Mortgage Industry in Flux: Fewer Regulatory Headwinds, but Technology and Higher Interest Rates Present Ongoing Challenges
By Richard Gottlieb, Brett Natarelli
February 25, 2019
We are experienced mortgage lawyers, not economists. But we can see the writing on the wall for our many mortgage industry clients, and it is not always pretty.
The era of burdensome new regulation may be over, but tougher laws, rising interest rates and new technologies, such as mortgages-by-smartphone, are reshaping the industry. And there may be some casualties along the way.
The story is well told: Since the 2007 meltdown, residential mortgage lending has been on an unending roller coaster. Back then, hundreds of traditional mortgage brokers and smaller mortgage banking operations either collapsed or suffered near fatal losses.
The Dodd-Frank reform law, designed in part to avoid future financial collapse for both industry and consumers, has been a mixed blessing. During the Obama administration and under an all-powerful Bureau of Consumer Financial Protection, enforcement was wielded like a cudgel for otherwise legal activities that were suddenly deemed unfair or abusive.
And the new laws and regulations have been both good and bad for industry. The good? Far more uniform mortgage regulation and (for the most part) a single regulator. And, of course, the CFPB has rooted out all sorts of evils. But the good was mixed with a brand-new compliance regime. Dodd-Frank brought major reforms including integrated disclosures (TRID), the qualified mortgage (QM) and ability to repay rules, new rules concerning periodic statements, and new regulations for mortgage servicing.
Today's headache for mortgage compliance personnel are many, such as new requirements for HMDA data collection. The added layer of CFPB supervision and enforcement has arguably been the biggest source of concern, but it is not the only one. State regulators, state attorneys general and private litigants continue to pursue the industry.
"The CFPB's on Line 2."
During the Cordray era, the CFPB was feared not just for its enforcement powers, but also for how those powers might be employed. It was not just the changes in the law that created the concern, but the very attitude that nearly every needed fix or "gotcha" moment was an enforcement matter suitable for public humiliation and huge civil monetary penalties. We've been there for our clients, assuring them they are not alone, but saddened and angered by the often unwavering demands for a pound of flesh.
While some may think that the tide has turned because of the change in leadership at the CFPB, the real story is decidedly a mixed one. Yes, there is renewed sanity at the CFPB, but state financial regulators and state AGs have picked up the pace. And the CFPB continues to make headlines. Even today we still see, for example, stiff penalties imposed against a lender who committed no wrongdoing but merely bought student loans from a for-profit college. We've also seen CFPB hubris in its refusal to engage in "normal" discovery in enforcement actions. And the CFPB continues to impose substantial penalties in enforcement actions.
As lawyers that regularly defend mortgage bankers, we know that the fight is often dependent on educating and persuading government lawyers and bank examiners that sometimes lack the interest or prior depth of knowledge to understand the intricacies of the many compliance issues they are attacking. That often means substantially increased expense to our clients, a dramatic increase in the overall cost of doing business, and the threat of draconian penalties that present existential threats to entities that are good corporate citizens that were just trying to comply with the law.
A Decidedly Mixed Future
In addition to ongoing regulatory headaches, the business side of the mortgage industry, likewise, is less than rosy. As we wrote this, interest rates on a single family 30-year fixed rate mortgage were up to nearly five percent, up from closer to three percent, and obtaining a rate under that amount was not unheard of for borrowers with outstanding credit, good shopping skills and a little bit of luck.
At the end of 2018, the Federal Reserve backed off its earlier projection of four 2019 interest rate hikes; it now says to expect two interest rate hikes in 2019, bringing the key federal funds rate to 3.1 percent by September 2019. That would put it around the halfway mark on the nearly straight-line cliff on the historical chart also known as 2007. The end of 2018 saw a surge in applications relative to higher rates earlier in the year.
But even if the Fed's rate projections hold, the market effects will continue to ripple in ways not seen since before the 2007 subprime crisis that led to the 2008 downturn.
Let's start with the obvious. In a market of rising interest rates, one might expect borrowers with low fixed rates--which they could have acquired anytime between 2008 and 2016, when rates were historically low--to not have much incentive to refinance. And you would be right. According to Ellie Mae, at the end of 2018, refinances were a lower percentage of the market, less than a third, than at any point since Ellie Mae began tracking the statistic in 2011. Borrowers refinancing today are either trying to lock in the best rate they can, having failed to do so earlier, or have been lucky enough to see a dramatic rise in their home's value and are willing to pay a premium on the interest rate to extract the new equity.
Competition for New Business is Fierce
What higher rates mean for purchases is less obvious. Volume has remained relatively steady, and the MBA projects purchase volume for 2019 will increase 4.2 percent over 2018 (and a decrease of 12.4 percent for refinance volume). When one needs an extra bedroom, a bigger and more modern kitchen or space for that dreamed-of man cave, higher interest rates will only discourage consumers at the far margins.
Because of this dynamic and others, borrowers in the purchase market are not dropping out of it altogether, but higher interest rates are changing how they shop in it. Try to think back to the pre-crisis days in the '00s, when mortgage origination volume was much higher than it is today (according to MBA statistics, $350-450 billion in recent quarters, compared to well over $600 billion in each quarter in 2006). Even with all the talk of the rise of the non-bank lender in that era, banks still had dominant market share and the idea of getting a mortgage by pressing buttons on a phone was barely an apple in some entrepreneur's eye. In 2019, it is non-banks, generally perceived as more nimble innovators, who have most of the market share, and "press-button-get-mortgage" isn't a dream, it's a Super Bowl commercial.
For the industry, modestly growing purchase volume and falling refinance volume has led to widely reported layoffs of mortgage loan originators and support staff. Some firms have even gone under. According to the Conference of State Bank Supervisors, there were 11,000 fewer mortgage loan originators in 2018 than 2017, a 7 percent drop. Even though revenue decreases have been modest for most firms, profitability is a challenge in the face of what origination companies call margin compression. With more room in interest rates to maneuver, some lenders can offer much lower rates than others. That has made the market more competitive now than it has been in years.
Lenders less able to compete on rates are looking to non-financial innovations to maintain volume. For example, it does not cost much for loan officers to respond to text or emails a little bit faster, and AI technology has made these fast responses better and more intuitive. Borrowers are also gravitating toward lenders who can make the application process easier, such as by electronically signing most documents and even offering increasingly popular remote or electronic closings. Mortgage brokers are even making a comeback as they can often offer a more personal touch and opportunities with a variety of products and lenders.
All these factors will lead lenders to push the envelope. Analysts are expecting riskier non-QM loan originations to increase dramatically in 2019, as they did in 2018. According to the Wall Street Journal, non-QM originations quadrupled in 2018 over 2017, and MBA is predicting a similar order of increase for 2019. It is inaccurate, however, to view non-QM as a synonym for subprime. These are often jumbo prime loans or based on bank statement income due to the growing segment of society that is paid in a manner other than the traditional W2 wage. While still a small part of the overall market, non-QM is the product seeing the most growth, so it is worth keeping an eye on as traditional refinances recede due to higher interest rates.
There's a saying in our hometown of Chicago: if you don't like the weather, just wait a little while, it will quickly change. The same continues to be true of the mortgage industry today. We may be past the rollercoaster's biggest first drop, and the most intense first set of loops and corkscrews are likely behind us, but the ride is far from over.
(Views expressed in this article do not necessarily reflect policy of the Mortgage Bankers Association, nor do they connote an MBA endorsement of a specific company, product or service. MBA Insights welcomes your submissions. Inquiries can be sent to Mike Sorohan, editor, at firstname.lastname@example.org; or Michael Tucker, editorial director, at email@example.com.)