Higher costs pinch nonbank mortgage lenders

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The mortgage upstarts that transformed the industry after the U.S. housing crash are now facing their own shakeout.

Soaring expenses are squeezing profits for nonbank lenders, which have grown to almost half of the mortgage market, as new rules and stepped-up regulatory scrutiny slice into already-thin margins. The average cost to originate a home loan jumped by 18 percent in the past two years, according to Mortgage Bankers Association data.

“There has to be consolidation,” said Warren Kornfeld, senior vice president at Moody’s Investors Service. “Most of these companies will acquire or be acquired.”

Winners and losers are emerging from the dash to pick up market share from big banks burned in the real estate collapse. Large companies such as Freedom Mortgage Corp. and Quicken Loans Inc. have grown so big that the scale of their operations helps dilute the increase in regulatory costs. Smaller originators unable to outrun those expenses may now be takeover targets, while servicers such as Ocwen Financial Corp. and Walter Investment Management Corp. have seen shares plunge after reporting deeper losses.

Heavy regulation after last decade’s housing crash caused banks to retreat from home-lending, creating an opportunity for independent firms with more flexibility to proliferate. Nonbanks made 45.9 percent of mortgages last year, up from 13.4 percent in 2011, according to data compiled by Inside Mortgage Finance. They’ve also increased their share of servicing, handling 31 percent of unpaid principal in 2015, from just 7 percent four years earlier.

CFPB rules

With the fast growth comes scrutiny. In 2013, the Consumer Financial Protection Bureau issued final rules related to the Dodd-Frank Act to help consumers better understand the mortgage process. The changes include simplified forms and rules designed to stop lenders from making loans without regard to borrowers’ abilities to repay them.

That’s led to record costs for originators, which have had to invest in new technology and hire more staff to help enforce and monitor new lending and servicing requirements. Average loan production costs reached $7,046 per mortgage in 2015, up from $5,948 in 2013, according to the Mortgage Bankers Association.

“The business is too capital intensive for the smallest guys to grow,” said Casey Crawford, chief executive officer of Movement Mortgage, which started in 2008 and originated $7.8 billion of loans in 2015. He expects to double that amount this year as competitors fall by the wayside.

Greater scale

Lenders with large production and servicing operations such as Freedom Mortgage and Quicken can benefit from scale, because fixed expenses are spread over a greater number of loans.

Freedom expects to “inherit market share from the less-well-endowed shops,” said Stanley Middleman, CEO of the Mount Laurel, New Jersey-based lender. “We are going to be in discussions with a variety of companies that we didn’t expect to be talking to the beginning of this year.”

The company, which originated $36.8 billion in mortgages in 2015, has made five acquisitions in the past two years, including Continental Home Loans, Aurora Financial Group and JPMorgan Chase and Co.’s rural-housing business.

Freedom has more than doubled its staff to keep up with the changing regulatory environment. The company said had about 4,520 employees in April, up from 1,871 in 2014.

“We need to do way more loans today than we did historically in order to support our machine,” Middleman said.

What’s fair

Over-regulation can hurt lenders of all sizes, according to billionaire Dan Gilbert, who founded Detroit-based Quicken, the biggest nonbank lender, 31 years ago. Many of the large banks are moving away from lending to first-time buyers and people with lower incomes who use mortgages with small down payments insured by the Federal Housing Administration, he said.

“You want to have the balance of what’s fair, but not where you’re chasing out all lenders,” he said.

While Quicken is “opportunistic,” it has traditionally taken a conservative approach to acquisitions, buying only two companies in its history, Gilbert said.

Mortgage servicers

Nonbank mortgage servicers such as Ocwen and Walter are running into trouble after gorging on delinquent home loans cast off by big banks. The cost to service soured loans has more than quadrupled since 2008, MBA data shows.

“Rapid growth by mortgage companies has elicited the attention of regulators based on their underwriting and servicing practices,” said Johann Juan, director of Fitch Ratings’ financial institutions division in Chicago.

Ocwen, one of the biggest servicers that’s not a bank, began shrinking its holdings amid complaints that the company mismanaged loans after growing too fast. Costs are rising for the West Palm Beach, Florida-based company, in part because of legal settlements. The shares have tumbled 70 percent this year.

After the firm reported a wider-than-estimated loss last week, Chief Financial Officer Michael Bourque said on a conference call with analysts that Ocwen is “actively working on reducing our servicing and corporate costs to not only catch up with the declining servicing portfolio and revenue, but eventually to return the company to profitability.”

Other mortgage servicers, including PHH Corp. and Walter, are seeing profits decline as expenses continue to rise. PHH said in March that it would explore options “in light of changing industry and regulatory dynamics impacting our business.” Walter on Tuesday plunged 27 percent after reporting a bigger first-quarter loss, and said it is working to “significantly” lower costs.

PennyMac Financial Services Inc. is “less impacted than large servicers that have to modify their existing operations,” CEO Stanford Kurland said Tuesday in an interview at the Milken Institute Global Conference in Beverly Hills, California. “We built for the regulatory environment that we have.”

Growing won’t be as easy as it used to be for many of the nonbanks. Originations will be flat this year, and there won’t be as many new loans to service, said Guy Cecala, publisher of Inside Mortgage Finance.

Movement Mortgage’s Crawford, a former NFL player, views the upheaval in the industry as an opportunity.

“Every time we see new regulation hit the space, it gives us a chance to outmaneuver more competitors,” he said.