Lenders welcome rush of refis, but it's no cure-all
Mortgage refinancing activity is back from the dead thanks to declining interest rates, and that's good news for banks and credit unions that will be starved for additional revenue as lending margins keep tightening.
But as with many good things, there's a catch.
First, the upside: Mortgage refinance volume in August increased almost 200% from a year earlier, according to the Mortgage Bankers Association Refinance Index. The index gauges fluctuations in refi application activity based on a weekly survey of lenders. The uptick came as the average rate on 30-year fixed mortgages stood at 3.6% earlier this month, the lowest level since November 2016, according to Freddie Mac.
That's been a boon for credit unions.
“On the positive side, the increase in loan volume is greatly appreciated partly, due to the financial impacts we are facing due to the yield curve environment,” a spokesperson at Boulder-based Elevations Credit Union told CU Journal. “The most recent wave of volume did come on fairly quickly,which was demanding for our team.”
Many of the individuals that the $2 billion-asset credit union is assisting are new members, which helps grow the CU’s base by bringing in additional business through deposits and other lending services.
Similarly, Chicago-based Alliant Credit Union is having a record-breaking month for mortgage refis. According to Mark O’Dell, residential lending manager, Alliant is on track to beat its best month ever by 25%.
The low-rate environment was not something the credit union planned for in the beginning of 2019, O’Dell explained.
“I don't think anyone could have seen rates dropping that quickly in a short period of time,” he said. “But it's been a positive for us, [though] it creates some capacity issues.”
Banks are also enjoying the spoils, according to interviews with executives and a review of transcripts of second-quarter earnings calls held in the past month.
“With the recent decline in the primary mortgage rate … [our] refinance volumes grew by 28% versus the prior year” to $631 million, William Furr, chief financial officer at the $14.3 billion-asset Hilltop Holdings in Dallas, said during a July 26 conference call. Other banking executives echoed Furr’s remarks during second-quarter earnings reports.
It’s a welcome turnaround after two years of tough conditions for mortgage lending, which led some bankers to exit the business or scale back.
Yet the conditions that have produced the refi boom — historically low long-term interest rates — are a double-edged sword, said Peter Winter, an analyst at Wedbush Securities.
“It’s just not going to be enough to offset what’s happening with margin pressure with this yield curve,” Winter said.
Yields on the 10-year Treasury, a benchmark for mortgage rates, earlier this month fell below 2% for the first time, according to Bloomberg. At one point in August the 10-year’s yield had dropped below yields on the two-year Treasury, a short-term benchmark.
An inverted yield curve — when long-term rates are lower than short-term rates — is a difficult operating environment for lenders, Winter said. That is because newly originated loans will have lower rates than the average rate of loans that FIs already hold on their balance sheets. That will lead to a tightening of net interest margins, he said.
In addition, floating-rate loans and securities in an institution's portfolio automatically reset at lower rates. And banks and credit unions cannot reprice their outstanding deposits fast enough to keep up, Winter said.
“Banks will lower their deposit rates, but they can’t lower them at the same pace as the decline in loan and security yields,” Winter said.
Even so, plenty of lenders are eager for the fee and interest income that come with the additional refinancing. Black Knight, a mortgage data provider, estimates that with the 30-year fixed mortgage rate at 3.6%, about 9.7 million consumers could benefit from refinancing, with an average monthly savings of $267 per borrower.
The MBA's Refinance Index rose 37% the week of Aug. 9, compared with the previous week. That was its highest level since July 2016.
The Federal Reserve’s interest rate cut on July 31 helped stimulate interest among homeowners, said John Ward, president of retail loans at the $5.7 billion-asset First American Bank in Elk Grove Village, Ill. Although mortgages are not tied to the federal funds rate, the Fed lowering that rate called attention to the fact that mortgage rates had dropped.
“It was free publicity to let people know that they should think about refinancing,” Ward said. The Fed’s rate cut “got people thinking, ‘What do these lower rates mean for me?’ ”
But low interest rates can cause another problem tied to mortgages — lower fee income from mortgage servicing as reduced rates prompt consumers to accelerate prepayments on outstanding mortgages.
“Lower rates can translate into higher prepayment rates,” said Andy Walden, director of market research at Black Knight. “This can, theoretically, result in a decline in a servicer’s revenue if those customers are not retained by their current lender and servicer.”
Additionally, some banks and CUs may be forced to take an impairment charge if the value of their mortgage servicing rights assets declines, said Kevin Reevey, an analyst at D.A. Davidson, though that's more likely to be a problem for larger shops holding heftier mortgage lending pipelines.
“The value of those servicing rights portfolios declines in a declining rate environment,” Reevey said.
Steve Williams, president and partner at Cornerstone Advisors, noted “It just means that credit unions will really need to be thinking what tighter margins mean for their business model." He added that credit union boards should examine and adjust three cores in upcoming months: additional growth, operating efficiencies and earnings expectations.
“Credit unions will require access to a larger pile of assets since they’ll be earning less, noted Lewis Lester, CEO of CU Capital Market Solutions. “Growth in this industry at this particular time is critical.”
The only way for credit unions to offset rising operating costs and shrinking margins is to grow, reminded his colleague, President and Chief Strategist Robert Colvin.
“If you look at credit unions, a majority of their money is in savings and money market accounts, which are already at extremely low rates – so you don't have much room to lower funding costs from here,” he said.