Navigating Margin Compression

By Max Slyusarchuk, CEO and Founder of A&D Mortgage

(Hollywood, FL) — One of the main factors impacting the business operations and profitability of mortgage lenders is margin compression, and in the past few years, profit margins have been steadily falling.

Lenders are currently receiving about 1/3 of what they previously earned, and in some cases, even less.

Naturally, this is cause for concern. In a recent sentiment survey conducted by Fannie Mae, lenders are very worried about the outlook for their profit margins, and what’s worse, most industry experts believe that margin compression will only become more extreme in the foreseeable future.

While this issue affects all banks and mortgage lenders equally, shrinking profit margins put smaller lenders at greater risk. They do not have the same flexibility, resources, or control as do the larger, more established lenders, so they are less able to weather the margin compression storm.

Market Factors

There are several economic factors in play that are contributing to margin compression:

• Market Uncertainty – All one has to do is go to the grocery store or gas pump or turn on the evening news to know that inflation is here. Inflation generally causes yields to rise but currently, we are facing a conundrum. The yield curve has been flattening since July of 2021 and it is not too far from inverting. An inverted yield curve tends to foretell a recession, and that tends to cause yields to go down. Nobody knows for sure which way any market will go, and the more uncertainty there is, the more difficult the navigation becomes, and that is especially true for the smaller firms.
• Rising Rates – The bull market in treasuries began in 1981 when the 10-year yield was above 16%, and it very likely ended in 2020 when the 10-year yield reached .39%. If treasury rates are headed higher, then so too are mortgage rates, and the Fed has already declared its intention to raise short-term rates this year in an effort to control inflation. It’s anticipated there could be as many as five rate hikes in 2022 alone. Rising interest rates contribute to shrinking margins for mortgage originators, and only those with a strong financial foundation can provide a steady platform throughout the short-term market gyrations that rising rates can trigger.
• Housing Shortage – In most parts of the country, housing inventory levels are at historic lows – less than a 60-day supply. There are simply not enough houses under construction or residential lots under development. Driven by the lack of housing inventory, purchases by volume are decreasing. A housing shortage causes home prices to rise, which means fewer borrowers in the market, and that leads to less loan activity for lenders, although the impact on non-QM lenders who offer more creative lending programs should not be as severe.
• Refi Demand – As interest rates rise, the number of borrowers seeking to refinance their homes drops dramatically, resulting in reduced loan production for mortgage lenders. It also means that the competition between lenders for borrowers in the purchase market becomes more intense, again contributing to margin compression. In these hyper-competitive circumstances, the stability of well-capitalized lenders is paramount.

Stability and Security 

In these challenging times, the impact of margin compression on mortgage companies cannot be overstated. In an effort to survive, lenders are focused on enhancing their operational efficiency. They are leveraging technology to reduce costs, while streamlining their internal operations and maximizing vendor performance.

Unfortunately, many smaller lenders do not have the financial resources to implement similar advancements and, as a result, they are barely able to remain solvent.

In these difficult circumstances, it is only the well-founded and well-capitalized lenders that will thrive, and it is with these stable and secure companies that brokers should partner.

Market Makers

In uncertain times, it is wise for brokers to align themselves with strong companies – lenders who are market makers, who are in charge of their own programs, and who are flexible enough to make their own rules, change their own guidelines, and, if necessary, to move prices the right way to keep brokers happy. In short, a broker’s best chance to survive margin compression is to work with true loan aggregators.

It’s also important for brokers to work with companies that are vertically integrated; lenders whose loan products are all-inclusive – from wholesale to retail, including conventional, government, and Non-QM loans.

Weathering the Storm

In difficult times, when you’re in the midst of a storm, you want to make sure you’re on a big ship, not a tiny boat. When waves are crashing overhead, stability and security are essential.

We are now in an environment where interest rates are likely to rise. Consequently, rules, rates, and timeframes will change. Lenders that can keep their rates low, make their own rules and manage their own guidelines will prosper, and be in a position to benefit their broker partners.

In turbulent waters, passengers seek a port in the storm. And they rely on the experience, expertise, and guidance of an expert crew to lead them there.

Because we are a loan aggregator that has received approvals from Fannie Mae, Freddie Mac, JP Morgan, and both KRBA and Fitch Ratings, A&D Mortgage is a large and sturdy ship that can issue our own proprietary programs and whose professional staff will guide you through the storm and lead you to a safe harbor.