible and foundational education to the mortgage industry to accelerate careers, improve financial performance, and foster respect in the industry.  Panoramic also provides mortgage capital market consulting services.  

More information can be found at www.panoramiccap.com.

The earliest paper we found examining the impact of climate risks on house prices was from 2017, which found a relationship between elevation/sea level rise and house price differences.^[1]

We built our climate-conditioned HPA model in 2022 based on the idea that an increase in insurance costs would impact house prices (something we had not studied yet) in the same way that an increase of the same size in mortgage rates would impact house prices (something that we were quite familiar with).

The real world evidence for this relationship has been accumulating recently – on October 15, 2024 the Washington Post published an article entitled “Where climate change poses the most and least risk to American homeowners” which contains the following chart (which is based on an analysis of 2 million home sales in Florida since 2000):

We can see from the lines comparing lower and higher flood risk properties that until very recently, the housing market was not pricing for flood risk. But now there is a clear divergence in price trend.

For the particular case of Florida, there is reason to believe that this trend will strengthen in the near term: until recently, the only reason most people got flood insurance was that they were in a FEMA flood zone and they were required to buy a NFIP policy in order to obtain a mortgage. FEMA flood zone maps are known to be extremely outdated. However, with the accumulation of flooding incidents occurring outside those zones and the publishing of flood risk scores on Zillow, buyers are becoming much more aware of flood risk whether or not a property is in a FEMA zone.

Additionally, the state of Florida is gradually requiring all homeowners buying insurance through Citizens (its FAIR plan for homeowner’s insurance) to also have flood insurance regardless of flood zone status. This requirement started in 2024 for houses priced $600,000 and above, and by January 1, 2027, will extend to all properties insured by Citizens. At the end of 2023, Citizens was the largest insurer in Florida with 15% of all policies and over half a trillion dollars of insured properties.

Furthermore, the different post-event experiences of homeowners who have flood insurance versus those who didn’t is likely to encourage more homeowners – even those not taking a policy through Citizens – to add flood insurance to their property. So flood risk, at least in Florida, is getting closer to being fully priced into real estate values.

While the Washington Post article only discusses flood risk, all borrower costs matter to housing affordability – property taxes, homeowner’s and flood insurance, and the mortgage (leaving aside the psychological costs of nuisance events that don’t rise to the level of filing a claim). To truly capture the potential impact on both house prices and borrower behavior of all these rising costs, a fully climate conditioned approach, combining home prices as well as borrower behavior models (how will prepayment, delinquency, default and loss severity be affected?) is required. This is what our Climate Impact Suite offers.

 [1] https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3073842&itid=lk_inline_enhanced-template