More banks sell MSRs, a natural hedge

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The Financial Times makes an interesting point about mortgage servicing rights (MSRs): they can serve as a hedge to rough times in the origination and refi market. It's fair to say that industry has now stumbled upon hard times in both. Big mortgage banks like Wells Fargo, Citigroup and Bank of America are actively managing their capacity by downsizing as the market continues to deflate.

But higher rates aren't all bad if you own lots of mortgage servicing rights. It is hard to predict how much padding MSRs will provide. They represent the value of future fees that banks receive for servicing mortgages: handling payments, monitoring delinquencies, and so on. "Their value rises as rates do, because the servicing fees have a longer life when borrowers refinance less."

MSRs can swing actively in value, and banks often hedge them actively. "For example, in the second quarter, the change in the value of Wells Fargo's MSRs (driven primarily by mortgage rates) was $1.9bn, but net of hedges it was only $68m. Banks can, however, dial back their hedges when rates are rising."

As of now, one has to wonder if the market has changed dramatically enough to make banks reconsider their recent moves to sell of more MSRs. Wells Fargo among others have been open about their desire to sell MSRs as the regulatory capital situation makes them less desirable. Selling MSRs has emerged a risk-management best practice, it would appear.

The issue is how much would rates have to rise, all other things equal (a big assumption), to make hanging onto MSRs the better choice.

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- here's the article