Go bust vs. resurgence for IMBs

The tumult in the banking industry set off by the failure of Silicon Valley Bank (SVB) on March 10, followed two days later by the collapse of Signature Bank, has sparked fear in the markets over a potential broader contagion infecting the entire financial industry — and ultimately the U.S. economy.

For independent mortgage banks [IMBs], the uncertainty of the direction the banking calamity will take and its impact on the housing-finance market remains an open question. Industry experts who spoke during a recent webinar — “The State of IMBs: The Impact of a Banking Liquidity Crunch” — struck an optimistic tone about the future prospects for the IMB industry, however.

U.S. banking regulators’ fast action in establishing liquidity channels for banks under stress seems to be taking a lot of steam out of the still-unfolding crisis. Federal Reserve lending to banks through its discount window and the new Bank Term Lending Program created in the wake of SVB’s failure stood at a combined $152.6 billion as of March 29, down from $164 billion a week earlier — a sign that the banking liquidity crunch, fueled by deposits fleeing smaller and mid-sized banks, may be starting to abate.

The bleeding of deposits in the banking system since the collapse of SVB, however, has been significant. The most recent Federal Reserve data, released March 31, show that between March 8 (two days prior to SVB’s failure) and March 22, overall deposits at commercial banks in the country declined by $262 billion. Some $220 billion moved into money market funds over the two weeks ending March 30, the Wall Street Journal reported.

Smaller and regional domestically chartered banks — lenders that don’t rank among the nation’s 25 largest banks — have seen an outflow of deposits between March 8 and March 22 totaling $185.7 billion, according to the Fed’s data. The nation’s top 25 domestically charted banks, by contrast, over the same period recorded a $24 billion deposit inflow. The deposit data has not been seasonally adjusted.

The flight to safety sparked by the recent bank failures has contributed to a rate rally that is a boost to mortgage lenders, however. The 30-year fixed mortgage rate has dropped for three consecutive weeks since the failure of SVB — declining from 6.73% as of March 9, a day prior to the bank’s collapse, to 6.32% as of March 30, according to Freddie Mac’s Primary Mortgage Market Survey— with new numbers due out April 6. Although rates are still volatile and likely to bounce around some week to week, the longer-term direction is expected to downward, according to the Mortgage Bankers Association (MBA).

“The dip in mortgage rates has boosted borrower demand in recent weeks,” said MBA President and CEO Bob Broeksmit. “…While rates remain much higher than a year ago, MBA is forecasting a gradual decline, with the 30-year fixed rate falling to around 5.3% by the end of the year.” 

Housing expert David Stevens, CEO of Mountain Lake Consulting and past president and CEO of the MBA, also expects rates to continue their downward slope, barring some unforeseen economic blowout. He added that, in his view, there will be no broad market “contagion” stemming from the recent bank failures. 

Stevens was one of the presenters at the webinar, sponsored by industry groups Lenders One and the Community Home Lenders of America [CHLA] — both of which represent IMBs.

“If we saw rates in the low [5% range] at the end of the year, will that help?” Stevens asked during his presentation. “It will absolutely be unbelievable for [the IMB industry] based on what we’ve been through for the last 18 months. 

“… That would be huge to see rates in the fives for the marketplace.”

Given the impact of the banking crisis and a likely lending contraction to come in that sector as a result, the Federal Reserve’s rate-hiking campaign to stem inflation is expected to end soon, market observers contend. Stevens said during his webinar presentation that he believes “we’re probably at the end of the [Fed rate] increases” now.

“…You [IMBs] should feel optimistic, even though it’s been a really rough ride, and every time something major happens, like SVB, you go, ‘Holy crap, is this the end of the world?’ No, it’s not.”

Lending contraction ahead

Despite Stevens’s positive outlook for IMBs, the deposit exodus from small and mid-sized banks in the wake of the recent bank failures remains a concern. A recent market analysis by Goldman Sachs said it may prompt many of those Main Street banks to pull in their horns in terms of extending new credit in order to cope with the deposit bleed.

“In the U.S,. we expect that stress on smaller banks could result in a tightening of lending standards,” the research report says. “Our rule of thumb implies that this incremental tightening in lending standards would have the same impact on growth that roughly 25 to 50 basis points of rate hikes would have via their impact on market-based financial conditions.”

Hence, the banking crisis may well relieve the Fed of the need to bump rates higher to stem inflation. The banking industry appears to be doing the job for the Fed. 

“If it looks like the bank credit expansion is really being pulled back on, then that could substitute for Fed tightening,” Chris Varvares, co-head of U.S. economics at S&P Global Market Intelligence, said in a recent S&P report. “Financial conditions are tightening. That is what the Fed wants to happen.”

