MSRs entitle the loan servicer to receive servicing fees for “servicing” a loan.  Loan servicing involves the logistics of collecting payments from the borrower(s), remitting those payments to the investor(s) that own the mortgage note(s), and other functions such as ensuring timely payment of property taxes and homeowner’s insurance for the underlying properties.  For government agency or government sponsored entity (GSE) loans, for example, loan servicers currently receive 44 basis points of the loan amount annually for Ginnie Mae-backed loans and 25 basis points annually for Fannie Mae and Freddie Mac conforming loans. 

Both the mortgage loan assets and MSRs are traded among investors in the secondary mortgage market, sometimes together and sometimes separately.  MSR valuation is often a complicated and esoteric topic, because MSRs are valued based on multiple criteria such as prepayment speeds (how quickly the underlying loans are expected to pay off), projected borrower delinquencies, and an individual servicer’s operating efficiencies, just to name a few.  In the world of MSR valuation, where multiple servicers have multiple sets of assumptions, there certainly is no consensus valuation for MSRs, and beauty is in the eye of the beholder.

As a result of the recent mortgage market meltdown and ensuing global economic crisis, the secondary market for trading MSRs has largely ground to a halt, with very few MSR portfolio trades of any significance occurring.  But that may be about to change, as a result of the recent Basel III accord on international bank capital standards.

The Basel III accord, with its multi-year phase in period, has language that radically alters capital treatment of MSRs for banks.  Currently, banks are able to count the value of their MSR portfolios 100% toward bank capital.  With Basel III fully implemented, it appears they will only be able to count 10% of the value of their MSR portfolios toward bank capital.

This tenfold reduction in the value of MSRs for bank capital purposes will have radical implications on MSR valuations and to whom those assets appear more beautiful.  It may also be the key that begins to unlock the frozen secondary market for MSR trading.  As these assets become less valuable to banks, and more valuable to non-banks and REITS (Real Estate Investment Trusts) whose capital standards are not federally regulated, it seems there may be a significant changing of the guard in terms of who the large servicers of tomorrow will be.  The bank mega-servicers, who currently hold several trillion dollars worth of MSRs, may have to start unloading these assets soon, and may no longer wish to purchase them, creating significant MSR trading opportunities in the near future.