The US housing market, believed to be bigger than the US stock market, has come under pressure again, as the Federal Reserve (Fed) has raised the Fed funds rate aggressively to curb inflation. Outstanding mortgage debt in the US, at c.USD13.3tn in 2022 and c.USD18tn in 2021, is estimated at c.USD13.7tn by end-2023, according to an April 2023 Mortgage Bankers Association (MBA) estimate.
Amid an uncertain geopolitical environment, the Fed has hiked the key rate 10 times between February 2022 and May 2023 to contain inflation, thanks to the pent-up demand amid the COVID-19 pandemic and the supply chain disruptions following the Ukraine-Russia conflict. This directly led to a cooling of the mortgage market and a significant drop in new-mortgage applications. The MBA expects total mortgage origination to decline 19% to USD1.8tn in 2023 from the USD2.2tn in 2022. Purchase originations are forecast to decrease 12% to USD1.38tn and refinance volume, -35% to USD428bn in 2023.
The following chart shows the composition of mortgage terms and originations in the US.
Trends expected to shape the mortgage sector in 2023
1. Interest rates are expected to remain high and peak by end-2023
Inflation has edged up significantly after the COVID-19 pandemic, due to supply-chain pressures and geopolitical tensions, prompting the Fed to take an aggressive stance on monetary policy. It has increased the fund rate 10 times, from 0.25% in February 2022 to 5.25% in May 2023 before pausing in June 2023.
The consumer price index cooled 1bp month-on-month in May 2023, bringing the level down to 4% in the past year — the lowest in the last two years.
The following graph provides a snapshot of the past and future trends expected in US inflation.
The Fed paused its historic rate hike in June, as various indicators hinted at the consolidation of the economy (e.g., CPI’s softening to 4%, driven by largely a decline in energy prices, as well as slowdown in food prices). Data published on 13 June 2023 by the Labor Department pointed to the important underlying growth catalysts — subdued rent and lease growth compared to expectations, as well as erosion in air travel, medical services, and gasoline prices. However, the inflation, partially pulled back by payroll growth, is still double the Fed’s 2% CPI target.
The following chart shows the trend in the Fed’s rate.
The following chart shows the trajectory of the 30-year mortgage rate, which closely tracks the Fed’s rate.
The demand for collateralised debt is expected to remain subdued in the near term.
vMay 2023 MBS issuance stood at USD493.9bn, -57.8% year-on-year, according to a SIFMA estimate.
The following chart shows the trajectory of agency and non-agency MBS issuance.
2. Home sales are expected to remain subdued in the next couple of quarters before picking up
The US mortgage industry derives its revenue from predominantly home-unit sales. The number of units sold and homeownership rates are key proxies of the health of the economy. Another important performance metric for the mortgage industry is the availability of fresh units. Amid the escalating-interest-rate environment, the cost of constructing a unit has edged up materially, limiting new supplies. Residential investment may continue to diminish since the housing market has yet to find a new lower equilibrium.
The following graph shows the sales trends for residential units and new constructions. New supplies are expected to lag behind demand.
Single-family home sales have dropped further, sliding below 850,000 units in 1Q23 from c.1m in 2Q22, while multi-family home sales contracted to 500,000 units in 1Q23, marking a fourth straight quarterly decline. Overall activity is expected to remain subdued for the next couple of quarters before it picks up (see chart below).
The following graph shows the trends in purchase and refinancing originations in 2022 and forecasts for 2023. Refinancing has declined rapidly and is expected to remain low in the short .
Source: Freddie Mac
3. GDP growth is expected to decline in 2023 before reversing the trend
GDP is a major demand driver in the mortgage sector. Notwithstanding the upward revision, 1Q23 GDP growth was the weakest since 2Q22. Residential investment has already softened significantly, due to high interest rates. On the other hand, commercial and industrial lending by banks continues to slow in the wake of the US banking crisis. The US unemployment rate is expected to rise to 4.0% in 2023 from 3.7% in May 2023.
The following chart shows the US GDP trend.
4. Third parties continue to optimise and streamline additional stages in the mortgage process
Many major banks and non-bank lenders have invested in either proprietary or third-party technologies across the value chain for modernising the front-end platform, workflow management, document extraction and management, appraisal management, automated compliance, employment verification and decisioning.
However, many mortgage originators still follow traditional processes that cannot be easily automated; this leads to high costs and long cycle times (see chart below).
5. Other trends
Non-bank lenders’ market share continues to grow, driven mainly by few players with a strong digital focus. More and more technology-focused lenders are remapping their front-to-back operating model, including streamlining document management.
Next-generation ‘subservicers’ are introducing more efficient digital platforms. Subservicers refer to experienced outsourcing partners that do not own the right to provide services (including administrative, compliance and financial services) but provide them on behalf of a master servicer for a monthly per-loan fee. The market is seeing a transition from in-house servicing to outsourcing, driven by higher regulatory scrutiny.
Companies are bundling home-buying services, including mortgages. Customers are looking for bundled home-buying solutions. Research by the National Association of Realtors indicates c.95% of homebuyers would consider a one-stop-shop model for their home-buying journey.
Strategies being adopted by lenders to manage the current challenges
- To cope with the increased cost of borrowing, banks have raised lending rates for retail borrowers and are focusing more on adopting new technologies to reduce costs. In line with market sentiment, and the drop in demand, banks are also streamlining their workforce. Mortgage giants, such as Wells Fargo & Co. and Rocket Co., trimmed their staff in 2022, while online lender Better.com has laid off about half its workforce since December 2021.
- Credit unions and private lenders are offering more competitive rates than traditional lenders. This is mainly because credit unions are typically responsible to their members rather than shareholders. Moreover, although they offer the same products that a bank does, they are not subject to the same federal regulations, enabling them to serve riskier customers.
- Many retail lenders are looking for offshore partners to reduce costs associated with hiring, training and on boarding staff and reduce office rent and maintenance overheads. Outsourced teams with relevant expertise that offer flexibility, agility and innovation can be deployed at a fraction of onshore costs. For instance, during the pandemic, Bank of America added close to 3,000 jobs in India to support an increase in retail and small business loans in its home market — the US.
- Lenders are going beyond the traditional focus on sales and customer service and prioritising customer experience in response to the preference of retail borrowers. A BCG study confirmed that by personalising a customer’s journey, a bank could increase revenue up to USD300m for every USD100bn of assets it owned. Personalisation can also help improve loan-recovery practices. For instance, a 2018 McKinsey study indicated that engaging digital-only borrowers through their preferred channel of communication could increase loan instalment repayment by over 10%.
Banks expect the Fed to cut rates by end-2023. Their risk management strategies are expected to revolve around the management of higher cost of funds and enhanced due diligence for new originations and refinancing.
Mortgage rates are expected to remain high in the coming quarters. Rising mortgage rates means fewer would qualify for a mortgage, leading to lower application volumes, which would compel mortgage lenders and brokerages to reduce costs.
How Acuity Knowledge Partners can help
We have nearly 20 years of experience supporting global banks across the loan life cycle. Our retail lending services offer origination, processing, underwriting, closure and post-closure support across consumer mortgage and other retail products, covering basic to complex tasks. Leveraging a mix of people, process and technology, we provide tailor-made solutions spanning retail, business, middle market, real estate and leveraged finance to above 90 banking clients.