In 50 years I have not seen a bust-to-boom to foreshadowed doom as dramatic as that in the US independent mortgage banking trade over the past six months. In April, the Mortgage Banking Association’s “forecast commentary” estimated that its people might be able to close on just $2.4tn of mortgage origination in 2020.
To get even that volume of purchases and refinancings done, though, the MBA pleaded to policymakers. “It is absolutely critical for the Federal Reserve and US Treasury to immediately establish a liquidity facility so that otherwise solvent mortgage servicers can borrow from the Fed to support forbearance programs,” the MBA said.
The MBA figured in April that “cash demands on [mortgage] servicers could exceed $75bn and could climb well above $100bn”.
At that moment, the Fed and Treasury’s rather clumsy pandemic-shutdown-bailout plan had created such gyrations in the mortgage finance industry that margin calls on routine hedge products were larger, in total, than the industry’s equity.
But by October, the MBA estimated the industry was on track to write $10.4tn in mortgage paper; $4.9tn to finance home purchases and $5.5tn of refinancings. In all, four times the origination volume projected in April.
Leading independent mortgage lenders had tossed aside their Fed begging bowl and were filling the champagne glasses for socially distanced IPO announcements.
For a crowd of clerks, mass-production lawyers and server farm techs the mortgage industry comeback was impressive.
How? Basically, by doing all the good stuff (house building, cheap mortgages) now and putting off the bad stuff (evictions, foreclosures, job losses from industry consolidation) for later. Genius.
Thanks to the miracle of election year politics, Democrats and Republicans united around good-stuff-now-bad-stuff-later. Cheap Fed money, “forbearance” for distressed voters, any reforms to be arranged after . . . after . . . by the next Congress. The agreed “Cares Act” intended as a bridge from the pandemic to just past the election had a lot of defects from the mortgage industry’s point of view.
But the mortgage banking entrepreneurs who had survived the great financial crisis, and their private equity backers, saw a once-a-cycle chance to move product and cash out before the Democrats got to rewrite Trump-era capital gains and estate tax laws. They took it.
By June, production and profitability targets were being exceeded. By July, the IPO papers and bond documentation were drafted.
The problem, as industry analysts could see, was going to be the mortgage originators’ requirement to cover months of principal and interest payments (P & I), as well as property taxes and insurance (T & I), on homes that would either receive forbearance under the pandemic-bailout Cares Act, or were simply delinquent.
Eventually, the mortgage bankers should be paid back by a government or government-backed guarantor, or by the proceeds of a sale or buyout.
In the meantime, as mortgage industry investment banker Christopher Whalen explains: “All servicers generally have a month between the receipt of the loan pay-off (from a refinancing) and the principal payment to the mortgage backed security investors.” He says most mortgage servicers used that time window from prepayments and mortgage pay-offs to fund P & I advances.
“This money, however, belongs to bondholders, and as a result (mortgage bankers) may need to use cash, including borrowing under warehouse lines (with banks) and bond debt to make the payments required under servicing operations.”
So the mortgage banks have booked enormous six month profits, but could have many months, or even years, of drains on cash.
No wonder half a dozen of the larger mortgage bankers scrambled to place IPOs. Rocket Companies, the owner of Quicken, was the first out of the gate in early August with a $1.8bn equity offering. By early October, a handful of mortgage banking IPOs were in the works, from the highly efficient AmeriHome Mortgage to others, such as Caliber Home Loans.
I am not sure how many will be completed now. Share prices are deflating again.
I would be inclined to let others take all of the upside left in this trade. Amazon and Alphabet, and the industry’s own clever geeks, are developing technology to whittle away transaction charges, ie salaries and office rents. And covering all the “advances” and operating costs is a business for those with monopoly cash or free money from the Fed.
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