At IMN’s Residential Mortgage Servicing Rights Forum today, a roundtable discussion on The Economy, Interest Rates, the MSR Market and its Supply/Demand Dyanamics and Cycle” underscored what the focus was when assessing MSR’s.
Mike Carnes, managing director at MIAC, put the value of outstanding mortgage servicing rights ( MSR’s) at 5.6 trillion. Of this, 2/3 were originated prior to 2017. “These loans are largely out of the money. Rates would have to fall substantially for these loans to refinance. Most of these people have had the opportunity to refinance and decided they didn’t want to.”
While interest rates affect MSR valuations, there are other factors as well. The shortage of housing supply across the nation over the last several years has created upward pressure on housing prices. What concerned Domonic Purviance, senior financial strategist at the Federal Reserve Bank of Atlanta, was the level of affordability. “ When housing becomes unaffordable that’s when we see adjustments on the type of mortgages being originated. We see downward pressure on affordability. The increase in rates at the end of last year caused a correction in demand which indicates we don’t have as much of a market as we once had in terms of affordability.” This would also explain why there is expected to be a 400% increase in non-QM lending this year.
“A couple of patterns that we see.” said Domonic. “Over the last two years as home prices have increased the mortgages originated have had a higher DTI ratio. Starting with 2014, we started to see a lot of the mortgages originated with a higher DTI start to go delinquent at a more rapid pace. If you look at FHA originations, 56% in 2018 had DTI of over 42%, a good portion had over 50%. That tells me that the consumer is taking on a lot of debt. As debt to homebuyers increases so does the DTI and so does the foreclosure rate. As interest rates go up consumers will be stretched and delinquencies will go up. That is the risk I’m concerned about. And increasing home prices just exacerbates this.”
The risk also seems to be layering. According to Mr. Carnes 24% of new FHA issuance is as low as 640 fico. So we are also seeing a slippage in FICO. There are also new non-QM loans being rolled out that are starting to offer alternative income options ( ie bank statement loans) and higher LTV’s.
To possibly address some of this, on March 15ththe FHA announced changes to its Total Mortgage Scorecard. While the exact nature of the changes hasn’t been announced, there are indications that loans with a 640 FICO or lower and a DTI of 50 or higher would need to be manually underwritten.
Another member of the panel , Edward Pinto, co-director and chief risk officer at the American Enterprise Institute, had this to say about the FHA’s move. “The good news is they took the step, the further good news is that they took the step during the boom, which is unusual, and they made it effective immediately, which is also unusual. From an MSR perspective this could be a significant event. On the positive side, it’s harder to refi a loan that has a 50% DTI or 630 FICO going forward. So there may be a slowdown in prepayments on the FHA side.”
Mr Purviance then restated his position on debt to income as the thing to be concerned about. “I’m more concerned about DTI than FICO scores because even if you have a good FICO score, if you had a high DTI and there is some kind of economic distress, you won’t have a good FICO for long. So the consumer overall, even if they have good FICO today, won’t have it tomorrow if their debt levels are high and you have economic distress. The GSE’s are also increasing their level of high DTI originations. The percentage is smaller than with FHA but it demonstrates where we are in the cycle. Home prices have increased while income hasn’t so the consumer has to take on a lot more debt to pay the bills.”
As for servicing values, Mr Carnes said that MIAC sees some FHA pools trading at 4, others almost being given away. There is a big disparity in FHA pricing, more so than the GSE’s, that is driven in part on the predictive models used to forecast default levels, models which use things like FICO, DTI, spread time of origination, has the asset been delinquent in the last 12 months, HPI, unemployment and other factors.