With each new presidential administration, the financial services industry becomes filled with some combination of optimism about the future, and a degree of uncertainty about potential changes in policy. Typically, the level of optimism is connected to the anticipated changes in monetary and fiscal policy. With most presidents, much of their policy and priorities are well-known and predictable prior to their election. President Donald Trump assumed office with little political experience, a vast business background, and a host of ever-evolving policy positions. He also came to office with a promise of returning the regulatory environment to something that was more business open – something that would accelerate GDP growth, expand job creation and ultimately grow a decade plus of stagnant wages; key components in reinstalling consumer confidence and the corollary consumer spending.
Now that the Trump administration nears five months on the job (more if you count the three months of transition), it is a good occasion to review the impact the president and his team have had on both the broader economy and the mortgage servicing industry, as well as a look ahead to what changes could be in store for the market.
Government impact – to deregulate, dismantle, and disassemble or not?
After his surprise victory in November, President Donald Trump repeatedly vowed to shred the federal regulatory apparatus, promising at one point that he would cut regulations by 75% or more. Additionally, his campaign (and now administration) made tax reform a priority, promising hefty cuts in taxes to businesses. Throw in his desire to spend nearly $1 trillion on infrastructure improvements, and it’s no wonder that Wall Street and the bond markets initially responded with nearly unbridled enthusiasm. After the first 100 days, the S&P 500 had gained nearly 5%. By comparison, the index typically gains less than 1% regardless of party – 0.9% for Republicans and 0.3% for Democrats. There was good reason for the optimism: improving labor market, promise of restoring some regulatory normalcy, and solid projected GDP growth.
Since then, however, the growing uncertainty that clouds the administration is taking its toll on the economy. Questions about the steadiness of the president’s public statements, various investigations, and a lack of tangible successes with an ostensibly friendly Republican Congress have conspired to deflate much of the optimism about the president’s lofty agenda.
Just recently, the president announced the nation will be withdrawing from the Paris Agreement on climate change. While popular with his base, the shift will have negative unintended consequences and further a sense of economic isolation and ambiguity. The daily dose of volatility has also sent a message of uncertainty to stock and bond investors, who have begun to hit the brakes. In particular, no-nonsense bond traders seem unconvinced that major infrastructure projects are in the offing. The Financial Times recently reported that “stagnant sales of bonds by local governments and authorities as they focus on budgetary discipline have helped fuel unexpected strength in municipal bond valuations.”
On the regulatory front, there is a good deal of uncertainty as well. While many business leaders would be happy to see some form of relief, there is great danger in calls to dismantle or dramatically scale back regulations that companies have spent years and billions in resources to comply and adapt to. For mortgage servicers like RoundPoint, the Consumer Financial Protection Bureau (CFPB) is one of its most important regulatory relationships, and there is much uncertainty when it comes to the future of the CFPB. Will the administration’s regulatory review, led by Treasury Secretary Steven Mnuchin, recommend wholesale changes to the structure, scope, and mission of the agency? Will Congress take action to replace the single director with a more standard (and likely more stable and healthier) commission-style leadership structure? Will the eventual outcome of the closely-watched PHH vs. CFPB case make that a moot point? With the president’s first budget proposal recently released, he’s made clear his desire to see change at the CFPB. The administration would see funding for the CFPB not only slashed by $145 million next year, but by as much as $700 million by 2021. Additionally, the president and Republican allies in Congress are in agreement that funding for the CFPB should go through the regular Congressional appropriation process and not through the Federal Reserve, which is not accountable to Congress by design. We’ll see how much of the president’s regulatory priorities become realities.
Time for reform
One way that the administration could make a positive impact is by encouraging and prodding regulators to provide businesses with more clarity on compliance. Recall that in the immediate aftermath of the TRID rollout, mortgage companies had hundreds of millions of dollars of loans on their balance sheets, in part because warehouse lenders and investors were concerned about their potential liability on even the smallest of TRID errors. So, whether for TRID or other issues, if the industry had a better understanding of the regulatory community’s risk assessment of possible issues, we’d have a transparent situation and consistency across the industry. That would translate directly to an improvement in consumer experience, as lenders and servicers could operate with more confidence, and focus on better products and solutions.
