Finding value in mortgage servicing rights

Sage Residential's founders, Mark Volosov and Damian Pasternak, have developed a scalable Mortgage Servicing Rights (MSR) platform that promises durable cash flows and consistent hedged returns across varying interest rate regimes. For over two decades, they have operated in the U.S. residential mortgage sector, specializing in MSR, which is the right to collect fees for servicing pools of mortgages, including collecting borrower payments and handling administrative tasks, while the mortgage is outstanding.

At Blackrock, their MSR portfolio accumulated an unpaid principal balance of around $200bn. After securing capital in 2021, Sage was launched with a team of four, which has since grown to 17 professionals. The Covid-19 pandemic presented an opportunity for investing in MSRs, as borrowers refinanced into historically low mortgage rates, leading to longer stays in homes and continued payments, thereby generating more cash flow.

Sage has acquired approximately $180bn of MSR UPB with a weighted average coupon (WAC) of around 3.8%, which is lower than the market average and de-risks cash flow by reducing the likelihood of refinancing. MSRs are also uncorrelated with equities and fixed income markets, providing a diversification benefit. Sage's unique advantage lies in its asset sourcing through direct, negotiated deals with selling counterparties, allowing for more attractive execution and less competition in auctions.

The firm has completed over 60 transactions, mostly bilateral deals, and has rapidly scaled to manage over $2bn in MSR. The low WAC of Sage's MSR portfolio is a key strategy, as borrowers have accumulated significant equity in their homes and are less likely to refinance to higher rates. Sage has also launched a fixed-rate close-end second-lien program to allow borrowers to access home equity without refinancing their first mortgage, acting as a natural hedge against cash-out refinancing.

To manage the portfolio, Volosov emphasizes monitoring interest rates and home-price trends at a granular level to determine borrower default and prepayment probabilities. The firm uses hedging instruments like swaps and TBAs to hedge localized rate exposure and deep out-of-the-money swaptions to hedge large downward moves in rates.