Non-bank lenders: market-grabbing play is risky business

Rising interest rates are bad news for US non-bank mortgage lenders. These companies, which do not take deposits or offer other banking services, rode a wave of liquidity from low rates through two of their best years on record during the pandemic.

Refinancing activity has now dried up. Mortgage origination, which reached $4.4tn in 2021, should drop nearly 50 per cent to $2.3tn this year, according to the Mortgage Bankers Association.

The stock prices of non-bank mortgage lenders reflect this. The two biggest — Rocket Mortgage and United Wholesale Mortgage — have shed 47 per cent and 41 per cent of their value this year.

Instead of waiting for better conditions, the pair have responded to the slowdown by increasing incentives to grab market share from smaller rivals. These include waiving some fees and lowering rates on certain products.

Both Rocket and UWM may be emboldened by the wide spread between the 30-year fixed mortgage rate and the 10-year Treasury yield. This stood at 240 basis points on Friday, compared to about 135 basis points at the start of the year, according to Federal Reserve data.

That has provided some degree of protection against pressure on profitability. Rocket’s gain-on-sale margin, a measure of how much it earns selling mortgages, actually rose during the second quarter to 2.92 per cent, from 2.78 per cent a year ago. That is still nearly half that of two years ago at the height of the refinancing boom. UWM had a smaller gain. The margin lift hints at some stabilisation of their businesses.

But discounting for market share has risks. Non-banks fund their loans with borrowings, not cheaper deposits. They then sell on the loans, eventually to bondholders, often retaining responsibility for collecting payment. The model works when the economy is strong. When borrowers face sagging economic prospects it grows more difficult. Rocket and UWM no doubt hope for better surf. Investors would do well to watch from the beach.