Another way that the administration can make a positive impact on the mortgage and financial services sector, is by embracing reform of the government sponsored entities, or GSEs. For too many years, Fannie Mae and Freddie Mac have languished in conservatorship with an uncertain future. The administration should be working with Congress to pass reform and allow Fannie and Freddie to be recapitalized and reborn as independent companies that are able to safely support the private mortgage market.
Macroeconomic and mortgage market trends
The big question that continues to drive both business and consumer behavior is where interest rates are headed. The good news is that in many ways we should be pleased that the Federal Reserve is planning to raise the target rate a couple more times this year – it indicates the central bank is convinced that the economy is gaining strength and that consumer activity will lead to further GDP growth. But are rising rates good or bad for the mortgage industry? For originators operating in a GSE-dominated market and heavily dependent on retail origination or refinance activity, it is likely going to be a challenging road ahead. Rising rates will mean decreased production and slimmer margins.
For the pure subservicer, this may lead to flat or even negative growth. As rates rise, mortgage servicing rights (MSR) duration extends, so borrowers will stay on the platform longer, making the MSR more valuable. However, many lenders will find themselves needing capital and will resort to selling the MSR to an aggregator or another servicer or capital provider for the needed operating capital. This often creates a loan transfer from the pure subservicer. This phenomenon accounts for the rapid growth in the MSR market in recent months. Buyers have had the opportunity to pick up product at prices that are still reasonable, and may now have more confidence in a higher and increasing long-term rate environment.
For fully integrated mortgage banking institutions, however, rising rates are good. As mentioned, mortgage bankers will find that the duration of the assets on their books will be extended. This will leave the lender in a decent position, with origination activity supported by its owned MSR position. The MSR valuations increase as duration and cash flow prolongs.
Bottom line: rising rates are great for balanced institutions. They reflect a strengthening economy, a confident consumer, and more opportunities in purchase originations and alternative products.
Foreclosures continue to fall
Another reason that MSR values have increased is the continued decline in default rates. The Mortgage Bankers Association (MBA) reports that homeowners are defaulting on their mortgages at rates not seen in a decade. Just 4.71% of all loans are in the foreclosure process, down six basis points from one year ago. Even states with lengthy judicial foreclosure processes, like Florida, New York, and New Jersey are starting to work through their backlog of foreclosures. Considering that home values continue to improve and wages have been steadily, albeit slowly, increasing since 2015, it is reasonable to expect default and foreclosure rates to continue to either fall or at least stay flat.
That also has implications for the growing rental market. While wages are increasing, they are not keeping pace with rising home values in many markets, leaving plenty of rental opportunities. Increases in interest rates will further exacerbate this, and many Millennials, already the largest cohort of homebuyers, have until recently been putting off homeownership, thanks to high levels of college debt, delayed family formation, and other factors. First-time homebuying is expected to be strong in 2017 – credit bureau TransUnion anticipates nearly 3 million new buyers this year, many of them Millennials. The Millennial “wave” still hasn’t even crested, as number-crunchers at NerdWallet note that only one-third of Millennials are 31 years old, the average homebuying age, and almost 1 in 4 are still under 25.
The increase in Millennial homebuying, however, is not happening in geographic symmetry. While there’s plenty of activity and movement in the more-affordable Midwest and South, coastal city home prices are out of reach for many young buyers, making rental housing an attractive investment.
What is “next” for mortgage servicers?
Looking ahead, in the near-term consumers are likely to see changes in both government regulation and technology-driven improvements to user experience. First, barring any immediate changes at the CFPB, expect to see adjustments to the CFPB amended Mortgage Servicing Rule, including:
>>New statements will now be sent periodically to consumers in bankruptcy,
>>Additional loss mitigation protections availed to consumers more than once during the life of the loan, and
>>Confirmed successor-in-interest in the mortgaged property will be extended same rights as consumers under Regulation X & Z.
In a world that is rapidly accepting on-demand mobile services like Uber, mortgage originators and servicers must do more to reach younger homebuyers who expect a more transparent and accessible process that extends far beyond the close of the loan. Servicers will begin to leverage technology to improve how they communicate with borrowers, reach out to those struggling to pay their mortgage, and find new and innovative alternatives to delinquency and foreclosure. Additionally, servicers will continue to maintain high levels of security to protect their customer’s data and information in the face of the constant threat of cyber-attacks.
Evaluating any president’s record on the economy and specific sectors like housing is an inexact science. What we do know about this president, however, is that he is advocating for major regulatory change at a time when lenders and servicers are already responding to the market’s demand for change.