The Federal Reserve's decision to accelerate the withdrawal of monetary stimulus could spell a return to a more normal mortgage market. And while the lenders saw this coming, it might arrive sooner than they thought.
Immediately after the Fed's announcement, the MBA hadn't changed its forecast for mortgage rates to rise from just over 3% to 4% by the end of 2022. However, the group also noted that the interest rate outlook has changed more uncertain with the announcement, and its estimate may change when it later releases its final forecast for the year.
"While market participants were likely to have expected this change in [the Fed's] asset purchases, the more restrictive view of rate hikes may have taken the market by surprise," said MBA chief economist Mike Fratantoni in an emailed press release.
Interest rates "could be more volatile if the Fed pulls out of the market," he added. "While this will result in a decline in refinancing, we expect the strong economy to support an increase in home sales in 2022."
Even before the Fed announced, nearly two-thirds of respondents to Fannie Mae's latest quarterly lender survey expected profit margins to decline, down from 46% in the previous quarter and 48% a year ago. Because they already knew they would face increasing competition, a shift from easy refinancing to more labor-intensive purchase credits, and possibly a slight slowdown in unusually strong consumer demand.
Interest rates, the easing of pandemic stimulus programs, and the burden of rising home prices are the main reasons 31% of lenders surveyed by Fannie Mae expect a change in borrower demand that could result in lower profit margins. Concerns about consumer sentiment had risen from 21% in the previous quarter to 23% a year earlier. The percentage of lenders citing this as a primary concern hasn't been as high since the fourth quarter of 2019, when the proportion of respondents in this category was 36%.
Lenders like Caliber Home Loans are increasingly looking for alternative ways to meet the needs of new homes without putting a strain on consumer finances.
"As the demand for single-family homes remains strong amid a supply chain crisis, potential buyers will increase the demand for alternative home types such as condos, Renos, and apartment buildings," said James Hecht, executive vice president of retail lending for Caliber, in an email noting that products such as non-warrantable condominium loans are offered through a new department "opens the doors to home ownership for entry-level buyers".
Lenders are likely to be helped by the unusually strong profitability they have seen from interest rate incentives over the past year and a half.
"The margins have decreased, but compared to 2019 they are incredibly large," said Fannie Mae chief economist Doug Duncan in an interview. "They are still above where they were before the pandemic."
With the spread between the interest rates lenders charge borrowers and the price they can get for selling their loans is historically high, the outlook for home financing remains relatively bright, he said.
The primary-secondary spread was 127 basis points in the third quarter. That number was 13 basis points above the 2019 average, but below its high of 174 in the third quarter of 2020, based on analysis of data from the Mortgage Bankers Association, the Federal Reserve, Fannie Mae and Freddie Mac. At $ 2,594 per loan in the third quarter of 2021, the MBA calculated net manufacturing income rose from $ 2,023 from the previous fiscal period, but from a high of $ 5,535 a year earlier.
While residential property and profit margins can still be historically attractive, many lenders will likely have to focus more on their previously limited expense management as interest rates rise.
"Competition will force lenders to get some efficiencies or they will get into trouble from a net profit standpoint," said Duncan. "The trick is to invest in technology that converts fixed costs into variable costs so that they can adapt to current levels of activity as volumes decline."
This likely needs to be addressed through increased use of automation, and how effective the technology used for that purpose will be remains to be seen, he said.
"That's an open question, and the rate at which interest rates change will affect it," Duncan said.