Don Laytonthe current Senior Industry Fellow at the Harvard University Joint Center for Housing Studies—and former CEO of Freddie Mac— published a new column on the policy implications of record mortgage origination profits during the pandemic, which he authored after the publication of the Mortgage Bankers Association (MBA) Mortgage Bankers Annual Performance Report.
Quoting the MBA report, the “net production income” of mortgage companies – a key measure of the profits of these companies – was a record 1.57% in 2020 and 0.82% in 2021. However, this compares to an average, since reporting began in 2008, of just 0.60%.
Put another way, mortgage profit margins were 262% of the historical average and are still 133% of the average in 2021. “That’s an extraordinary increase during the upheaval of the pandemic,” Layton commented.
“This profitability model is evidence of an unintended flaw in the nation’s new mortgage funding system, created by the way the origination process sits between the primary market (several thousand lenders who provide loans directly to homeowners) and the secondary market (which consists almost entirely of three government agencies) that provide permanent funding,” Layton said in his article. “These two markets are closely linked because far more than half of the loans issued on the primary market are only held by its lenders for a short time and then sold to a permanent funding source through the secondary market.”
“Thus, primary market companies will earn in revenue the difference between the interest rate charged to borrowers and the lower rate paid to the secondary market lender when the loans are sold,” Layton continued. “Given the mechanics of the market, this interest rate differential is reflected in primary market lenders selling loans to the secondary market for more than is actually advanced to borrowers, producing what is known as the ‘gain on sales margin.’ (Unlike the MBA’s net production income measure, it does not take into account expenses or other sources of income.)”
Layton goes on to say that the gain on sale margin confirms a pattern of “significantly increased profitability” during the pandemic and cited Rocket Mortgage as an example of this – Rocket Mortgage had a gain on sale margin of 3.19% before the pandemic. pandemic which increased to 4.46% in 2020 and decreased to 3.13% in 2021.
He cited a second example of another large non-bank mortgage originator, Loan Depot, which experienced a similar rise and fall in profits during the pandemic. Their gain on sale was 2.18% in 2019, 4.13% in 2020 and 2.61% in 2021.
“The unusual structure of the primary market versus the secondary market was designed to ensure that the primary market could continue to lend even in the most stressful economic or financial times, which it largely does,” Layton said. “Unfortunately, however, it also means that the economic benefit of federal policy measures cannot be assumed to be fully and quickly passed on to the owners who were the intended beneficiaries; instead, some may be diverted to primary market intermediary lenders, which is exactly what has happened during the stress of the pandemic.
At the start of the pandemic, the Federal Reserve aggressively intervened to cut interest, which meant that the two government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac, as well as Ginnie Mae, were able to offer to finance mortgages at much lower interest rates than they were. a few months earlier. However, primary market lenders were not required to pass on these lower rates to borrowers.
While the market typically moderates its own prices through competition, that was decidedly not the case during the pandemic, as a tsunami of refinances swept through major lenders by those taking advantage of historically low rates.
As a result, the market largely decided not to pass these savings on to borrowers competitively, and instead decided to increase their margins to balance supply with the massively increased demand by raising interest rates for homeowners. by a much lower amount than if the much lower secondary market interest rates had been fully passed on to owners.
This resulted in record profits in 2020 when the supply/demand imbalance was at its peak, then returned to normal in 2020 as supply and demand balanced further.
“Interestingly, the increase in profit margins could have been even more pronounced,” Layton said. “In October 2020, at the request of the government, GSEs announced that they would add (with some exceptions) an upfront ‘adverse market charge’ of 0.50% on their refinances. It was justified by credit losses high expected due to the pandemic and took effect on December 1.”
“Understandably, the mortgage industry has complained loudly about the fees. It was eliminated on August 1, 2021 when it became apparent to the government that the expected losses were not incurred,” Layton continued. “However, in retrospect, we can see that fees prevented industry profits in 2020-21 from growing even more than they did (with the impact of fees being widely felt in 2021). As a result, part of the increased primary market profit margin benefited the GSEs instead of going exclusively to lender shareholders. And since the GSEs do indeed belong to the taxpayer, that means the taxpayer has captured some of those increased profits, which seems fair since it was government policy making that created the conditions for the record profits in the first place.
This primary versus secondary market friction in policy-making can also be found elsewhere, including the requirement that GSEs meet certain affordable lending targets.
“In order to make future policy-making more effective, the ability of primary market intermediaries to improve their margins, as described above, is something that those who make decisions about the design and operation of the mortgage system should think deeply,” Layton concluded. “While the industry would understandably be vocal against any attempt to limit its margins, a program to do so, but limited to times of great economic stress or with respect to targeted programs designed to expand home ownership, could make sense. It would be implemented through changes to the legal contracts that primary market sellers enter into with GSEs and Ginnie Mae; what is not clear is how difficult it would be to operationalize it. But it is definitely worth exploring.