Mortgage Banker November 2023

INNOVATION

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MARKETS NOVEMBER 2023 | $20

MortgageBanker MAGAZINE

Why HELOCs Are Still Viable

The Hunt For

PREMIUM PRICING

SPENDING WISELY:

A Dozen Strategies For

Data Security Still A Priority

GROWING YOUR BUSINESS

FREEZING OUT THE MIDDLE

A COLD WINTER AHEAD FOR MEDIUM SIZED LENDERS

A PUBLICATION OF AMERICAN BUSINESS MEDIA

Brett Ludden Managing Director Sterling Point Advisors

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REGULATORY CORNER FFTC, DEPARTMENT OF LABOR PARTNER TO PROTECT WORKERS FROM ANTICOMPETITIVE, UNFAIR, AND DECEPTIVE PRACTICES The Federal Trade Commission and the U.S. Department of Labor (DOL) signed a new agreement that will bolster the FTC’s efforts to protect workers by promoting competitive U.S. labor markets and putting an end to unfair, deceptive, and other unlawful acts and practices, as well as unfair methods of competition, that harm workers. The new memorandum of understanding (MOU) between the two agencies outlines ways in which the FTC and DOL will work together on key issues such as labor market concentration, one-sided contract terms, and labor developments in the “gig economy.”

The MOU builds on the FTC’s recent efforts to increase collaboration on issues facing workers, including the FTC’s recent MOU with the National Labor Relations Board as well as the FTC’s enforcement policy statement related to gig work.

STAFF

Vincent M. Valvo CEO, PUBLISHER, EDITOR-IN-CHIEF Beverly Bolnick ASSOCIATE PUBLISHER Christine Stuart NEWS DIRECTOR Keith Griffin SENIOR EDITOR Katie Jensen, Sarah Wolak, Erica Drzewiecki, Ryan Kingsley STAFF WRITERS Alison Valvo DIRECTOR OF STRATEGIC GROWTH Julie Carmichael PROJECT MANAGER Meghan Hogan DESIGN MANAGER Christopher Wallace, Stacy Murray GRAPHIC DESIGN MANAGERS

The new agreement enables the FTC and DOL to collaborate closely by sharing information, conducting cross-training for staff at each agency, and partnering on investigative efforts within each agency’s authority. This MOU is in line with the President’s Executive Order on Competition, which affirms the importance of enforcing antitrust laws to combat abuses of market power, including in labor markets.

Navindra Persaud

The MOU identifies areas of mutual interest for the two agencies: collusive behavior; the use of business models designed to evade legal accountability, such as the misclassification of employees; illegal claims and disclosures about earnings and costs associated with work; the imposition of one-sided and restrictive contract provisions, such as non-compete and training repayment agreement provisions; the extent and impact of labor market concentration; and the impact of algorithmic decision-making on workers.

HEAD OF CUSTOMER OUTREACH

FANNIE MAE EXECUTES 2023’S EIGHTH CREDIT INSURANCE RISK TRANSFER TRANSACTION ON $8.4 BILLION OF SINGLE-FAMILY LOANS Fannie Mae has executed its eighth Credit Insurance Risk Transfer (CIRT) transaction of 2023. CIRT 2023-8 transferred $344.3 million of mortgage credit risk to private insurers and reinsurers.

The covered loan pool for CIRT 2023-8 consists of approximately 27,000 single-family mortgage loans with an outstanding unpaid principal balance of approximately $8.4 billion. The covered pool includes collateral with loan-to-value (LTV) ratios of 60.01 percent to 80.00 percent acquired between September 2022 and December 2022. The loans included in this transaction are fixed-rate, generally 30-year term, fully amortizing mortgages and were underwritten using rigorous credit standards and enhanced risk controls.

With CIRT 2023-8, which became effective Aug. 1, 2023, Fannie Mae will retain risk for the first 140 basis points of loss on the $8.4 billion covered loan pool. If the $117.6 million retention layer is exhausted, 24 reinsurers will cover the next 410 basis points of loss on the pool, up to a maximum coverage of $344.3 million.

Coverage for this deal is provided based upon actual losses for a term of 12.5 years.

Depending on the paydown of the insured pool and the principal amount of insured loans that become seriously delinquent, the coverage amount may be reduced at the oneyear anniversary and each month thereafter. The coverage on this deal may be canceled

by Fannie Mae at any time on or after the five-year anniversary of the effective date by paying a cancellation fee.

Since inception to date, Fannie Mae has acquired approximately $25.6 billion of insurance coverage on $858.7 billion of single-family loans through the CIRT program, measured at the time of issuance for both post-acquisition (bulk) and front-end transactions. As of June 30, 2023, approximately $1.27 trillion in outstanding unpaid principal balance of loans in our single-family conventional guaranty book of business were included in a reference pool for a credit risk transfer transaction.

