Why Hedge Mortgage Servicing Rights?

Holding an asset on the balance sheet brings your institution revenue, but revenue comes with risk. A regular part of the mortgage origination business is creating Mortgage Servicing Rights (MSR) as institutions sell their production to one of the GSEs or private investors. Swings in the market can switch a profitable holding – like an MSR – into a loss. By appropriately hedging those servicing rights, your institution can protect itself against market movements outside of your control.

ALM First’s MSR Hedging Strategy

ALM First offers both risk measurement valuation and hedging solutions to reduce the impact MSRs may have on your institution’s financial statements. Together, we hedge this risk through the use of various financial instruments, including Treasuries (cash and futures), interest-rate derivatives, and MBS.

Benefits of MSR Hedging Service

  • Generate a variety of stress testing and scenario analyses
  • Identify market risks, shock scenarios, and returns
  • Evaluate the outcome of MSR values relative to different hedging instruments

Why Partner with ALM First for Your Mortgage Servicing Rights Hedging?

  • Fee-based Compensation: we don’t take commissions, and we have no incentive to push you into specific trades; all actions are for your benefit.

  • Capital Market Access & Expertise: we have a specialized Investment Management Group that interacts with the market all day every day. With over 250 clients across the country, ALM First manages over $20 billion in assets.

  • Hands-On Approach: monitoring and measuring the effective duration of the balance sheet and its components is crucial in intelligently managing the institution. We dynamically rebalance the portfolio; rather than a one-time strategy of buying options, we are frequently updating the position and structure of the hedges as rates move.

  • Advanced Resources: dynamically rebalancing requires the systems, the time, and the experience – all of which ALM First provides. Success demands continually assessing the market and executing the right trades at the right time. Your job should not be playing the market – and neither is ours. Instead, our strategy exists for the long-term growth and stability of the asset’s income stream.

  • Active Management: the focus of hedging is not providing a mean return, but providing portfolio stability. In the long-run, it could be that the portfolio performs well without any hedging included; the interim movements, though, can result in large income volatility. Management shouldn’t be in the position of explaining why income dropped millions over the course of a quarter.

Mortgage Servicing Rights Risk and Valuation FAQs

What is MSR Hedging?

Put simply, Mortgage Servicing Rights are the fees earned to service a sold mortgage loan. After originating a mortgage, the institution decides whether to hold the loan on the balance sheet or sell the loan to an agency or private investor. Should the institution sell the loan, it can then generate an MSR asset. By doing so, the institution agrees to service the loan while maintaining a portion of the interest payments (typically 25 basis points of the interest component). In addition, mortgage servicers earn the float off of escrowing taxes and insurance collected with borrower mortgage payments. Alongside the explicit earnings, the institution may implicitly earn a stronger relationship with the borrower.

How does MSR shield the institution from market swings?

While the sold mortgage is no longer on the balance sheet, the MSR asset is. As such – as with any originated asset – there exists risk. Rate movements impacting mortgage payments will dictate the interest income earned from that loan, and the reduction in interest income paid will negatively affect the servicer’s income stream. An MSR Hedge, therefore, protects the balance sheet from the high costs associated with dramatic swings in the market.

How advantageous is MSR?

MSR income typically is not its own line item on the income statement, and the costs are often embedded costs that aren’t easily visible. Movements in MSR earned income can be noticeable, of course, but measuring the exact impact of market changes on MSR income can be difficult, if not impossible, without the proper analytics. Moreover, acting on those analytics can be tricky and costly – the institution must have the time, personnel, and market connections to hedge these assets effectively. A sophisticated and involved partner is a must; ALM First is here to help.