Fair market value adjustments to mortgage servicing rights will continue to put downward pressure on earnings throughout the rest of 2016, according to a report from Kroll Bond Rating Agency.
Kroll estimated that trends in interest rates and other factors that have driven the unfavorable adjustments to MSR valuations will continue for the foreseeable future, the ratings agency said in its report on Thursday. But Kroll emphasized that blame for these troubles does not lie solely with the Federal Reserve.
"These are mostly self-inflicted wounds," Kroll said in the report.
The ratings agency traced the MSR-related pains to multiple sources. Indeed, Kroll conceded that the MSR-related issues were "yet another example of the downside of market manipulation by the Federal Open Market Committee."
But the FOMC's quantitative easing strategy doesn't fully explain why the total fair market value of MSRs has gone from $80 billion at its peak in September 2008 to roughly $36 billion in 2016.
Kroll, in part, laid the blame with traditional MSR buyers and newer entrants including BlackRock and Two Harbors Investment who "chased these obscure intangible assets to unheard of valuations" in pursuit of the big returns promised by distressed mortgages.
Beyond shooting themselves in the foot by artificially driving up the valuations of these assets, MSR holders also reportedly engaged in activities that created trouble for buyers.
"One big issue some investors have expressed to KBRA over the past year is the practice by sellers of MSRs of immediately soliciting the underlying borrowers for mortgage refinancings — in pools they've just sold to investors," KBRA wrote. "Needless to say, such practices violate standard industry terms and do little to bolster investor confidence in this important asset class — especially with prepayment rates already at high levels."
Kroll further noted that one issue contributing to the MSR-related risk is that investors have generally overshot how long the servicing would remain on their books, routinely assuming an average life of between six and eight years when it's closer to between five and seven years.
Looking ahead, the report noted that assessing the fair value of an MSR asset will become more subjective as the number of transactions for Ginnie Mae and conforming MSRs dwindles as a result of a lack of liquidity, capital or appetite for risk.
"A more conservative approach to valuation by investors, consultants and auditors is the solution to the excessive price volatility in the MSR market," Kroll said.
