Not many people have fond memories of 2020. Except those in the US residential mortgage banking trade, which had an exceptional year for profits, pay and employment.

Americans tend to think entitlements are for the poor or elderly, forgetting that the effectively free option to refinance home mortgages is a form of transfer payment for the middle class. Last year, homeowners were able to refinance or purchase their houses at the fastest rate since the financial crisis.

In 2020, there was a record $3.83tn of mortgages written, up from $2.25tn in 2019, according to the trade body Mortgage Bankers Association. And profits for the bankers followed. Some 99 per cent of the firms surveyed by the MBA posted pre-tax net financial profits.

In a way, the residential mortgage bankers’ prosperity is the other side of the distress in much of the US commercial property business. Working and shopping from home meant more demand for home space. New home construction, particularly in high growth areas such as Austin in Texas, or Orlando in Florida, was not able to keep up. So home buyers have been bidding against each other for a shrinking supply of available units.

The home buying (and lending) boom covered up some longer-term problems for the bankers. At the beginning of the pandemic, federal and state authorities put foreclosures and evictions on hold. These “forbearance” periods are under challenge in the courts, and are scheduled to end anyway late this year.

Also, more rapid house price increases have made bankers more complacent about problem borrowers, since they reduce projections of expected losses on a delinquent mortgage to low or non-existent levels. As we saw after the 2007 subprime crisis, that sunny outlook can darken for a long time.

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As long as most homeowners are employed or otherwise solvent, mortgage bankers are better off in a period of gently rising interest rates. Most of the time the bankers do not recover the full transaction costs of mortgage lending from their charges at the time a transaction closes. Usually, profitability only comes over a period of years after accruing fees for “servicing” the mortgage by collecting payments, distributing them to mortgage securities holders and taking care of the paperwork.

When mortgage rates fall, homeowners have an incentive to refinance, which means the bankers’ servicing revenue from their mortgage is cut short. In a rising rate environment, such as the present, those mortgage servicing fees tend to carry on, month by profitable month.

At the beginning of the pandemic, the independent mortgage banks that sell their loans to investor pools faced an existential threat to their revenues and balance sheets as markets went into turmoil. With pandemic relief from the government and the Federal Reserve rate cuts and securities purchases, this quickly reversed into flush prosperity.

Christopher Whalen, a New York mortgage banker, says “profitability in July was astounding”. He says: “You were making money right after the close and after the sale [of mortgages], which is not normal. Usually you make it on servicing fees.”

New home starts and mortgage applications peaked in December, and mortgage rates began to rise in early January. Mortgage “production” is, at least temporarily, declining from last year’s torrid pace.

“This is a feast or famine business,” says Whalen, who forecasts mortgage volumes might fall by 40 per cent this year.

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“We [the mortgage banks] increased headcount by 50 per cent over the last 12 months. Last year, we were adding capacity so quickly that nobody thought about expense management. Now they are thinking. Volume is slowing and profit per loan is down too.”

The share prices of listed mortgage bankers still reflect the post-pandemic recovery, not the more recent slowdown. Maybe equity investors will be proven right about the long-term value of these shares. But a lot of stars will have to align for that to come true.

While there is a structural demand for housing in the US, costs are rising for would-be homeowners. For example, an index of the price of lumber is nearly four times’ last year’s low. Builders are pressed to find skilled construction workers. Planning restrictions choke new home building that would increase supply to damp price rises.

The easy money in residential mortgage banking has probably already been made.



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