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As a ‘higher-for-longer’ rate scenario unfolds, how is the mortgage industry adapting?

Analysts bet on lower volumes and more M&A deals than previously estimated, but they say there’s no room for dramatic reductions in capacity

Last week’s above-consensus inflation figures brought the mortgage market back to a sour reality: The average 30-year fixed mortgage rate, an index closely watched by industry experts, may be close to or even above the 7% level for longer than previously expected.

If this scenario unfolds, analysts and executives will be ready to update their baseline expectations for 2024, including fewer refinance and purchase loans than previously forecast. But they also say there’s no more room for a dramatic capacity reduction across the industry. 

Mortgage experts added that struggling lenders — which laid off staff, received cash infusions and were overly enthusiastic about a market recovery after two years of shrinking originations — may be forced to find other options, such as mergers and acquisitions.

“We’re back in the land of 7%-plus mortgage rates,” Will Chang, Pennymac’s senior managing director and chief investment officer, said in an interview with HousingWire. “For better or worse, consumers are starting to realize that the days of 2% or 3% mortgages are well behind us and not going to be seen again for some time.”

Chang said that some industry professionals had thought that at least “a little bit” of refinancing volume would come back this year, but “that’s gotten pushed out.” Meanwhile, in the purchase market, despite turnover based on life events — such as people having kids or getting a divorce — volume will remain small for the foreseeable future, he added.

Last week, the U.S. Bureau of Labor Statistics reported that consumer prices were up 3.5% in March compared to a year earlier. March was the second month of accelerating inflation and the most significant jump since August 2023.

Investors reacted by adjusting their expectations for the number of rate cuts from the Federal Reserve this year. At the end of 2023, they anticipated six rate cuts for the year. A few weeks ago, three cuts became the expected norm. Now, it’s two or fewer cuts, and some experts — like former Treasury Secretary Lawrence Summers — have included a rate hike in their scenarios, although the likelihood of that remains low.

Goldman Sachs analysts pushed back their forecast of the first rate cut from June to July as the Fed needs to see higher inflation data from January to March “balanced by a longer series of softer prints in subsequent months.” A second rate cut is expected for November.

HousingWire lead analyst Logan Mohtashami said that so far, “we have held the line on the market pricing in three rate cuts,” but last week’s Consumer Price Index data was a “clear break from that.” He added that it was high enough for him to remove one of the rate cuts he expected in 2024. Another layer of uncertainty comes from a potential war in the Middle East.


Where are mortgage rates headed?

As investors adjust their expectations for the Fed’s moves, 10-year Treasury yields jumped roughly 40 basis points during the first two weeks of April, going from 4.20% to 4.60%, the highest level since November 2023.

In March, the Mortgage Bankers Association (MBA) estimated that the 30-year fixed mortgage rate would average 6.6% in second-quarter 2024. But, according to Freddie Mac, mortgage rates, which tend to align with the 10-year Treasury notes, went up to 6.88% for the week ending on April 11, compared to 6.82% the previous week. At HousingWire’s Mortgage Rates Center, rates for conventional loans were 7.21% as of April 15.

And more increases are yet to come.

According to Bose George, managing director at Keefe, Bruyette & Woods (KBW) who covers mortgage companies, the mortgage-backed securities market levels “imply that the Freddie Mac PMMS should be something like 7.15% or 7.20%, a level where refinancings are going to be low and a recovery in purchase is going to be even more challenging,” 

KBW’s team forecasts $1.8 trillion in mortgage origination volume for 2024, which George considers high. He added that the forecast should be reduced if higher mortgage rates persist for longer.

At BTIG, managing director and mortgage analyst Eric Hagen said it is “needless to say that mortgage rates could be volatile.” But he “still feels there’s room for mortgage rates to come down a little bit, partially because secondary spreads in the mortgage market are still relatively wide.” Hagen believes that rates below 6.25% would be supportive of the market.

M&As to the rescue

Industry experts say that higher-for-longer rates will impact lenders that are already hemorrhaging — primarily those that rely on refinances or those that have already sold at least a portion of their servicing portfolio. On average, independent mortgage banks (IMBs) lost $2,109 per loan in Q4 2023, the MBA reported.

These lenders are more likely to reduce capacity even further, if possible, or pursue options such as mergers and acquisitions, which they may have been previously resistant to considering.

“I’ve been surprised by the lack of companies willing to raise their hand and acknowledge that they’re in a tough spot,” said Brett Ludden, managing director of the financial services team at Sterling Point Advisors. “That means you’re largely going to see companies that put themselves into desperate situations instead of being proactive on the M&A front.”

Ludden added that many lenders have been “holding off on getting involved in M&As, hoping for the next cycle to kick off and production to rise.” They are holding on to servicing revenues, selling mortgage servicing rights (MSR) or injecting cash into their operations. But if higher-for-longer mortgage rates materialize, they will have to “look at alternative options and that likely means more M&As,” Ludden added. 

If sellers wait, their business valuations could remain relatively stable or come down. Each quarter that they move forward is closer to recovery. But higher rates can impact gain-on-sale margins and production forecasts. Meanwhile, Ludden said that acquirers may be more concerned about cash flow, which affects upfront cash and earn-out negotiations. 

In the current market, legitimate buyers are companies with substantial amounts of cash — the groups Ludden represents have at least $50 million — or are parent entities with deep pockets. They are also lenders with experience in either previous acquisitions or large branch acquisitions. According to him, 20 companies are well positioned for acquisitions right now.

“Certainly, in the last two years, distributed retail, in particular, has been the primary interest for all the buyers,” Ludden said. “As we come to the end of this cycle, you’ll see buyers interested in potentially adding channels to their capabilities. But in the short term, retail is the place that has the ability to create the most marginal value.”

MSRs are a difference maker

Originators with relevant servicing books and a focus on purchase loans are better positioned in this scenario since they can count on revenues coming from their mortgage servicing rights. These assets tend to appreciate in a higher-rate environment and promote recapture opportunities when rates drop. 

“Servicing is a very good asset to have in a higher-for-longer scenario,” Chang said, referring to the stability provided by expected cash flows, which has been enough for some lenders to keep “the lights on.”

Some analysts, such as KBW’s Bose, expect more transactions involving MSRs this year than mergers and acquisitions of entire operations, which are more complex and involve more resistance for lenders.

Analysts are less concerned about big lenders with scale and dominance in their niches, such as Rocket Mortgage in retail, United Wholesale Mortgage in wholesale and Pennymac in the correspondent channel.  

“For the nonbank mortgage finance complex, where we spend most of our time, we don’t feel like higher mortgage rates prevent these guys from growing,” Hagen said.

“We can still see decent conditions in the mortgage market,” he added, noting some constructive signs from homebuilders that point to the fact that affordability is tight. Still, this isn’t preventing some borrowers from getting a mortgage. 

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