The S&P report indicates that small commercial banks accounted for 57.3% of the $2.752 trillion in [residential] mortgage loans and 45.2% of the $2.071 trillion in consumer loans in 2022. S&P in a separate report states that “banks are likely to implement stricter lending standards” to prevent liquidity challenges from spreading into “credit concerns.”

 “…There are about 4,500 banks, thrifts and credit unions in the country and the vast majority of them are tiny, in local communities, little, tiny thrifts or banks, and many of them have also made bad basis [interest rate] bets,” Stevens said. “They have long assets [at low rates] on their balance sheet and their cost of funds [deposits] is rising. 

“It’s squeezing them because they don’t have the size, they don’t have the ability to outrun their fixed costs as well as larger banks do. So, there is concern about that, but that really won’t impact our [IMB] market.

IMBs vindicated

Scott Olson, executive director of the CHLA, who also presented at the recent webinar, added that he agrees with Stevens that “there does not appear to be any panic or contagion from the Silicon Valley Bank [collapse] spreading to the IMB sector.”

“IMBs still need to be vigilant about their relationships with their warehouse lenders, assessing the counterparty risk of doing business with them,” he stressed. “So, for IMBs it’s important to pay attention to liquidity, and it’s particularly true if you’re a servicer with advance responsibilities, because you have to make the advances.”

Olson added that CHLA issued a recent report that explained “why IMDs do not pose any taxpayer or systemic risk.” He said that conclusion “has been vindicated, at least so far, in the aftermath” of SVB’s failure and the resulting woes in the banking industry.

“…IMBs pretty much emerged unscathed, and the main focus in Washington, at least right now, is on regional banks,” Olson said. “…So, everyone in the IMB community needs to make it a priority to educate Congress and other officials in Washington about the IMB business model, how important they are for mortgage credit, why IMBs don’t represent this big risk to taxpayers, and why they don’t represent systemic risks.”

CHLA President Taylor Stork, who also serves as chief operating officer at Developer’s Mortgage Co., stressed during the recent webinar that even though “it may not feel like it right this second, and it may be a little slow,” he believes that “the market is absolutely turning in our [the IMBs] favor.”

“The concern about IMBs amongst the rest of the world has not gone away,” he added, however. “It is imperative that we do the hard work to make sure that they understand how we do business and that we fortress our business models and solidify them.”

Stevens said one area the government-sponsored enterprises (GSEs) are focused on is mortgage-servicing rights (MSR) valuations. Stevens said he recently had lunch with the “CEO of one of the GSEs” where that subject came up. (The GSEs include Fannie Mae, Freddie Mac and Ginnie Mae.)

“We talked about a couple of really large publicly-traded nonbank lenders who seem to be competing on price and have questionable valuations on their MSR books, and the GSEs are focused on those,” he said, without naming the institutions.

Stevens also said the GSEs are focused on a broader market problem: the current size of the IMB industry.

“There’s still twice as many people in the mortgage industry than the mortgage industry needs today,” Brian Hale, founder and CEO of Mortgage Advisory Partners, said in an interview conducted a few days after SVB’s failure. “…In less than two years, we’ve gone from $4.22 trillion [in 2021] to call it $1.3 trillion [in projected mortgage originations] this year. To make it easy to divide, that’s a 69% drop in volume.”

Stevens said the GSEs are worried that the IMB sector and the lenders in it have not yet adjusted their operations to the new normal in the housing-finance sector that is likely to be with us for some time.

“They look at the MBA reports and the Stratmor studies of [IMB] losses that we just saw in the last quarter, and they are concerned that the IMBs of the world have not right-sized to the market that’s going to be in front of us for the next many years to come,” Stevens said. “I agree with that by the way … that they haven’t right-sized, but they will.”

He added that once the IMB industry is “finished right-sizing,” and the Fed is done boosting rates, with “rates normalizing and lowering,” there is a “brighter future ahead” for the industry. For the IMBs that survive the ongoing industry downsizing, then, a far more lucrative “new normal” awaits — assuming no other big shocks to the financial system or the IMB sector.

“But we just haven’t finished the work yet to get us all back, and the industry back, to the size it should be to bring back a more normalized level of margins to allow us to begin revitalizing ourselves in the new normal of what’s ahead over the next several years,” Stevens concluded. “But I’m optimistic about the business frankly, and I think once this is all done, we have some really great years ahead, and we’re going to have increasing loan originations over the next several years from where we are this year.”