MBA NewsLink Q&A: Rice Park Capital Management’s Nick Smith and Chris Bixby

MBA NewsLink recently interviewed Nick Smith, Founder, Managing Partner and CEO of Rice Park Capital Management, Plymouth, Minn., and Managing Director of Strategic Equity Investing Chris Bixby about their perspectives on the mortgage industry.

Rice Park Capital Management is a private investment firm that manages capital through three complementary investment strategies: residential and commercial credit, mortgage servicing rights and strategic equity investing including venture capital.

MBA NewsLink: Technology, particularly Artificial Intelligence, is reshaping the financial landscape. Recently you made an investment in AI company Purlin. Tell us a little bit about that and AI’s importance to the mortgage industry.

Chris Bixby: Generative AI is going to reshape our sector, including real estate, mortgage and fintech. We believe the mortgage industry has lagged in terms of the adoption of technology to provide a more automated experience compared to other industries such as payments, banking and ecommerce.

Even though the mortgage industry is consumer facing, the decisions being made about AI are driven by B2B commercial issues and are being made by people in organizations that have limited insights into how generative AI or machine learning (ML) can help build a better process with consumers.

We think technological innovation will continue to accelerate, that manual tasks will be automated and more complex, non-routinized tasks will increasingly be handled by Gen AI. We believe that the ultimate winners will be those who know how to apply this technology at an industry-specific level. In other words, the organizations that understand emerging technologies and have a vision of where they can apply them in specific industry-use cases will be the ones that succeed.

Nick Smith: The mortgage market is fundamentally prone to booms and busts. Consumer mortgage demand is highly elastic to changes in interest rates but the capacity (supply) of a mortgage company is relatively fixed in the short term. Given the inherent volatility in the interest rate markets, mortgage businesses naturally will experience periodic booms and busts. One way that AI could transform the market and help mortgage firms and their customers is by reshaping mortgage companies to have less operating leverage and a higher proportion of variable expenses. Certain tasks could be automated, which would improve the stability of the mortgage market and provide access to more affordable interest rates for consumers.

Chris Bixby: Rice Park’s Ventures Fund II recently made an investment in Purlin, which uses proprietary data, AI, and ML to bring solutions to areas within large, legacy real estate companies. Purlin launched a chatbot that ties in with underlying real estate data to answer questions with no hallucinations. It takes it a level further than what ChatGPT would do, in terms of regulatory compliance and brand alignment.

We believe some of Purlin’s AI capabilities are going to involve collaborative search and the ability to anticipate what a homeowner wants more quickly than a real estate agent or even the homeowner themselves. By using this data and ingesting behaviors that Purlin is tracking, AI will help homeowners navigate the real estate journey, faster and with higher satisfaction.

MBA NewsLink: With regard to investing in early-stage technology, how do you approach investments in mortgage-related innovations? Are there specific areas where you see significant potential for disruption and transformation?

Chris Bixby: Origination costs have increased tremendously and are currently $11k-12k per loan. Technology could play a significant role in reducing the portion of origination expenses, which are primarily tied to legacy systems and processes that were designed prior to the role of AI.

We are continuing to see opportunities to bridge gaps between legacy technology systems to provide significant cost savings, create alternative revenue streams and bring data into decision making and into interactions with customers to create a better journey and experience for the consumer.

For our venture capital strategy, we’re seeking to invest in businesses within the residential real estate and mortgage technology sectors that: first, we understand well because of our backgrounds; second, we can influence because of our connectivity and industry experience; and third, we can assist in terms of helping management navigate the markets to find partnerships and other areas/strategic outcomes that they can benefit from. It’s very much tied into how we built out the Rice Park team, how we think about the connectivity we have in the mortgage ecosystem, and how we leverage our advisory board – which includes senior C-suite staff. We look for a leg up on the competition because of what we have been able to build around our MSR strategy, our lending strategy and how we tap into our advisory network so we can get into situations to add more value.

MBA NewsLink: How do you navigate the challenges and opportunities presented by shifts in interest rates and broader economic conditions?

Chris Bixby: From the standpoint of investing in technology companies, we believe it’s a unique time because lenders are feeling the pain of the interest rate environment. It has created opportunities to re-evaluate how they run their businesses.

