Improving the Precision of MSR Pricing Using Cloud-Native Loan-Level Analytics (Part I)

Improving the Precision of MSR Pricing Using Cloud-Native Loan-Level Analytics (Part I)

Incorporating both credit and prepayment modeling into an MSR valuation regime requires a loan-by-loan approach-rep lines are simply insufficient to capture the necessary level of granularity.

Performing such an analysis while evaluating an MSR portfolio containing hundreds of thousands of loans for potential purchase has historically been viewed as impractical. But thanks to today’s cloud-native technology, loan-level MSR portfolio pricing is not just practical but cost-effective.

Mortgage Servicing Rights (MSRs) entitle the asset owner to receive a monthly fee in return for providing billing, collection, payday loans Lebanon Tennessee collateral management and recovery services with respect to a pool of mortgages on behalf of the beneficial owner(s) of those mortgages. This servicing fee consists primarily of two components based on the current balance of each loan: a base servicing fee (commonly 25bps of the loan balance) and an excess servicing fee.

The value of a portfolio of MSRs is determined by modeling the projected net cash flows to the owner and discounting them to the present using one of two methodologies:

  1. Static or Single-Path Pricing: A single series of net servicing cash flows are generated using current interest and mortgage rates which are discounted to a present value using a discount rate reflecting current market conditions.
  2. Stochastic or Option-Adjusted Spread (OAS) Pricing: Recognizing that interest rates will vary over time, a statistical simulation of interest rates is used to generate many time series (typically 250 to 1,000) of net servicing cash flows. Each time series of cash flows is discounted at a specified spread over a simulated base curve (generally the LIBOR or Treasury curve) and the resulting present value is averaged across all of the paths.

While these two pricing methodologies have different characteristics and are based on very different conceptual frameworks, they both strongly depend on the analyst’s ability to generate reliable forecasts of net servicing cashflows. As the focus of this white paper is to discuss the key factors that determine the net cashflows, we are indifferent here as to the ultimate methodology used to convert those cashflows into a present value and for simplicity will look to project a single path of net cash flows. RiskSpan’s Edge platform supports both static and OAS pricing and RiskSpan’s clients use each and sometimes both to value their mortgage instruments.

The latter is simply the difference between each loan rate and the sum of the pass-through rate of interest and the base servicing

Residential mortgages are complex financial instruments. While they are, at their heart, a fixed income instrument with a face amount and a fixed or a floating rate of interest, the ability of borrowers to voluntarily prepay at any time adds significant complexity. This prepayment option can be triggered by an economic incentive to refinance into a lower interest rate, by a decision to sell the underlying property or by a change in life circumstances leading the borrower to pay off the mortgage but retain the property.

Traditional MSR valuation approaches based on rep lines and loan characteristics important primarily to prepayment models fail to adequately account for the significant impact of credit performance on servicing cash flows – even on Agency loans

The borrower also has a non-performance option. Though not usually exercised voluntarily, forbearance options made available to borrowers in response to Covid permitted widespread voluntary exercise of this option without meaningful negative consequences to borrowers. This non-performance option ranges from something as simple as a single late payment up to cessation of payments entirely and forfeiture of the underlying property. Forbearance (a payment deferral on a mortgage loan permitted by the servicer or by regulation, such as the COVID-19 CARES Act) became a major factor in understanding the behavior of mortgage cash flows in 2020.

Weitere interessante Artikel...