Mortgage lenders timed the market perfectly

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When people think back to the market euphoria of 2021, there’s a lot to choose from: Meme stocks, SPACs, digital coins – all capture the zeitgeist. One candidate for the poster boy of the day, however, can easily be overlooked among all the exciting new financial contraptions: the otherwise stable mortgage industry. Mortgage stocks have avoided the headlines, but they are no less reflective of the hype.

Until 2020, there weren’t many mortgage stocks listed on US exchanges. The last publicly traded full-size stand-alone mortgage company was Countrywide Financial Corp., which was taken over by Bank of America Corp. in July 2008 amid mounting losses as the global financial crisis neared its peak. After that, mortgages were handled mainly by big banks.

But the underlying economics of the industry never changed, especially the boom-bust nature of the market. Now that rising interest rates are turning off the refinancing faucet, a new generation of specialty mortgage lenders find themselves in the crosshairs.

Over the past decade, specialists have gradually reasserted themselves. From a 10% share in 2010, they increased their market share to 70%, and for most of that time they remained private. The largest, Rocket Cos., remained in the hands of its founder, Dan Gilbert.

But almost suddenly, they became public. In a six-month period beginning with Rocket in August 2020, a group of mortgage companies with a collective value of almost $60 billion went public. For the first time since the peak of the housing boom, public market investors had the opportunity to share in the pros – and cons – of the residential mortgage market.

Unlike electric vehicle companies that went public around the same time, mortgage companies have had no problem making money. The issue was rather the sustainability of their profits. Few industries are as cyclical as the US mortgage industry, and these companies were selling at the top.

Mortgage companies take a reduction in the value of the loans they make and therefore when volumes increase, profits also increase. Spurred on by generationally low mortgage rates, millions of borrowers refinanced, generating record volumes. From $2.3 trillion in mortgages in 2019, volumes soared to more than $4 trillion in 2020 and 2021. Three mortgage companies – LoanDepot Inc., UWM Holdings Corp. and Home Point Capital Inc. – managed to time their market debuts to coincide with an all-time low for mortgage rates – 2.65% in early January 2021, according to data from Freddie Mac.

But it’s not just volumes that fuel mortgage earnings cycles — margins inject another layer of cyclicality. A mismatch between volumes and industry costs means that margins tend to increase when volumes increase and decrease when they decrease. Thus, 2020 and 2021 were characterized not only by high volumes of mortgage origination, but also by high margins. According to the Mortgage Bankers Association, independent mortgage banks earned more than $4,200 per loan in 2020, compared to a long-term average of $1,460.

Since then, the market – to put it mildly – has changed. Mortgage rates are heading towards 6% and there is no longer anyone to refinance. Analysts at Credit Suisse Group AG estimate that only about 1% of mortgages are at least 50 basis points ‘in the money’ to be refinanced – and it’s not certain, given that they haven’t. not already done, that these borrowers will refinance at all. The Mortgage Bankers Association predicts mortgage volumes will plummet to $2.4 trillion this year. Meanwhile, mortgage companies remain staffed for a $4 trillion market.

This leaves their new public owners exposed.

“Mortgage is a cyclical business,” Home Point chief financial officer Mark Elbaum reminded investors last week. “It never seems right, it’s always a little too hot or a little too slow. What we are going through right now is what I would describe as a kind of boiling market hangover. But I think we all agree, it happened much faster and much more extreme than anyone could have imagined. »

Many other market trends of 2021 reflect a story about the future. The mortgage companies were just trying to sell the profits of the present. Both can evaporate quickly. With less than $19 billion in market capitalization remaining in the sector, mortgage company owners have benefited from the massive transfer of wealth from equity investors.

If history is any guide, these lenders might not stay public for long. And then the cycle will begin again.

More from Bloomberg Opinion:

• Mortgage rates won’t drop any time soon: Allison Schrager

• Cooling housing market will lead to more dysfunctions: Conor Sen

• Is the era of property booms and busts in the UK over? : Chris Hughes

This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.

Marc Rubinstein is a former hedge fund manager. He is the author of the weekly financial newsletter Net Interest.

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