DIRECTOR OF EVENTS William Valvo UX DESIGN DIRECTOR Andrew Berman AND ENGAGEMENT Matthew Mullins MULTIMEDIA SPECIALIST Melissa Pianin MARKETING & EVENTS ASSOCIATE Kristie Woods-Lindig ONLINE ENGAGEMENT SPECIALIST Regina Morgan ADVERTISING SALES EXECUTIVE Nicole Coughlin ADVERTISING ASSOCIATE Lydia Griffin MARKETING INTERN

If you would like additional copies of Mortgage Banker Magazine call (860)719-1991 or email info@ambizmedia.com Submit your news to editors@ambizmedia.com

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© 2023 American Business Media LLC. All rights reserved. Mortgage Banker Magazine is a trademark of American Business Media LLC. No part of this publication may be reproduced in any form or by any means, electronic or mechanical, including photocopying, recording, or by any information storage and retrieval system, without written permission from the publisher. Advertising, editorial and production inquiries should be directed to: American Business Media LLC 88 Hopmeadow St. Simsbury, CT 06089 Phone: (860) 719-1991 info@ambizmedia.com

M ARKETS

Good Luck Searching For Long-Term Returns INVESTORS ARE WARY OF PIPELINE RENEGOTIATIONS

BY ROB C H R I S M A N, C O NT RI BUTO R, MORTGAGE BANKER MAGAZINE

4 MORTGAGE BANKER MAGAZINE | NOVEMBER 2023

I

t was only a few years ago that conjecture arose about the likelihood of U.S. Treasury yields turning negative, and if they did, would the 30-year mortgage rate go to 0%? That did not happen, and now rates have moved higher. But the question is often asked, “Why are mortgage rates higher than a 10-year or 30-year Treasury yield?”

The short answer is, who would you rather loan money to: yourself or the U.S. government? The U.S. government is considered to have zero default risk.

You will be paid, on time, for the duration of that specific financial instrument.

With a loan to yourself, there is a much higher likelihood of default and early prepayment. Those two factors mean investors need to be compensated with a higher yield for the increased risk.

Throughout most of 2023, bond prices have fallen. Given the inverse relationship between price and yield, rates have moved higher, and 30-year fixed-rate mortgages are well above 7%. Inflation has been higher than the Federal Reserve’s target rate, and so the Federal Open Market Committee has ratcheted up the Fed Funds rate.

Higher rates discourage, in theory, borrowing. A negative interest rate means that the central bank (and perhaps private banks) will pay regularly to keep depositors’ money with the bank. This incentivizes banks to lend money more freely and businesses and individuals to invest, lend, and spend money rather than pay a fee to keep it safe.

As we head toward the 2023/2024 winter, we are faced with the opposite problem.

We are still, however, paying the price for low rates, which contributed to driving home prices higher as home affordability improves with lower monthly payments.

During deflationary periods, people and businesses hoard money instead of spending and investing, collapsing aggregate demand, depressing prices, slowing real production and output, and increasing unemployment. Theoretically, during inflationary times the opposite occurs.

HEAD SCRATCHER The 2023 movement in treasury yields, and therefore mortgage prices, has the industry, and potential borrowers, scratching their

heads as to why mortgage rates resulting in price compression. have fared worse than Treasury (“Why should I pay you more rates. Looking back to 2020, for a 7.75% 30-year Fannie loan rates dropped as the 10-year than a 7.50% loan; they’re both first broke below 2% but didn’t going to prepay.”) And when change much afterward. Though loans prepay, often the cash is the MBS market does loosely put into the Treasury market, track the Treasury market, with with the demand driving prices its 10-year yield, it does not ROB CHRISMAN higher and yields lower for sequite achieve a 1:1 ratio of movecurities that don’t pay off early. ment when rates are falling or In the primary markets, should rates rising. This is due to several factors, such drop, lenders don’t want their entire as Wall Street traders hedging the differpipeline to renegotiate (those hedges with ence in price movement, prepayment risk, and everyone else strategically pricing Wall Street firms don’t have their prices refor when rates inevitably change again. negotiated), so many capital markets staffs Wall Street firms don’t renegotiate prices, set rates that are “sticky” when Treasury but borrowers can through refinancing. rates drop. No one has a crystal ball, no And when a borrower refinances, and one knows what inflation is going to do or how long these mortgages will be on their books, and if rates drop, pipelines will be filled with illiquid coupons that are hard for investors to value. How much would you pay for an 8% loan in a 7% world? So, there is a big premium for uncertainty.

The 2023 movement in treasury yields, and therefore mortgage prices, has the industry, and potential borrowers, scratching their heads as to why mortgage rates have fared worse than Treasury rates.

the loan pays off prematurely, mortgage lenders and servicers are on the hook.

