Ripple effects: Shifting demand creates mortgage winners and losers

With mortgage rates on the rise, home prices skyrocketing and homeownership tenure redefining what it means to “age in place,” a new era has emerged in mortgage lending, one where long-held assumptions may no longer apply.

Lenders are learning to navigate the rebirth of a purchase market as rising mortgage rates eliminate the incentive to refinance for many current borrowers. But affordability and inventory challenges are keeping this purchase market from living up to its full potential. Servicers, dealing with borrowers likely to hold onto their mortgages longer, may actually see their side of the industry become more valuable as loan durations are extended.

And as the housing market continues evolving, shifts in the demand for mortgages will ultimately dictate winners and losers in key areas of the industry.

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New era spurs strategy revamps
Two years into a housing drought and the mortgage industry is thirsty.

Limited inventory has put upward pressure on home prices and stifled home sales activity, keeping would-be homeowners on the sidelines and forcing sellers to stay put out of fear of not being able to afford another place to live.

Homeownership tenure has nearly doubled what it was in the early 2000s, further withholding existing home inventory from the market, according to Attom Data Solutions. Homebuilders, meanwhile, face ongoing challenges with labor, land, laws and lumber — aka the “four Ls” — and are struggling to increase production of new, and in particular, entry-level, homes.

As a result, property values have surpassed housing bubble peaks and continue rising as demand for a limited number of homes has not backed down. All the while, average mortgage rates are on the rise, slowly creeping toward 5%, resulting in a mortgage market more reliant on purchase transactions than refinance activity.

“We’re in a new normal and here’s why: We have systematically, over the last two or three decades, abandoned certain affordable segments of the market,” said Freddie Mac Chief Economist Sam Khater.

The problem, Khater said, is the depletion of both new and existing starter-home inventory and neglect of the manufactured housing market, which boomed and busted between 1993 and 1998 and never quite recovered.

The implications of these changes in loan demand go far beyond the bottom line for mortgage lenders and servicers and will influence the direction of several key components of the industry. In some cases, companies will seek to invest more heavily in technology to develop more efficient processes or improve the borrower experience. Institutions may also beef up or cut back on their headcounts in kind.

And given the outsize role Fannie Mae and Freddie Mac play in the industry, shifts in loan demand will no doubt reverberate with policymakers grappling with the future of the government-sponsored enterprises.

What follows is an examination of how changes in the demand for loans — both purchase and refi — create distinct outcomes for technology investment and innovation, industry employment and GSE reform.
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Deploying tech in a down market
As loan volume dwindles, lenders have more time to streamline processes and invest in enhancements that often get put off when an organization is busier. But lenders may also be skittish about committing the necessary resources to fund those improvements when less revenue is coming in the door. It’s a delicate situation, but successfully navigating it can position lenders for greater success when volumes return.

“The players who survive in a low-volume environment are those that have the capacity to invest in technology,” said Tendayi Kapfidze, chief economist at online loan marketplace LendingTree.

And when technology investments result in more efficient operations, lenders are better equipped to weather periods when business is down.

What’s more, the lenders that can effectively leverage their technology strategies in a down market are often able to grow their business through acquisitions of smaller entities that aren’t keeping up. But the real winners are those companies that prioritize investment in innovations, even when demand thrives.

“If demand goes up, meaning lots of business for everybody, if you’re smart and you’re playing the long game, you would still focus on tech,” said Kapfidze.

For companies that both originate and service mortgages, changes in loan demand can also influence which side of the business should get more of their technology resources.

“I think it’s a bit cyclical. When the demand is high people focus more on origination technology: ‘How do I get more borrowers into more homes?’ Joe Dombrowski, director of product management and chief mortgage strategist at Fiserv, explained. “Countercyclical to that is servicing loans. When demand is low, people look at ‘How can I squeeze more efficiency out of my servicing staff?’ In other words, ‘How can I contain servicing costs?’”
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Musical chairs: employee edition
A mortgage company’s workforce is one of its most costly expenditures, not to mention one of the hardest to manage in a period of market uncertainty.

Mortgage companies often lay off workers when volumes fall, but it’s a blunt strategy that can affect morale and productivity of the workers who remain employed and leave lenders understaffed when demand starts to rise.

“There are only really two ways to do things in a less expensive way, and they are kind of the same thing: less people, more technology — and you get cheaper,” said Kapfidze.

