In the last 100 basis point move in mortgage rates, servicer hedging needs have actually been rather muted, according to Barclays Capital.
In a report released late last week, analysts pointed out that convexity hedging needs of the MSR universe were close to zero, and that on moves of +/- 50 basis points, their needs are relatively small as their portfolio is mildly positively convex. However, activity could pick up if there is a greater than +/-50 basis point move.
Historically, servicers tend to be buyers of duration in a rally and a seller in a sell-off, but given the current convexity profile of the universe. "Servicers could actually be moderate sellers of convexity in a future rally," analysts said.
The prospect of becoming more positively convex if rates continue to rally should lead servicers to play a stabilizing role for the mortgage basis: i.e., sell in a rally and buy in a sell-off, Barclays analysts said, which would lead to a reduction in mortgage basis volatility.
Also contributing to a reduction in basis volatility, analysts added, is the Federal Reserve and the U.S. Treasury Department buying which has provided for a steady and significant demand source.
While MSR hedging effects are expected to be muted in the near term, analysts believe they could play a significant role longer term as issuance patterns and structural changes in the industry point to greater hedging.
For example, the composition of the mortgage market consists almost entirely of agency MBS issuance versus non-agency, and within agencies it is primarily all fixed rate.
They expect this trend of shifting away from non-agencies and hybrids into agency fixed-rate will continue. This shift "which is much more rate sensitive and negatively convex, should lead to an overall increase in the convexity of the MSR universe," analysts said.