As mortgage rates have gone up through 7%, investors have been wary about owning any loan or MBS. What happens when rates go down? Prepayment risk is a big issue: who wants to pay 105, with a 5-point premium, for something that pays off a short while later. (“I pay you $210,000 for that $200,000 loan, and in four months you give me $200,000 back? Let me run that by my boss.”) Many investors don’t even offer to pay premium prices above par (100),

THE REAL DRIVER In 2020 and 2021, the real driver behind the fact that the rates are not moving in sympathy with the 10-year was capacity.

Lenders had to hire actual underwriters and then train them which adds months to the lead time for a lender to ramp up. In the old days, lenders would hire clerical staff to help move the streamlined refinance paper around, but with Dodd-Frank it is all 100% underwritten and verified to be eligible for delivery to the GSEs. However, lenders are continuing to lay off staff due to over-capacity.

Now, with the Federal Reserve no longer buying MBS and, in fact, shedding securities from its balance sheet, and the bank failures from March, mortgage prices have worsened compared to Treasury prices.

No one has a crystal ball. It is especially difficult given that higher rates have not impacted the U.S. economy as much as one might have thought a year or two ago. The trend, however, is toward higher rates, but investors are still wary about paying prices above par.

MORTGAGE BANKER MAGAZINE | NOVEMBER 2023 5

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SURVEY REVEALS BIGGEST PAIN POINTS FOR CHIEF INFORMATION SECURITY OFFICERS ARE 3RD PARTY RISK MANAGEMENT AND AI SECURITY

eam8 released its 2023 CISO Village Survey, aggregating insights and responses from 130 CISOs representing prominent global enterprises, including Fortune 500 companies.

Among the executives who reviewed and contributed to the report are David Cross, SVP, CISO SaaS Cloud Security at Oracle, Renee Guttmann, Former CISO at Campbell Soup Company, Royal Caribbean Cruises and CocaCola, Sounil Yu, CISO and Head of Research at JupiterOne, Iain Paterson, CISO at WELL Health Technologies Corp, Paul Branley, CISO at TSB Bank, Steve Sparkes, CISO at Scotia Bank and more.

One of the core findings of the survey was that despite the macroeconomic environment, 56% of CISOs reported that their budget had increased since last year.

CYBER BUDGETS UP AMIDST ECONOMIC UNCERTAINTY Despite being in a period of economic slowdown, 56 percent of survey respondents reported an increase in their cybersecurity budget from 2022.

This data aligns with the global trend that cybersecurity spending has not been significantly impacted by recent geopolitical and economic challenges, as expected, as cyber threats continue accelerating.

Among the CISOs reporting budget decreases the majority of these cuts were observed in larger companies with over 100 cybersecurity employees and budgets exceeding $10 million.

Budget Change

Speaking on the centrality of cybersecurity in an enterprise’s strategy in 2023, Admiral Mike Rogers, former director of the NSA and operating partner at Team8 said, “In a world rife with economic and geopolitical challenges, cybersecurity takes center stage as enterprises recognize the critical necessity of increasing investment in robust defense measures to protect their most valuable assets.”

WHERE SHOULD IT BE ALLOCATED? Survey results revealed that Identity and Access Management (IAM) and cloud security are the top categories for anticipated budget expansion.

With the accelerated adoption of cloud technologies and remote work trends, CISOs seek to enhance their cybersecurity posture by investing in robust IAM and cloud security solutions.

David Cross, senior vice president, CISO SaaS Cloud Security at Oracle, added on why Cloud Security budgets are expected to increase, saying that “Businesses are rapidly migrating their data and applications to the cloud to

MORTGAGE BANKER MAGAZINE | NOVEMBER 2023 9

Budget Line Expansion Expectations:

take advantage of the innovation and security benefits that are difficult to achieve in on-premise environments.

They are equally seeking out cloud security best practices, technologies, and solutions to assist in this transition from the traditional data center skills, experiences, and processes.”

Speaking on the expected budget line expansions in Identity and Access Management, Renee Guttmann, former CISO at Campbell Soup Company, Royal Caribbean Cruises, and Coca-Cola, added that “Identity and access management is a decadesold challenge that requires clear prioritization and investment to address the protection of cloud, SaaS and IoT environments.” Guttmann added that “Companies will need to embrace emerging technology including AI-based identity solutions that will more effectively – and at scale – validate identity, support compliance and enable the detection and response of behavioral anomalies of its employees, third parties, and IoT systems.”

“Identity and access management is a decades-old challenge that requires clear prioritization and investment to address the protection of cloud, SaaS and IoT environments.”

10 MORTGAGE BANKER MAGAZINE | NOVEMBER 2023

> Renee Guttmann,

Former CISO Campbell Soup Company

WHAT’S KEEPING CISOS UP AT NIGHT? Surveyed CISOs expressed the need for innovation in several areas to tackle emerging cybersecurity challenges. Third-party risk management, AI security, and insider threats emerged as the most pressing problems where existing solutions fell short. The COVID-19 pandemic and the rapid adoption of remote work have created unmet needs in existing IGA tools and programs. With the rise of Generative AI, 48% of surveyed CISOs called ‘AI Security’ their biggest concern.

