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Mortgage Lenders Timed the Market Perfectly

Homes in Hercules, California, US, on Wednesday, June 15, 2022. The number of home sellers lowering prices has reached the highest level since October 2019, the latest sign that the housing market is slowing from its once-frenzied pandemic pace. (Photographer: Bloomberg/Bloomberg)

When people look back on the market euphoria of 2021, there’s plenty to pick over: Meme stocks, SPACs, digital coins — all of them capture the zeitgeist. One candidate for poster-child of the era, though, can be easily overlooked amid all the exciting new financial contraptions: the otherwise-staid mortgage sector. Mortgage stocks avoided the headlines, but they reflect no less of the hype.

Up until 2020, there weren’t many mortgage stocks listed on US exchanges. The last publicly traded standalone mortgage company of size was Countrywide Financial Corp., which was taken over by Bank of America Corp. in July 2008 amid mounting losses as the global financial crisis neared its climax. After that, mortgages were handled mostly by the big banks.

But the underlying economics of the industry never changed, in particular the boom-bust nature of the market. Now that rising interest rates are turning off the refinancing spigot, a new generation of specialist mortgage lenders finds itself in the firing line.

In the past decade, specialists gradually reasserted themselves. From a 10% share in 2010, they increased their market share to 70%, and for most of that time, they stayed private. The largest, Rocket Cos., remained in the hands of its founder, Dan Gilbert.

But virtually all at once, they went public. In a six-month period starting with Rocket in August 2020, a clutch of mortgage companies collectively valued at almost $60 billion came to the stock market. For the first time since the peak of the housing boom, public-market investors were given an opportunity to share in the upside – and downside – of the residential mortgage market.

Unlike the electric-vehicle companies that went public at about the same time, mortgage firms had no problem making money. The issue was rather the sustainability of their profits. Few industries are as cyclical as the US mortgage industry, and these companies were selling at the top.

Mortgage companies take a cut of the value of loans they originate and so when volumes go up, so do earnings. Incentivized by generationally low mortgage rates, millions of borrowers refinanced, driving record volumes. From $2.3 trillion of mortgage originations in 2019, volumes ballooned to more than $4 trillion in both 2020 and 2021. Three mortgage companies — LoanDepot Inc., UWM Holdings Corp. and Home Point Capital Inc. — succeeded in timing their market debuts to coincide with the all-time low in mortgage rates – 2.65% at the beginning of January 2021, per Freddie Mac data.

But it’s not just volumes that drive the cycles of mortgage profits – margins inject another layer of cyclicality. A lag between volumes and industry costs means that margins tend to rise when volumes go up and shrink when they fall. So 2020 and 2021 were characterized not only by high mortgage-origination volumes but also by high margins. According to the Mortgage Bankers Association, independent mortgage banks earned over $4,200 per loan in 2020, compared with a long-term average of $1,460.

Since then, the market — to put it mildly — has shifted. Mortgage rates are heading toward 6% and there’s no one left to refinance. Credit Suisse Group AG analysts estimate that only about 1% of mortgages are at least 50 basis points “in the money” to refinance – and it’s uncertain, given they haven’t already done so, whether these borrowers will refinance at all. The Mortgage Bankers Association forecasts that mortgage-origination volumes will collapse to $2.4 trillion this year. Meanwhile, mortgage companies remain staffed up for a $4 trillion market.

This leaves their new public owners exposed.

“Mortgage is a cyclical business,” Home Point Chief Financial Officer Mark Elbaum reminded investors last week. “It never seems to be just right, it’s always a little bit too hot or a little bit too slow. What we’re experiencing right now is what I would describe as somewhat of a hangover from the hot market. But I think all of us would agree, it’s happened a lot faster and a lot more extreme than anyone could have anticipated.”

Many of the other market trends of 2021 reflect some story about the future. Mortgage companies were simply trying to sell profits of the present. Both can evaporate quickly. With less than $19 billion of market cap left in the sector, mortgage company owners benefited from the massive transfer of wealth from stock market investors.

If history’s any guide, these lenders may not stay public for long. And then the cycle will turn again.

More From Bloomberg Opinion:

• Mortgage Rates Won’t be Falling Anytime Soon: Allison Schrager

• Housing Market Cooldown Will Lead to More D ysfunction: Conor Sen

• Are the Days of UK Property Booms and Busts Over?: Chris Hughes

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Marc Rubinstein is a former hedge fund manager. He is author of the weekly finance newsletter Net Interest.

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