Several lenders have told us they have gone through a Reduction In Force (RIF) and a “Rip and Replace” strategy whereby they evaluate every vendor with whom they have spent money over the past few years. This exercise has caused them to develop a deep understanding of and appreciation for what a true ROI is with regard to originations. They are starting to think differently about how to build their businesses, how to address their technology stack from a cost standpoint and how to structure their organizations to achieve optimum efficiency.

We are thinking broadly about these opportunities and trying to identify situations to invest in which will help lenders approach their businesses differently.

MBA NewsLink: Thoughts onmortgage servicing rights trading? What are some of the tailwinds? What are some of the concerns?

Nick Smith: MSR trading volume remains significantly elevated. In the last three years (2021-annnualized year-to-date Q3 2023) the market traded approximately $1 trillion of MSR per annum. In the six years that preceded 2021-2023 (2015-2020), the market traded an average of $535 billion of MSR per annum. We believe higher trading volume is driven by persistent factors that will continue to be part of the story in 2024.

First, record origination volume between 2020 and 2021 of more than $8.5 trillion that is being unwound.

Next, a long-term shift of MSR and mortgage lending activity from the bank to non-bank sector.

Third, ongoing margin and volume issues with originators, many of whom have large MSR portfolios.

Private capital has played a key role in filling the MSR supply/demand gap, kept prices stable and liquidity broadly available to MSR sellers. While the overall MSR trading market has been robust, co-issue flow volume has been crowded out by bulk. Co-issue flow represented 12.5% of traded volume YTD Q3 2023 versus 31.3% on average from 2015 through 2020. Until the low coupon 2020-2021 vintage MSR has been fully worked through and/or pricing adjusts, we suspect originators will continue to have challenges with co-issue flow liquidity.

MBA NewsLink: What is your outlook for the rest of the year?

Nick Smith: There is a lot of uncertainty in 2024. The devil on my shoulder says…80% of all U.S. first lien mortgages have an interest rate of 5% or below and prepayment rates are historically low given the rate “lock-in” effect. These borrowers are not going anywhere and are effectively out of the market in terms of mortgage opportunities for the foreseeable future (and as a source of housing supply). Times will be challenging for originators in 2024 and potentially beyond.

The angel on my shoulder says….The current 30-year fixed mortgage rate is hovering in the mid-to-high 6% range. Despite the fact that the market has a large proportion of low coupon mortgages, 12.5% of borrowers have a rate above 6%. This equates to approximately $1.75 trillion of mortgages with a rate that is a refinance opportunity with a modest dip in mortgage rates, and the market thinks rates are going down in 2024, as does the Fed’s dot plot. This is intuitive given the significant moderating of inflation in the last half of 2023.

Moreover, the Fed does not have to drop interest rates for the mortgage rate to go down. The spread between the 10-year rate (Fed influenced) and the 30-year fixed mortgage rate has widened by approximately 75 basis points compared to the historical average. If this spread reverts to the long-term average, with no change in the base 10-year rate, we could have mortgage rates in the 5s. Times will be good again for originators in 2024 and potentially beyond.  

Our overall view when weighing the devil versus the angel’s perspective is that we are at a potential inflection point in the mortgage market, but the result remains highly unpredictable and largely dependent on the Fed and interest rates. Mortgage companies will continue to shed capacity to right-size to the current level of origination demand. Should origination demand increase, origination margins will likely improve significantly and restore the overall mortgage origination market to profitability.

There will be a continued focus on technology, labor market arbitrage and outsourcing to convert fixed costs to variable costs. MSR supply will remain robust and hedging and recapture will gain prominence again as higher prepayments becomes a potential risk.

Chris Bixby: We think there will be opportunities for distressed situations – whether that means mortgage consolidation and/or companies that have previously raised capital but have run out. Debt and capital flowed freely in the past, but it is now difficult to raise and limited only to high-quality companies and strategies. We think there are many high-quality companies that are going to have to get creative regarding how they capitalize and run their businesses over the next 24 months.

This information has been prepared by Rice Park Capital Management and is subject to change at any time without notice. While all of the information presented herein is believed to be accurate, we make no express warranty as to the completeness or accuracy of the information. Past performance is no guarantee of future results.

Rice Park Capital Management is an Investment Advisor registered with the U.S. Securities & Exchange Commission.

(Views expressed in this article do not necessarily reflect policies of the Mortgage Bankers Association, nor do they connote an MBA endorsement of a specific company, product or service. MBA NewsLink welcomes your submissions. Inquiries can be sent to Editor Michael Tucker or Editorial Manager Anneliese Mahoney.)