Regarding these emerging challenges, Admiral Rogers added, “As technology evolves, it brings with it a new breed of risks that demand our constant vigilance - complacency is not an option in the face of evolving threats. We are determined to stay one step ahead of malicious actors by driving innovation in critical areas, as the need to manage third-party risks and AI security.”

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Hello, Home Equity.

Or Is It Goodbye?

MORTGAGE PROS STILL REPORT PROFITING ON HELOCS DESPITE NEGATIVE PROJECTIONS

S

BY ERICA D RZE WIECKI , STA FF W RI T E R, MORTGAGE BANKER MAGAZINE

ometimes biting the bullet to build out “Americans can always benefit from consolidation that bonus bathroom is better than and also sometimes need more cash,” he says. banking on a bigger house. Now still “The vehicle that they’ve used in the past has been appears to be one of those times. cash-out refinances … really not a smart economic High property values coupled with decision for consumers when mortgage rates are soaring interest rates this year have had borrowers (this high).” continuing to turn to their home equity and lenders Homeowners opting to borrow large lump sums vying to capture all the originations they can. from their home’s equity at a high interest rate can still retain their first mortgage’s original lower rate.

The National Credit Union Administration “For them to borrow $50,000 and take out a 9% (NCUA) reported a rise in home equity lines of credit loan for that and keep their 2.5% loan makes all the (HELOCs) in 2023. So much so that NCUA Chairman Todd Harper expressed concern, citing higher default sense in the world,” Schiano says. “So I think it was predictable that home equity lending would rise.” rates and increases in credit card balances.

On the other hand, property data provider PROVIDING VALUE ATTOM’s June 1 Residential Property Mortgage Origination Report reflected WFG Enterprise Solutions offers a a 25.3% decrease in HELOC loans in suite of products specifically for home Q1 of 2023, compared to Q4 of 2022. equity lending. Senior Vice President However, HELOCs still comprised Dan Bailey says he is thankful for the 19.6% of all loans originated in Q1, four recent uptick in home equity business. times that of the early part of 2021.

“Since home values have risen, While Q2 data had not yet been people have gained a lot of equity,” released by the time this article went Bailey points out. “So now it’s time to to print, Spring EQ CEO Jerry Schiano use it. And I think in this interest rate told Mortgage Banker Magazine that environment as well. Rates are really Jerry Schiano CEO it’s still a home equity landscape and high, especially for refinance. People Spring EQ not a cash-out refinance arena. are staying in their homes or fixing up

14 MORTGAGE BANKER MAGAZINE | NOVEMBER 2023

their homes, and they’re using their equity as they choose.”

This is in contrast to the housing market during the height of the COVID-19 pandemic when interest rates dropped to historic lows and refinance was the name of the game.

“Now we’re in a little bit of a weird spot where interest rates are not so low. People have value, so they’re using home equity. And I think a lot of lenders are trying to figure out - really can they and how do they participate in home equity lending?”

While HELOCs and HELOANs don’t offer the same revenue of other home loans, these products do offer lenders the chance to profit from past clientele.

“There’s always gonna be some form of movement in home and purchase,

“It’s not good for everybody, but it’s good for a lot of people and it’s good for a lot more people today than it was a couple of years ago.” > Jerry Schiano but there’s also a lot of people who, for right now, it pays to sit,” Schiano says. “Call them up and see how they’re doing. You like your house, but would you like to put on something? It’s a good time for home equity.”

It’s up to a loan officer to provide value to their customers, both past and present. Oftentimes that can mean offering a product or service they didn’t know they needed.

“I’m a big believer that you should put people in a product that you would buy with them,” Schiano says.

“A HELOC or HELOAN is not good for everybody, but it’s good for a lot of people, and it’s good for a lot more people today than it was a couple of years ago.”

Right now, lenders are adopting different strategies to capture home equity transactions.

MORTGAGE BANKER MAGAZINE | NOVEMBER 2023 15

“They’re going to rise to have greater prominence than what they did before,” Bailey points out. “We’ve already seen a lot of fintech firms grab hold. And I think you have a lot of lenders that just aren’t going to participate, to be honest with you.”

we’re a little different than some home equity lenders is we really focus on the affordability of the borrower and the debt ratio. And we use traditional underwriting as opposed to some home equity lenders that do it based upon Dan Bailey algorithms and things of Senior Vice President WFG Enterprise Solutions that nature.”

Homeowners seeking equity don’t want to wait THE RISKS AND a few months. They want their money THE PLAYERS now.

Consumers should be mindful of a few “Speed is of the essence when things before they stick their hands you’re dealing with home equity into the home equity cookie jar. One is transactions,” Bailey says. As a lender potential hikes in interest rates, which you have to make sure that you’re the Federal Reserve has not ruled out doing it in a very cost-effective manner for the remainder of 2023.

