Mortgage companies raising debt in the current high mortgage rates landscape is a sign that market conditions are improving, although a recovery from the downturn may come later than expected, analysts told HousingWire.
Executives have decided to improve liquidity to fund their businesses and investments, targeting mortgage servicing rights (MSRs) deals. And recent transactions show that there’s an appetite among investors for debt in the mortgage space.
With the equity market unattractive at this point, issuing debt is the ideal option to raise capital for public and private businesses. Companies are issuing mainly unsecured debt, which has no collateral, to elevate their share in the balance sheet.
“With rates going up last year, spreads increasing very dramatically and nonbank mortgage companies facing difficulties, the debt market shut down,” Warren Kornfeld, senior vice president of the financial institutions group at Moody’s Investors Service, said.
However, things are different this year, Kornfeld said.
“With profitability starting to improve – and it looks like we have at least hit the bottom with respect to profitability – the markets opened up. The fears that investors had as to how much damage this downturn would have on companies have abated.”
Eric Hagen, managing director and mortgage analyst at BTIG, said that some companies are raising debt because they see an opportunity to grow ahead. However, it could be a defensive tactic to improve liquidity in other cases.
“Liquidity and generating cash are core components of the business. And so it makes sense to us that, even though interest rates are very high, there could be some demand for mortgage companies to raise capital in the debt markets,” Hagen said.
Investors have an appetite
In September, Freedom Mortgage raised $1.3 billion in about 24 hours. The volume was above the $1 billion expected in June when the company announced the offering, reflecting an oversubscribed deal.
The company issued two tranches: the first tranche, of $800 million, is due in October 2028 with a 12% coupon, and the second tranche, of $500 million, is due in October 2030 with a 12.25% coupon. The use of funds is retiring about $1 billion of unsecured debt maturing between 2024 and 2025. The remainder will be used for market-growth opportunities.
“Due to the overwhelming investor demand, the company accepted more capital than it had originally set out to raise. These proceeds will enable the company to extend its debt maturities and to continue to invest in opportunities to service more loans,” a spokesperson at Freedom wrote to HousingWire.
Meanwhile, Pennymac Mortgage Investment Trust announced on Sept. 18 that it priced an underwritten public offering of $50 million of its 8.50% senior notes due 2028. The notes are fully and unconditionally guaranteed on a senior unsecured basis by Pennymac Corp., an indirect wholly-owned subsidiary of the company.
The company intends to use the proceeds to fund its business and investments. It includes acquiring mortgage servicing rights (MSRs) and supporting its correspondent lending business, such as purchasing agency-eligible mortgages. The REIT also plans to repay other indebtedness, such as 5.50% exchangeable notes due in 2024.
Pennymac declined to comment on this story.
Piper Sandler & Co., Janney Montgomery Scott LLC and Ladenburg Thalmann & Co. Inc. served as joint book-running managers for the offering.
Outlook for new offerings
The debt issued by mortgage companies during the COVID-19 pandemic years with a maturity of five or six years and low-interest rates may reach maturity soon. But that’s not a red flag so far.
Data compiled by BTIG shows that 10 lenders have $4 billion in unsecured debt with maturity in 2024 and 2025, only around 10% of the total is due next year, which is not alarming.
The data includes Mr. Cooper Group, Finance of America, Freedom Mortgage, Home Point Capital, loanDepot, Rithm Capital, Ocwen, Pennymac Financial Services, Rocket Companies and UWM Holdings Corp.
“On the one hand, the Freedom case shows us that there’s demand [for mortgage companies debt], but maybe it’s limited. One of the things that we’re focused on is the debt maturity schedule of that $4 billion, which is spread out over the years. If a whole bunch of debt were rolling over next year, that would be more concerning,” Hagen said.
Mortgage companies may face higher costs to issue debt due to the surging rates environment, pressuring their financials. However, the decision to issue unsecured debt now can improve their liquidity and provide financial flexibility.
“The reason that we think some of that debt, which does have a lower coupon, is being retired or could be retired is just to manage the liquidity on the balance sheet,” Hagen said.
He continued: “The question we’ve been getting is: What do the returns look like in the business when you’re at that level of rates? Needless to say, it’s lower than it was before. But at the same time, when they were raising debt at 6%, that was just very low.”
Regarding the market outlook for these companies, Kornfeld said, “With the rise up in mortgage rates – the 1% increase we’ve seen over the last three or four months – instead of Q3 profitability being equal to Q2 and maybe being a little bit better, Q3 is likely going to be a little bit worse than Q2.”
“We then thought that 2024 would be way better than 2023. But we still won’t get back to an average long-term profitability for these companies, which is about a 2.5% to 3% return on assets [basically net income to the balance sheet]. Maybe we’ll be back a little under that, about 1.5% to 2%. 2024 will still be better than 2023, but likely only modestly,” Kornfeld said.