Investing in an esoteric asset class is tricky

August 4, 2016

About the author

Noam Ganel, CFA is the founder of Pen&Paper, a value-oriented, contrary-minded journal of the financial markets. Between 2010 and 2020, Ganel worked for Silvergate as Vice President in Capital Markets. He provides advisory services to family offices,  private companies, and financial advisors.

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Mortgage Servicing Rights (MSRs) are an asset
that represents the right to service a portfolio of mortgage loans. Servicing
is the act of collecting and distributing payments. The value of an MSR is
dependent on assumptions, such as prepayment speeds, loan delinquency and
discount rates.
, a financial institution

Excess MSR and Basic Fees are key components. A
$10 million pool of mortgages, with 100 loans and an average principal balance of
$100,000, amortized over 30 years at a rate of 6 percent, pay a monthly payment
of $60,000. The owner of the mortgage pool receives $57,500 after the servicing
company collects 30 basis points, or $2,500 for the collection and distribution
of the interest and principal payments. A basic fee of $500, or 6 basis points,
is paid to the servicing company. The right to receive Excess MSR, at 24 basis
points, or $2,000, can be sold. 


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such as
. The company
acquired Excess MSRs on residential mortgage loans with an aggregate unpaid
principal balance of over $400 billion. This esoteric asset represents 58
percent of the company’s equity.

Supply-demand imbalance, attractive pricing and significant barriers to entry catalyzed New Residential Investment Corp interest in Excess MSR purchase. Banks need to sell MSRs due to regulatory guidelines. Because of the influx, attractive pricing is apparent. And the company boasted about its industry strong relationships. But it is one thing to purchase an asset; quite another thing to derive value from it.

The value in Excess MSR purchases is dependent on pricing correctly for prepayment and extension risk.  Prepayment risk is an uncertainty related to pass-through securities. Extension risk, a common concern in a rising interest rate environment, is the uncertainty that a pass-through security life will extend beyond expected maturity.

Whether acquiring Excess MSR is speculative in nature, or a sound investment practice for a Real Estate Investment Trust, is arguable. But there can be one consensus: former President Eisenhower, who signed the REIT Act in 1960, would be in awe of its evolution.