Borrowers who opt to use their residence as collateral for loans could face foreclosure if they don’t pay up on time.

“One of the concerns that a credit union may have, if they lent to somebody and their rate was [4.5%], and they paid their bills, and now > Diverse companies all of a sudden they’ve gone up to outperformed [8.5%], that shock could cause some those that are less diverse by 36% delinquency for people if it’s not in profitability. underwritten correctly,” Schiano says, giving an example.

He harnessed 30 years of experience running a variety of different mortgage and you’re doing it with a provider that companies when he founded Spring can adapt to what your requirements EQ, which offers customers the ability are and the speed with which you wish to access up to 95% of their home’s to close your transactions.” equity - up to $500,000 - in an average HELOCs are typically second of 21 days with flexible terms. mortgages with variable rates. This HELOCs are much smaller than can get a borrower into trouble if they traditional mortgages, so efficiency is haven’t planned for a rate increase everything. down the line.

“What our job is as lenders is to lend “I think with a loan officer, they to people that we think have shown always want to keep the best interest of a history of paying and can afford the the borrowers in mind,” Bailey says. “I payments,” Schiano adds. “Where think each situation they’re presented

36%

16 MORTGAGE BANKER MAGAZINE | NOVEMBER 2023

with is different and as an advisor, they should keep in mind whether or not a HELOC makes sense for that particular borrower or not.”

The majority of borrowers are still enjoying lower rates they’ve locked in all the more reason to fix up the homes they’re in rather than refinance or sell.

Also, an incentive for lenders to secure the right service provider.

“As volumes grow, they want someone that can scale,” Bailey says.

“They want the products that they need. They want experienced providers that can deliver with quality and on time and on a cost-effective basis.”

PREDICTIONS Year-over-year spending on homeowner improvements is expected to shrink almost 6% by the end of Q2 2024, according to Harvard University’s Joint Center for Housing Studies’ Leading Indicator of Remodeling Activity (LIRA).

“Home remodeling activity continues to face strong headwinds from high-interest rates, softening house price appreciation, and sluggish home sales,” says Abbe Will, associate project director of the Remodeling Futures Program. “Annual spending on homeowner improvements and repairs is expected to decrease from $486 billion through the second quarter of this year to $457 billion over the coming four quarters.”

But home improvements are far from the only thing borrowers can spend their home equity on. Bailey predicts that these loans will continue to increase into 2024 if an expected drop in interest rates proves true.

“Should we see a little bit of a rate decline, I think you could see more home equities,” he says, adding, “I think you’re going to see a lot more refinance transactions as well.”

Hear From Industry Leaders As We Peek Under The Hood Of Non-QM.

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The State of Non-QM Non-QM has seen its share of ups and downs over the past several years. But one thing is certain. As one of the only growing niches in the mortgage business, keeping up to date on this space is more important than ever. Serving the underserved community, non-QM is an essential part of the mortgage ecosystem. And with the number of borrowers non-QM serves continuing to rise, now is the time to learn more about these products.

December 14 Prospects for 2024 programs, state of nonQM, what’s coming, how to prepare

NMP is launching a monthly series called “Non-QM Townhall – A Monthly Report”. We will cover different topics each month with a panel of experts in non-QM. They will share their knowledge and experience so you too can become a non-QM expert.

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MORTGAGE BANKER MAGAZINE | NOVEMBER 2023 19

COVER STORY

The Mortgage Market’s

Disappearing Middle

20 MORTGAGE BANKER MAGAZINE | NOVEMBER 2023

A brutal winter reckoning to come for undercapitalized, medium-sized lenders

BY RYA N KIN GS LE Y, STAFF WRI T ER,

MORTGAGE BANKER MAGAZINE

n the Northern Hemisphere, animals spend the spring and summer months eating voraciously, building up fat stores to insulate themselves against the colder, leaner winter months.

Mortgage bankers do the same – operationally, at least – squirreling away profits from the hotter housing seasons to help manage cash flows from November through March.

This year, despite the early optimism, there are scant profits for lenders to lean on. Many lenders have already burned through the equity they accrued during the pandemic boom years.

Total residential mortgage volume rose 21% from the first quarter to the second quarter, according to ATTOM, a curator of land, property, and real estate data, but volume was still down 38% annually. In August, funded mortgage volume rose 8% from July but fell 26% year over year, according to Curinos, a provider of data, technologies, and insights for the financial sector.

I

MORTGAGE BANKER MAGAZINE | NOVEMBER 2023 21

If low inventory and high interest rates persist through the winter, as expected, industry experts predict a brutal reckoning for medium-sized lenders that are too thinly capitalized to survive the winter.

“If you go to the industry conferences,” observes Brett Ludden, managing director at the mergers and acquisitions (M&A) firm, Sterling Point Advisors, “it’s not a happy occasion. Two years ago it’s people bragging about what kind of jet they took to the conference. Now it’s them talking about whether or not they need to start talking to a bankruptcy attorney.”

