Lenders May Have To Scale Back To Survive


Since early 2022 officials at the Federal Reserve have been raising interest rates as a means of combatting inflation but the trickle-down effect is making life hard for the lending industry. More specifically for non-bank lenders.

This is according to financial experts and industry observers such as Dr. Rohan Ganduri of Emory University’s Goizueta Business School.

Ganduri says there are really only two types of lenders, bank and non-bank lenders. In the current mortgage climate the smaller, non-bank lenders have a landscape that is changing rapidly and not in the favor of those employed by such lenders, he told The Mortgage Note.

“A non-bank lender differs from a bank lender in several ways,” says Ganduri. “The biggest difference is how they fund their mortgage originations and what they do with it later. The ‘Bank’, as we know, takes deposits and those deposits are insured by the FDIC (Federal Deposit Insurance Corporation). So, they are very stable sources of funding. Then the bank lends them out, makes mortgages, etcetera.”

“Even if some of the loans sour and the bank does not make good investments, the depositor’s funding is protected by FDIC insurance.”

Non-bank funding works very differently.

“Non-banks lend much more than the banks, so their market share in terms of originations is much greater than banks and this has been the case since 2016,” said Ganduri. “We have gone back to the pre-crisis levels when it was very similar to 2008-2009. What these non-bank lenders do is instead of deposits, they finance the loan originations by taking loans from other banks and institutional lenders. These are generally very short-term loans.”

Ganduri explains this way of lending, and borrowing to pay for it, works very much like the way you or I would use a credit card or line of credit.

“The idea here is they would draw down the credit line, make a mortgage, and then sell the mortgage,” Ganduri said. “They have to look for another buyer on the other side to see the mortgage to. Once they sell it, they recover the money that was dispersed and pay down the credit line.”

Ganduri said during “good times,” as long as the securitization market is doing well and as long as there is as good demand for securitized assets, the entire pipeline and arrangement works well.

But, in today’s market. Not so much.

“The time taken to originate mortgages, securitize, and sell them is very short,” said Ganduri. “Sometimes the demand for mortgages goes down and that is what we have today. Many non-bank lenders cannot make enough mortgages and getting them into the pipeline of other lenders securitizing can take a month or longer to pool the loans, securitize and sell them. Within this month, and sometimes up to 45 days, the interest rates go up, which they have, the value of the mortgage goes down and it is a non-bank lender that takes the hit.”

Ganduri says this combination can and does have a choking effect on many non-bank lenders.

“When they sell these mortgages, because they are paying less than what the current interest rates are, they are already not going to get as much money as under the old interest rates. The non-bank loan originators will then have to make up the difference,” Ganduri said. “Even if mortgages cannot be sold, they need to be marked to the market value. So, mortgages in the pipeline have to be repriced, often at a lower value. Once the value goes down, the lenders could experience a margin call from the warehouse lender. The margin calls have to be satisfied. If they are not satisfied the warehouse lenders can seize the assets of the non-bank originator and then liquidate them. This is the biggest risk the non-bank lender faces.”

These factors and many others are forcing lenders to do some re-adjusting at the local level.

According to Financial Planner Elizabeth Rose of American Home Lending USA in Dallas, Texas, lending businesses across the country are being hit.

Rose said according to many reports, the lending industry as a whole is down 40-to-60% and that puts a strain on a lot of companies.

“What we experienced in 2020 and 2021 was an incredible amount of production which meant companies were hiring and in many cases paying a premium,” Rose said. “Now companies are having to lay off. It is a cycle we’ve seen before but this one is garnering so much more attention because it happened so quickly and drastically. Rates shot up at a faster pace than they have in history so we (lenders) don’t even have history to go back and look at and see what we did last time.”

Rose said, “I think that has just made it really tough on the companies and while we’ve seen companies lay off personnel, mostly operations-type people, we have seen some big companies cut out programs or even exit the industry. I think the smaller, independent companies are more likely leaner than the bigger companies, with less layers of management and probably started shedding headcount early last year when they saw production was going to fall off.”

Rose said in most companies that are scaling back, salespeople appear to be doing all right as they are the breadwinners of any company. They draw in business.

“They are reducing other head count,” Rose said. “In operations to things like processing.”

Rose had many thoughts on the factors that have led to the situation lenders and many other parts of real estate are finding themselves in.

“We still have all sorts of supply issues and transportation issues with getting goods to the homes,” Rose said. “I have been watching construction in my own area and when they break ground on a house, there is a period where they cannot get windows and then there is another period when they can’t get brick and when these periods happen, construction just stops.”

Rose said when there are drags on a builder, it is hard for them to commit to a smaller price point product with a lesser profit margin because there is no room for error.

“I don’t really know how to fix the problem, but we need affordable housing. In my area (Metropolitan Dallas, TX), a first-time buyer, unless they are going to the outskirts, and really it is the outskirts of the outskirts, they are going to be paying $375k-$400k for a starter home. Now granted that is substantially lower than California, but it is expensive. That is a $3k-to-$4k a month payment and what young couple can afford that?”

Perhaps this situation could have been avoided, Rose said. She pointed to decisions made by officials at the Federal Reserve.

“If we go back to different periods of time, generally a Fed hike is good for mortgage rates,” Rose said. “However, in my opinion, they waited a year too late to start. If they had started in August of 2021, when inflation was rising, if they’d started something then, we’d probably not be in the dilemma we are in today.”

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