Preparing for the End of the Refinance Market

Recently Market Watch published an article looking ahead at the top 5 stories for 2020. In it, their top item for 2020 was an expected continuance of refinance volume. They pointed out, “Remarkably, some 82% of loans originated between six- and 25 months ago can benefit from a refinance today — and 2016 was the last time that this percentage of loans were in the money. If rates drop another 25 basis points, or 0.25%, this will bring even more homeowners into the money.”.

I think the expectation for continued refinance volume for the year is perhaps the expected path, but it is important to note the risks to any interest rate forecast, especially when virtually any rate forecast these past years has proven to require a re-forecast. In fact, at the beginning of 2019 the majority of economists suggested that the fed would increase rates at least once, and maybe twice more during the year and that mortgage rates would rise at least 50 basis points and perhaps another similar amount in 2020.

What happened was a global weakening of economies, negative corporate bond yields, a failure to finalize Brexit, and a trade war with China. All of this changed the rate path as a flight to quality emerged and concerns about a weakening US economy stopped the fed in its tracks causing it to reverse course.

But to be clear, any expert suggesting that rates will remain as low as they are, or perhaps go lower should understand the risks to the model. The Mortgage Bankers Association Chief Economist, Mike Fratantoni, points out the risks or rewards of varied rate paths:

I grew up in a company whose CEO constantly stressed that the time to worry most is when things were at their best. In an industry that can be shortsighted at times and focus on their current pipelines versus the long term, we have often missed seeing the market changes ahead and have paid the price for being unprepared. So, my advice is to enjoy the rally as long as it lasts, but when the contraction hits it will be extremely difficult for those that have overly depended on refinances. In fact, the current MBA forecast predicts a decline in refinancing from $796 billion in 2019 to $432 in 2021.

One fact is clear, there is an end coming. Just consider the multi-decade interest rate rally that built this industry. In fact, just look at this history from the Federal Reserve:

I began my career when rates where in the teens in the early 1980’s from that point until now we have created an industry supplied for progressive refinance waves. The fact is that the industry is staffed and supported for a marketplace that got approximately 40% of its volume from refinances in 2019. 

If I were still running a mortgage origination firm, whether broker, banker, or bank, I would be taking proactive steps now to begin preparing for the inevitable. The fact is that as you look at that rate history graph there is only one conclusion and that is the reality that there is far less room downward than upward.

Here is what I am advising those whom I consult with:

  1. Analyze all LO performance breaking down refinance volume and units to purchase volume and units. Both elements are important. Identify any LO who nears 40% in refinances for enhanced focus.
  2. Analyze branch profitability by purchase vs refinance units and dollars. get a breakdown of loan products originated using the same approach. Finally get down to profit per loan by product with sub-categories for refi vs purchase. You can have an analyst do this by contract if needed. Identify any branch at or above 40% refinance for enhanced focus.
  3. Implement a formal sales training program beginning with the management team. Managers need to understand the skills to sell so that they can reinforce these skills through role play and other management techniques in the field.
  4. Implement a sales management training for all managers at the branch manager level and above. It’s not enough to know how to sell; managers need to understand how to develop and reinforce these skills with their LO’s.
  5. Develop a sales training program for the LO staff preferably taught by the managers vs an outside company. A third party can be there to consult and support but to create a sales culture it must become part of the management teams’ core skill set.
  6. Finally, do an assessment of staff resources and assume a 50% decline in refinance volume by branch. Isolate where higher refinance mix branches may be targets for right-sizing when the inevitable happens.

Being a leader requires the vision to see ahead and to prepare for that moment. Frankly managing in today’s strong purchase and refinance market makes many seem invulnerable but situational leadership, as seen in this model, teaches us that a change in market conditions can change the skill assessment of any sales team member from competent and committed to less competent and less committed. 

Just some food for thought as we look not just to 2020, but to the strategy of success in the years ahead.

David H. Stevens, CMB, is the CEO of Mountain Lake Consulting, Inc. Dave is a 36-year veteran of the mortgage banking industry having served as the US Assistant Secretary of Housing and as CEO of the Mortgage Bankers Association.