With Fannie Mae projecting an annual origination volume of $1.6 trillion for 2023 – slightly over one-third of the record $4.4 trillion originated in 2021 – it’s eat or be eaten for the scores of mortgage bankers intent on survival but fighting over scraps.

AN ENTREPRENEURIAL ACHILLES’ HEEL

T

his year’s spring homebuying season was supposed to be an oasis in an origination desert.

Instead, the wave of mergers and acquisitions that began in the second half of 2022 has continued to thin the ranks of IMBs this year. Analysts predict that industry consolidation will continue as long as low inventory, elevated mortgage rates, and soaring repurchase demands continue to starve lenders. In large measure, it’s entrepreneurial optimism leading lenders astray.

“Most of these lenders in the third and fourth quarter last year,” Ludden recalls, “said, ‘I just need to get through a couple of quarters. I made a lot of money in 2020 and 2021, and therefore I can make it through. I just need to get to that spring season when things are gonna get better.’”

But things did not get better. Instead, the market deteriorated further, and for the majority of lenders, profitability was piecemeal through the first half of the year as total mortgage balances fell for the first time since 2015. Sales volume rose in March when mortgage rates dipped, but rising rates in May and June disappointed lenders who had hung their hats – and their companies – on the spring homebuying season.

“A lot of them made that decision because they had just been through so much pressure related to staffing,” says Garth Graham, senior partner at Stratmor Group, the mortgage advisory firm. “They said, ‘Gosh, I can’t imagine getting rid of all these people I

conversations that Graham has, there are mortgage bankers who, at this very moment, still stand to gain by making the difficult decision to sell. “It’s really a story about corporate overhead. The buyer can bring synergies in terms of additional revenue and expense savings, and then they become valuable,” he explains.

LENDERS FEELING BURNED BY VENDORS

> Brett Ludden

Managing Director Sterling Point Advisors

fought so hard to get in 2020 and 2021.’”

Which isn’t to say that no lenders read the writing on the wall last summer.

As the Federal Reserve embarked on its crusade against inflation, raising interest rates 75 basis points for four consecutive months, some lenders prepared for lean times in 2023. Ludden watched several hundred well-managed lenders cut costs at the very beginning and thus be able to manage over the past year at a relatively low loss rate.

Moving forward, Ludden thinks that companies that allow their profit-and-loss (P&L) branches to operate at losses or with high compensation for loan officers (LOs) will struggle substantially relative to companies that don’t. But don’t be too quick to call the lenders who’ve survived this long without taking strategic action “the lucky ones.”

Waiting too long to sell a company or alter LO compensation can be worse than acting too soon. Graham has spoken with many lenders who have reported four consecutive quarters of losses, which makes counterparties such as regulators, agencies, and warehouse lenders nervous. It’s the counterparties who, contractually, can force lenders into making hard decisions.

“We have lenders all the time who call us, and I feel bad, but we can’t help them,” Graham says. “Whether their top producers have already left or their locked pipeline is too low, there’s just not anything really of value left other than maybe the tickets and what’s referred to as the shell.”

And yet, for every three “no value left”

22 MORTGAGE BANKER MAGAZINE | NOVEMBER 2023

F

or many lenders, surviving the winter depends on whether they had a cohesive cost-saving strategy from the beginning. That strategy involves the vendors who sell silver-bullet technological solutions for cutting costs.

“There’s a lot of over-promising. To some degree, that’s normal in the vendor community. But in our industry, that tends to be over-promising a more holistic or deeper solution,” says Jeremy Potter, a former senior director of capital markets at Rocket Companies who is now president of titleLook, a software company.

Potter has spent the past three years on the vendor side of the mortgage industry as an investor and founder of various technology companies. While some vendors question whether lenders have cut staff as dramatically as necessary, he says that lenders are tired of getting burned by vendors who are promising more savings than they can deliver.

“The vendor community is ‘the boy who cried wolf’ to a degree at this point to a CEO of a mid-size IMB,” Potter admits. CEOs and decision-makers at IMBs have been burned by promises of savings, promises of speed, and promises of differentiation. “In many ways, the vendor tech community has not lived up to that,” he observes.

Every vendor pitch, booth, and email blast highlights vendors’ abilities to improve efficiencies and lower costs in a holistic manner so employers can “get more” out of their people. But, Potter says the efficiencies (à la savings) haven’t materialized. As a result, vendors are finding it increasingly difficult to convince CEOs and decisionmakers who have been burned in the past that the best option for saving money is spending more money, especially after those stakeholders have had to make difficult staffing decisions. And yet, dragging their organizations through multiple rounds of layoffs, rather than cutting deep from the beginning, has increased the pain for both employers and employees.