Savvy lenders are increasingly relying on borrower self-service tools that improve efficiency and allow more flexibility in how workers are hired and deployed. But managing headcounts isn’t just a concern for the originations sector. Servicers must also be mindful of staffing, particularly as loans are staying in servicing portfolios longer.

“Whenever there’s a major swing like during the crisis in 2008, companies will often throw a lot of people at the problem. But then they have to figure out how to limit the cost of those folks,” said Robert Lux, executive vice president and chief information officer at subservicer Cenlar FSB and the former CIO of Freddie Mac.

The ability to quickly scale an operation in response to market shifts may give subservicers an upper hand against smaller firms that manage loans themselves, Lux said.

“There’s always this mentality that servicers can do things better in-house than by subservicing. I think that it’s a matter of scale,” Lux said. “Subservicers have an advantage in the way we invest in and deploy technology, and frankly, take bets on emerging technologies, because of our scale.”

While a number of high-profile companies, including Ditech, Guaranteed Rate, Movement Mortgage and Wells Fargo, have announced layoffs this year, industry employment among nonbank lenders and mortgage brokers remains above year-ago levels, according to the most recent Bureau of Labor Statistics data.

But as companies adjust staffing levels, it is essential for them to plan ahead and ensure the right tools and processes are in place to support a smaller workforce. That way, when volumes return, operations can scale more efficiently.

“It’s often better to make that decision quickly as opposed to having to be forced to do it, because in this environment, you also as a company need to stay liquid. If you’re paying out for your fixed costs and sort of eating into your cash on hand, then that’s not a good outcome,” said Michael Fratantoni, chief economist and senior vice president of research and industry technology at the Mortgage Bankers Association.

While job cuts aren’t typical when business is booming, certain roles may be de-emphasized and workers may get reassigned to new tasks as technology improvements take hold.

“I think staffing will continue to move with volume. You need staff in different places, though. Ideally, you’d be getting more productivity out of more of your employees, but to get that maybe you need to hire more in the tech space, or maybe you need to hire more processors, for example,” said Fratantoni.

“If through a technology investment you’ve made the process more efficient, you may not need those multiple layers of compliance personnel or GSE personnel in the same way that you did before, but you may not have them doing the same thing, even if you had the same number of bodies,” he added.

Regardless of the direction of demand, staffing efforts overall call for a reimagining of roles as the industry continues making digital mortgage strides.

“Job qualifications become less about being order takers and more consultative types of jobs: ‘How can I help you understand this?’ as opposed to ‘Yes, we got your payment,’” said Dombrowski. “The nature of the job changes.”
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Rethinking reform to match market needs
The effects of market swings may be more pronounced for individual companies in areas like technology and staff, but they also influence broader issues, like GSE reform.

To be sure, GSE reform is not explicitly tied to fluctuations in the demand for mortgages. But the current political climate, headed by a Trump administration poised to name a new Federal Housing Finance Agency director to replace Mel Watt next year, may offer a unique opening for Republicans to steer the mortgage market from government control.

“When you’re thinking of making changes to something that’s at the center of a $10 trillion market, you want to be thoughtful about it because there could be unintended consequences that could disrupt the world economy,” said Lux. “I think GSE reform is going to be something that is evolutionary and not revolutionary.”

It’s unclear to what extent changing levels in the demand for mortgages can kick-start GSE reform. A slower market may help maintain the status quo, particularly given Fannie and Freddie’s mandate to shrink their size.

Alternatively, policymakers may see it as an opportunity to implement a new system during a time that presents less risk of disrupting broader financial markets. But the same argument could be made about the prospects of implementing changes while the market is on an upswing.

“The general sense is that absent a consensus and absent a crisis, the system is working reasonably well and therefore there isn’t a lot of impetus that’s going to create the tailwinds to get reform,” said Scott Olson, executive director at the Community Home Lenders Association. However, “you shouldn’t wait until the next crisis to complete the reforms; that’s a bad way to do it.”

House Financial Services Committee Chairman Jeb Hensarling, R-Texas, has been advocating to reduce the government’s role in the mortgage market. His latest proposal would repeal Fannie and Freddie’s charters, while relying on Ginnie Mae to preserve some functions in the current system. However, Hensarling is not running for re-election in the upcoming midterms and it’s unclear who will take up the torch for his plan after he’s gone, or perhaps champion another proposal altogether.

“It’s like mystery meat; nobody knows what it is,” said Kapfidze. “People like to point out the problems that they see with the GSEs, but I don’t know that anybody that has an actual idea that it’s going to get done.”