Rising interest rates have slowed a recent run of unexpectedly high prepayments of government-insured mortgages, making servicing rights for loans held in Ginnie Mae securities more attractive to investors.
Many Ginnie Mae MSR bidders have been sitting on the sidelines amid concerns about faster-than-expected prepayments fueled by the Federal Housing Administration's streamline refinance and the Department of Veterans Affairs' interest rate reduction refinancing loan programs.
"We expect that once we see a couple months of reduced speeds on discount rate servicing, that market's going to improve," said Matt Maurer, managing director at MountainView Servicing Group, a subsidiary of MountainView Capital Holdings in Denver.
Correspondent originators have become more aggressive about soliciting borrowers through these programs, and home price appreciation has reached a point where more FHA borrowers have been able to refinance into agency products to avoid mortgage insurance premiums for the life of their loans. Agency prepayments, in comparison to Ginnie's, have been much more in line with investors' expectations.
Servicing rights become less valuable when borrowers refinance, move or otherwise pay off their mortgages faster than investors project because fewer monthly payments are collected over the life of the loans. But with mortgage rates higher since the November election, loans collateralizing all mortgage-backed securities may not prepay as fast and Ginnie prepayments could be more predictable.
"When that happens, buyers can be much more comfortable buying servicing," said Maurer.
Even a small increase in mortgage rates can dramatically cut borrowers' refinance incentive. For example, from July 11, 2016 to Feb. 22, the average rate charged by lenders for 30-year fixed-rate Federal Housing Administration loans increased to 3.56%, from 3.2% (excluding mortgage insurance premiums). That eliminated the refinancing incentive on 68% of the unpaid principal balance of loans held in Ginnie Mae securities, according to an analysis by FTN Financial and KDS Global.
When the average FHA rate was 3.2%, more than $1 trillion in unpaid principal balance had a refinance incentive of at least 50 basis points, including more than $482 billion in UPB with at least a 100-basis-point refi incentive. Now, less than $485 billion in outstanding UPB has at least a 50-basis-point refi incentive, including less than $242 billion that has at least a 100-basis-point incentive.
This shows that while higher rates offer more prepayment protection, the current mix of outstanding government loans is sensitive to small rate moves in either direction, said Walter Schmidt, senior vice president and manager of mortgage strategies at FTN Financial, a capital markets and investment services company in Chicago.
"If rates fall 30 or 40 basis points from here, we could see a big increase in prepays. I don't think the market is properly pricing that in," he said. "A lot of the servicing now resides with specialty servicers and if they have an origination arm, they could be quick to refi."
And some forecasts do call for rates to fall later this year.
"Once the capital markets come to appreciate that the promises of tax reform and fiscal stimulus by President Trump are unlikely to impact the overall economic situation, we fully expect to see benchmark interest rates fall," Chris Whalen, a senior managing director and head of research at Kroll Bond Rating Agency, wrote in a report.
Another factor that's making Ginnie Mae servicing rights more attractive to investors is a clarified contract designed to encourage the use of Ginnie MSRs as collateral for financings.
"I have heard that change by Ginnie is a big deal," Whalen said in an interview.
Lenders have indicated the new contract has the potential to improve the appetite for MSR financings.
"It definitely sounds like something that could open up that box a little more," said Danny Jasper, senior vice president in capital markets for Castle & Cooke Mortgage in Draper, Utah.
Even with the new agreement, the Ginnie approval process for MSR financings can take three to six months, said Maurer.
"It still takes a good amount of time for Ginnie Mae to provide approval on a financing line, so I think that'll help the market but I don't think that'll be the main driver of why the market improves," he said.
Some providers of financing secured by MSRs remain skeptical that the clarification offers much new certainty that Ginnie won't interfere with their claims to collateral, said James Reynolds III, managing partner of The Reynolds Group in Summit, N.J.
"They say nothing's really changed. From what I gather from the industry, there's sort of a wink, and a 'We'll take care of you,'" said Reynolds, who consults with companies that provide commercial financing to home mortgage lenders.
MSR financing is growing, but there can be deep haircuts on it and some banks "will not touch it" due to continuing concerns that Ginnie Mae could stake a competing claim on the collateral, he said.
The new agreement is a clarification that Ginnie won't interfere with financiers' rights to servicing — so long as Ginnie is given all the information it needs to be sure the bond payments that the agency insures flow through to investors.
Legally, the latest revision of the Ginnie agreement "incrementally ameliorates some of those concerns participants in the agreement have had about their rights to the servicing in the financing arrangement," said Nanci Weissgold, a consumer finance attorney in Alston & Bird's Washington, D.C. office.
The agreement has been revised multiple times in the past several years to address these concerns. During that time, MSR financing activity has slowly increased, but it's unclear whether the two trends are related, said Aimee Cummo, a partner in Alston & Bird LLP's New York office.
"There are more participants in the space than eight years ago, but it's a little difficult to say whether all of that incremental participation is a direct result of the acknowledgement agreement," said Cummo, who represents commercial financiers.