“It could be that you see substantially worse economics for lenders even after we get through what we believe to be the hardest interest rate environment.” > Brett Ludden

MORTGAGE BANKER MAGAZINE | NOVEMBER 2023 23

Of course, the silver bullet cost-saving measure is a holistic approach that happens to be the most difficult balance to achieve: keeping “the right people” for CEOs and decision-makers to build additional savings and efficiencies around. What tends to happen, Potter says, is the one person left after layoffs does more work, but they don’t do it more efficiently or as effectively.

He argues that the piecemeal way companies evolve in the industry will not work in the future.

“That’s the real trouble here,” says Potter, “for CEOs and decision-makers at midsize IMBs. What tools and solutions are real that you can give that person so that now they can do their job three times as well, instead of doing three jobs?”

CASHING OUT THE BACK OFFICE

R

ick Roque, previous founder of Menlo Company, a mergers, acquisitions, and capital fundraising firm, believes the market of the past 18 months has exposed a financial inflection point for small- to medium-sized regional lenders that he calls “the regional ditch.”

Essentially a cash problem exacerbated by current market conditions, the ditch results in polarization within the mortgage finance industry.

“You need the cash to be able to make mistakes,” he explains, but for many lenders, the time to make mistakes has come and gone.

Sustained by the annuities of mortgage servicing rights (MSRs), the nation’s largest lenders are well-positioned to expand their market share whenever the market rebounds. Larger lenders (more than $2 billion per year in originations) also tend to be better capitalized, with more and easier access to cash through secondary markets and higher net-worth ownership.

Meanwhile, small lenders are circling the wagons in local markets, doing their best to retain top talent as Rocket and PrimeLending move to recruit local LOs. With less than $500 million in annual originations, small lenders can pivot with the market more easily than larger lenders by reducing their liquidity requirements, staffing levels, and core back-office expenses.

Small lenders tend to have strong referral partners, which helps sustain purchase volume during periods of declining refinances. On paper, small lenders are also less risky for capital partners like local banks

“We have lenders all the time who call us, and I feel bad, but we can’t help them . . . There’s just not anything really of value left.” > Garth Graham Senior Partner Stratmor Group

to support if they need extra liquidity.

Being thinned from the herd are medium-sized lenders, a group that includes approximately three-quarters of all IMBs. These lenders lack the agility to pivot quickly or hybridize due to contractual obligations and financial covenants required to remain operational.

More than a cash problem, though, the regional ditch is a trap for lenders with “a lack of market knowledge and lack of cash to hire correctly,” Roque explains. For a growth-oriented company that wants to hit $5 billion in annual originations, he advises, ignore the industry’s pervasive tribalism — hire leadership who’s been there before.

Don’t hire from within.

Though Stratmor’s Graham prefers the

24 MORTGAGE BANKER MAGAZINE | NOVEMBER 2023

phrase “volume tranche” to “regional ditch,” he agrees that lenders who are not exceeding certain financial thresholds will struggle to compete when the market rebounds.

Lenders producing roughly $500 million to $2 billion annually are finding it very difficult to make money right now, Graham says.

Seventy-eight percent of mortgage banks reported losses in the first quarter, but nearly all fall into the “finding it very difficult to make money” category this year. “It doesn’t mean you have to sell,” says Graham, “because if you’re willing to lose money or break even and keep your capital in there, that’s okay. Wait until next year; that’s a reasonable strategy. But, between those two, it’s very difficult to make money.”

With few employees left to cut from the front office, the back office is now getting expensive, making mergers and acquisitions deals all the more attractive to buyers. During the boom years of 2020 and 2021, corporate back office functions such as closing and post-closing, executive compensation, quality control, human resources, and technology cost about 50 basis points. Now that cost is more than 100 basis points.

“That’s the driver of the M&A,” Graham says. “The buyers can say that a 100 basis points are gone – I can buy you without adding one human in the back office. That’s the economic impetus for the deal.”

What buyers are willing to pay for is production. And pay they will.

MANAGING UNPROFITABLE BRANCHES

W

hen business is strong, smalland medium-sized lenders will often branch into new markets using expense management branches (EMBs), otherwise known as profit and loss (P&L) branches.

However, Roque has witnessed how lenders can struggle to manage P&L branches when the market turns. “When times are good, they’ll grow in markets that aren’t in their backyard and then close those branches because they don’t know how to manage those branches remotely,” he says.

Given the cyclical nature of the mortgage industry, this is an unsustainable growth strategy that Roque points to as evidence of the lack of leadership he sees among smalland medium-sized regional lenders.

In the run-up to rate contractions, this pattern exemplifies how the “regional ditch” is a cash problem that a lack of cash

exacerbates. “Once you’re in the ditch, it becomes more expensive to get out,” Roque explains. Two levers lenders pull in a tight market are margins and staff, but this popular branching strategy outsources those decisions to branch managers.

“It doesn’t mean there’s not some very good independent mortgage bankers who run these models and are successful … but a lot of them struggle,” says Stratmor’s Graham, who’s seen a lot of disruption to this model as the market shrinks.

