Fitch: U.S. Non-Bank Mortgage Lender Margins Could Fall Further

Fitch Ratings, New York, said U.S. non-bank mortgage lenders could face further margin pressure as interest rates continue to rise, owing to higher funding costs relative to banks with lower-cost, stable depository funding.

The report, Rising Rates to Challenge Certain Non-Bank Mortgage Models, said profitability metrics for non-bank mortgage lenders are “generally weak,” with expenses outstripping net revenues by nearly 21% across the five public non-bank mortgage companies for the 4.5-year period ending June 30.

“We expect consolidation to continue as a result of weak profitability, with non-bank lenders seeking scale efficiencies to combat rising rates, persistently high technology and regulatory compliance costs, and declining refinancing activity,” said Fitch Director Johann Juan.

That said, the report noted non-bank lenders with multiple origination channels and established mortgage servicing platforms that generate higher fee income and more sustainable earnings should be better positioned for the shifting trends of the interest rate and economic cycles. “These lenders are generally less exposed to cyclical swings in the mortgage market, as the complementary nature of origination and servicing businesses can serve as a natural hedge, reducing earnings volatility,” the report said.

Aside from driving funding costs higher, Fitch also sees rising interest rates as a headwind to origination volumes, which could further pressure profitability in the medium term. The Mortgage Bankers Association forecast calls for originations of roughly $1.6 trillion annually from 2018-2020, down 6% from 2017 levels. MBA said refinancings are forecast to 24% of originations by 2020, down from 49% in 2016, in the face of rising rates.

Fitch said more positively, mortgage servicing right valuations generally increase with rising rates and economic growth, as prepayments fall and default risk lessens. Reflecting these dynamics, MSR valuations have increased in recent years, averaging 104 basis points of the unpaid principal balance of servicing portfolios for the five public non-bank mortgage companies.