2008 - Sub-Prime was unsustainable, 2023 - Bond Duration bets are unsustainable. Similar Outcomes

The mortgage industry is currently undergoing a significant transformation due to the rapid increase in the Fed Funds Rate since mid-2022, coupled with the industry's lack of compliance with prudent profitability objectives. 

All mortgage companies must comply with GAAP accounting and meet financial covenants to remain listed on stock exchanges, retain funding from banks, and maintain approval with Fannie, Freddie, and HUD "The GSEs."

When mortgage companies incur losses due to below market pricing believing it creates volume or they react slowly to align expense with margins, the equity on the balance sheet pays for the loss and misjudgment. 

The result?  Banks cease funding agreements and GSEs revoke approval status to sell mortgages once the tangible equity and financial covenants are not met.

Eventually, the balance sheet equity (shareholder's equity or LLC owner's cash reserves) will reach zero and the business closes or must sell its assets to a competitor for pennies on the dollar.

Housing Wire and other mortgage news outlets have been reporting these realities recently.

This shift is similar to the transformation that occurred in 2008-2009, albeit for different reasons.

Remember, prior to today the last highest Fed Funds rate was in 2007. We all know what happened after that. Poor business decisions were exposed as volumes fell 34%. Today you have a higher Fed Funds rate and volume has fallen 50% industry wide. Both were fueled by assuming risk using unsustainable assumptions in an effort to keep their volumes up. 

The upheaval has begun and has already forced many companies to close their doors, and one large mortgage originator is projected to lose $2 billion dollars in 2023, with only $500 million of their common equity remaining. Accounting matters no matter what size company they all will be held accountable.

Every company in the mortgage industry is unique, with different costs, margins, and opportunities. A one-size-fits-all pricing strategy "Follow the Joneses Strategy" is unsustainable, especially when it is based on bad or incompetent assumptions. Companies should balance pricing with the costs associated with their individual business to avoid another calamity like the one in 2008-2009. Does a Can of Coke cost the same at the Baseball Game as it does at a Convenient Store or Costco? No! they all have different cost structures and levels of service. While it may be too late for some lenders, it is never too late to take a prudent path.

“What gives you opportunities is other people doing dumb things.” Warren Buffett

Easy Read Summary:

The mortgage industry is changing because interest rates have increased too fast and many companies are not making enough profit due to one size fits all pricing. All mortgage companies need to follow financial rules and keep their finances in order to stay in the mortgage business. If a company loses money because they priced their loans too low or didn't manage their expenses well, they have to pay for it by using the money shareholders and LLC Owners saved up. This can lead to problems remaining approved by banks and government agencies that help mortgage companies provide mortgages to consumers. The result, companies have to sell their assets or close down.

This is similar what happened in 2008-2009 except mortgage volume is down 50% in 2023 versus 34% in 2008, when companies made risky assumptions and caused problems for themselves and the economy. It's important for mortgage companies to price their loans based on their own costs and profits to avoid making the same mistakes. Some companies have already gone out of business and others are too far down the road to be saved. Those that are left have to decide if they will choose to make better decisions.

Cal Haupt

Chairman and Chief Executive Officer

www.southeastmortgage.com Phone: 770-279-0222