P&L branches struggle during periods of margin compression and industry consolidation because operational control is split between the branch manager and the corporate office. Usually, branch managers are responsible for day-to-day operations, including staffing, while the corporate back office covers underwriting, closing and post-closing risk, technology, and human resources, among other services. As margins have shrunk, tensions have risen between unprofitable branches and corporate offices that are carrying the losses.

“Suddenly, you’re negotiating with the branch,” says Graham, explaining that the conversation usually goes something like: CORPORATE:

Hey, you need to cut staff.

BRANCH MANAGER:

Well, I make those decisions.

You cut your staff.

CORPORATE:

Then, you need to adjust your margins.

BRANCH MANAGER:

I’m responsible for that, too.

You adjust your margins.

Closing branches outright is the quickest way to cut losses, but abandoning a foothold in a market is a painful decision. What’s more, most mortgage companies lose $30,000-$50,000 when opening a new branch before that branch turns a profit – if it ever does. Half of newly opened branches never turn a profit, Roque says.

When it comes to small- and mediumsized lenders struggling to grow (let alone stay afloat), Graham says that centralization improves efficiency. Well-organized companies are also more valuable in the offing. Not only does centralization make it easier to leverage staff in various ways, but it allows companies to better focus their relationships and marketing.

“Generally, the companies that have a very defined market share in a few markets are more valuable than the small independent mortgage bankers that may be in a bunch of markets,” he says, speaking from experience.

“The vendor community is ‘the boy who cried wolf’ to a degree at this point to a CEO of a mid-size IMB.” > Jeremy Potter President titleLook

MULTI-YEAR MARGIN COMPRESSION

W

hat remains to be seen is whether margin compression or margin erosion will persist even after mortgage rates drop.

Ludden looks to the housing crisis of the 1990s when margin compression was a multi-year phenomenon impacting lenders well after the market had turned.

As interest rates rose in the early 1990s, refinance rates significantly dropped, forcing lenders to grow through purchase volume – but lenders then didn’t face the same constraints on housing supply that lenders face now as they make a similar pivot toward purchases. Still, the mortgage industry in the 1990s experienced a dramatic reduction in total

MORTGAGE BANKER MAGAZINE | NOVEMBER 2023 25

volume followed by a period of margin erosion that extended for multiple years, not several quarters.

If history is bound to repeat itself, lenders should be learning that the mortgage industry wines and dines by refinances but lives and dies by purchases. An increase in refinance volume eventually lifted lenders out of the crisis in the 1990s. However, the mini refinance boom that many lenders hoped would materialize in the second half of 2023 seems less likely to materialize now that the second half of 2023 has arrived and mortgage rates are holding altitude.

A former loan officer (LO) himself, Graham says that LO compensation is a major driver of margin erosion that needs to be addressed. “We keep paying basis points. Basis points are on a loan amount, and the loan amount keeps going up, yet the margin or revenue per loan in this type of market is going down.” As average loan amounts rise, LOs pull more money out of every transaction. “That creates a lot of pressure on the P&L for owners,” he says.

Lenders contribute to long-term margin compression when they lower rates to compete for loans. Ludden has talked to lenders who experienced month-over-month, double-digit reduction in margins in the second quarter. These lenders found that originating loans for less profit per loan only increased their losses due to fixed origination expenses. Doing the same volume or increasing volume, but making less money per loan, means lenders have nowhere to go to recoup that loss.

“Even if you still do the same number of loans,” Ludden explains, “you still have the obligation to keep the people in place that are doing the loans. You’re

still paying the loan officer some origination fee, you’re just making less money on that loan you sell. That’s even worse than less volume because at least with less volume, you can reduce your headcount.”

SECONDARY IMPACT

S

econdary markets are also squeezing lenders’ margins. An anticipated spike in early payoffs has soured investors’ appetites for newly originated, residential mortgage-backed securities (RMBS) that have coupons averaging between 7-8%. This has investors demanding higher premiums as historical buyers of RMBS, such as banks and the Federal Reserve, are exiting secondary markets altogether. Lenders fear that even when mortgage rates drop, investors will be able to name their price, preventing rates from dropping as low as borrowers would like.

Warns Ludden, “It could be that you see substantially worse economics for lenders even after we get through what we believe to be the hardest interest rate environment.”

Nevertheless, all lenders are focused on strategic actions right now, whether investing in servicing infrastructure or looking for an exit strategy. No holdout seller wants to become a walkout seller in a fire sale.

“The question they have to ask is: Do I want to run the risk of having to put more cash into this business after I’ve already gone through a year and a half of losing money, or do I want to be smart and look at where things might be headed and choose to make an exit now while I control my own destiny?” To be in control of his own destiny, for now, Ludden is grateful.

26 MORTGAGE BANKER MAGAZINE | NOVEMBER 2023

“You need the cash to be able to make mistakes.” > Rick Roque Previous Founder Menlo Company

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