by Dr Thomas J Healy, CMB

MSR Negative Convexity

Wednesday, April 27, 2022

Servicing values (Y-axis) tend to rise as rates go up, and fall as rates decline (X-axis).  The resultant slope of this curve, however, changes dramatically depending on where we are in an interest rate cycle. 

An MSR portfolio that was ABOVE market coupon in September 2021 could expect a large increase in value if rates rose.  This has already been realized as of March 2022.  As can be seen in the 3/31/22 line above, now that this portfolio has a coupon LOWER than market, speeds cannot get much lower.  Refi levels are already approaching a pure demographic level (i.e. due to deaths, divorces, promotions, etc) so further value increases are muted.

The downside, if rates fall, is still there but requires a larger drop in rates to be realized.

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