There are five "forces" of change coming down the line for the mortgage industry, according to housing analysts at Citi (C).
Perhaps more importantly, after examining these five changes, the analysts then asked if being in the mortgage business is even a good idea anymore.
This is a question certainly facing all mortgage finance players currently. As noted in the housing outlook report, return on equity in the servicing sector is expected to fall to around 15%, compared to 40% pre-crisis.
Force 1: GSE reform remains "operationally daunting."
The new director of the Federal Housing Finance Agency, Mel Watt, nixed the g-fee rise, keeping it below 70 basis points, which is the mark the Citi analysts say is necessary to lure private capital back to the market. "Reform is difficult in near term as the infrastructure being built for future mortgage securities issuance is a technically complex multi-year effort and the structure for the government to offload credit risk needs to be established and tested."
Force 2: The Qualified Mortgage
Starting tomorrow, the mortgage market wakes up to the reality of the Qualified Mortgage and Ability-to-Repay standard. Where the QM makes the greatest impact will not be on the borrower's profile, but rather on the size of the loan. "The Consumer Financial Protection Bureau estimates that QM legal costs can reach around $65-140k on a $210k mortgage compared to only around $2k in revenues from originating that mortgage origination today." High net worth clients obviously need not worry about the QM on their jumbos.
Force 3: Higher capital requirements
Either by meeting Basel 3 standards or falling in line with national regulations under the proposed Supplementary Leverage Ratio, banks will be require to hold more capital against mortgage holdings. Under Basel 3, for example, mortgage-servicing rights are limited to up to 10% of total tier 1 capital holdings. Real estate investment trust will also reduce demand for these assets. "We expect that the cost of repo financing will increase due to the SLR. This will negatively impact the profitability of mortgage REITs which rely on repo to finance investments."
Force 4: Refi fades away
The market for refinanced mortgages will be further diminished in the 2014 rising interest rate environment. Basing estimations on CoreLogic (CLGX) and Freddie Mac data only 35% of all mortgages in 2014 would benefit from a refinance. Lenders who don't have a strategy into reaching new borrowers are going to have a rough year. "It is critical for lenders to have strong relationships with real estate agents because they are gatekeepers to forward-purchase borrowers, as they guide them through the buying process."
Force 5: Higher compliance costs
The Citi report estimates costs to originate a mortgage will rise 24%. And then to service that loan, costs are going to nearly double, which will squeeze all players in the space. Overall, this should not immediately equal a barrier to enter into either business, but firms will need around $100 million in monthly originations to remain solvent. Outsourcers stand to benefit, as a result. "Bank servicers are trying to combat rising costs by selling delinquent servicing to specialized servicers as well as selling servicing for non-core customers that they cannot cross-sell."
After taking these five forces into consideration, the Citi analysts then posit if it even makes sense to remain in the mortgage business with costs rising and opportunities shrinking.
It does, they note, but with several caveats. For one, mortgage originations should no longer be a loss leader, with an anticipated return on the mortgage servicing. Therefore, only the big lenders will compete in the Qualified Mortgage space. In the non-QM, it will be nonbank competition in 2014. Furthermore, smaller banks will likely still offer mortgages, but with more and more relying on outsourced mortgage operations.
"Independent mortgage servicers have been the beneficiaries, as they are unencumbered by capital requirements and are free to grow their servicing portfolios as desired," the Citi analysts conclude.