Sage Residential’s founders are leveraging decades of experience, relationships, and proprietary sourcing channels to build a scalable MSR platform designed to deliver durable cash flows and consistent hedged returns across interest rate regimes.
Mark Volosov and Damian Pasternak have spent that last two decades in the U.S. residential mortgage sector. After the pair partnered together at Blackrock in 2014, they began building a specialised investment capability focused on mortgage servicing rights (MSRs). MSR is the right to collect fees for servicing pools of mortgages, including collecting borrower payments and handling administrative tasks, while the mortgage is outstanding.
Over the course of their time at Blackrock, the MSR portfolio reached approximately $200bn of unpaid principal balance. Wanting to replicate that success independently, Volosov and Pasternak began preparing for the launch of Sage. Volosov explains, “Covid delayed things by about a year, but we ultimately secured capital in 2021.” We started with a team of 4 and have deliberately added professionals across all critical business functions. Today, we’re a team of 17”.
Covid created a compelling and historic opportunity for investing in MSRs. “During the pandemic, borrowers refinanced into historically low mortgage rates. In the MSR business you want duration, and so the longer borrowers stay in their homes and continue making payments, the more cash flow is generated. So, we began acquiring and continue to purchase as much low-coupon mortgage servicing exposure as possible. To date – we’ve primarily been successful buying off-market and out-of-broader market competition. In total – we’ve acquired approximately $180bn of MSR UPB with a WAC in roughly 3.8%.” WAC refers to the weighted average interest rate across the portfolio. For Sage a lower WAC means a more de-risked cash flow, as the borrowers are less likely to refinance, so the MSR servicing fees continue for a longer period.
For investors, consistent and substantial cash flow is an attractive proposition. Moreover, MSRs are uncorrelated with most equities and fixed income markets, which creates a strong portfolio diversification benefit. Volosov adds, “they can also act as a hedge against other mortgage related exposure or positive duration fixed income risk.
Sage’s most acute edge is asset sourcing, which they do directly, on a negotiated basis with selling counterparties, granting the firm unique access and attractive execution. “This is appealing for investors, as we are not competing in large auctions alongside major banks and institutional buyers. We’ve completed around 60 transactions, and the vast majority have been bilateral deals where others have never had the opportunity to participate.” The firm has rapidly scaled, much quicker than other participants who launched around the same time, to now manage north of $2bn. Volosov explains the firm’s exponential growth, “We have outpaced our peer group, and that’s largely due to our sourcing relationships and the work of our capital formation team, which has done an exceptional job raising assets from an increasingly diverse group of high-quality institutional investors. Mortgage originators want to retain control of borrowers, and we can provide a way for them to monetise servicing assets without sacrificing those relationships and losing connectivity.”
As aforementioned the average WAC of the MSR managed is roughly 3.8%, having as much of the low-coupon mortgage as possible has been at the core of the firm’s strategy. This is especially prescient in today’s economic environment, where homeowners have built significant equity because of rising house prices in the past several years. Volosov is seeing their strategy play out in real time. “Borrowers today may have loan-to-value ratios of 50% or 60% and mortgage rates of around 3-4%. They’ve accumulated a huge amount of equity in their homes, but they’re also rational enough to understand that swapping a 3% mortgage for a 7% mortgage is highly unattractive.” He adds,” We’re seeing this lock-in effect play out in real time, and because our strategy focuses on low-coupon mortgages/MSRs, our borrowers are generally highly incentivised to stay put.”
While strong home price appreciation is positive for both the homeowner and the lender, Sage is conscious of the notion that homeowners having high levels of equity, doesn’t translate to high levels of liquidity. For someone who needs cash, an easy way to access it is through a cash-out refinance, where they take out a new mortgage loan for a larger amount, extract some cash, while paying off the old one. In turn, the initial mortgage and the associated MSR ceases to exist. To negate such instances unfolding, Sage launched its own fixed rate close-end second-lien program, which allows borrowers to access some home equity without forcing them to refinance the first mortgage. Volosov explains, “this acts as a natural hedge against cash-out refinancing. We’ve now originated more than $1bn of second liens through our partners, and most of that activity is tied directly to our MSR portfolio.”
To manage the portfolio, observing the perception and trajectory of interest rates is fundamental. However, Volosov is keen to stress the importance of having a broad view of the investment environment. “In addition to constantly evaluating mortgage rates and interest rates, we are monitoring home-price trends on an extremely granular level, tracking appreciation and depreciation on the metropolitan and county level.” This data all feeds into the fundamental questions that Sage has to constantly ask itself when making decisions: what proportion of borrowers are likely to default and what proportion is likely to prepay ? The firm uses hedging instruments such as swaps and TBAs to hedge localized rate exposure and deep out of the money swaptions to hedge large downward moves in rates..
Going forward, Volosov only sees that asset class becoming more attractive to investors and attracting far more bidders. “When I first entered the sector, a conventional MSR portfolio might attract three to five bidders. Today a portfolio will attract well into the double digits in terms of bidders.” Additionally, large banks are likely to become more aggressive acquirers. “They have large servicing platforms with thousands of employees. Years ago, a servicing platform might efficiently achieve 400 to 600 loans per employee, now the number is more like 1,200 to 1,400. You simply cannot originate enough mortgages organically to operate efficiently.” Volosov believes this will always give Sage an edge as their “approach is much simpler. We are primarily concerned with servicing income, not deposit balances, or cross selling opportunities.
