Plan B: How the Lending Environment Might Evolve if Mortgage Rates Rise

I'm not a naysayer and just like everybody else I've been rejuvenated by the stellar year the industry is having. Most of our clients are making boatloads of money on refinances today,  but rates will eventually rise from these historic lows and mortgage bankers will once again become the proverbial  “deer in the headlights”.

We’ve all been down this road before but I think we need to remind ourselves what happened in the past so we're prepared for a potential shift in business models. Let’s take a look at how the environment might shift....

If history repeats itself, the first thing to happen will be tighter primary/secondary loan pricing spreads. Lenders will deploy aggressive pricing to help maintain current production levels. Without thinking about margins and return on capital, some operators will reduce margins in order to maintain volume.  Rather than cutting expenses, most will accept a compromise on earnings.  The companies that started the ball moving will start dragging more and more players into this strategy.  Eventually, we will see margins decrease industry wide. 

Another bi-product of higher rates might be a modest comprise on loan quality.  You would think after what we all went through over the past three years that no one in the business would originate any less than stellar quality loans. However, in order to keep production rolling in, we might see a few players start approving and closing loans that are a bit outside the lines.  Again, after one major player starts this tactic, more players might follow just to keep production rolling in.  

The problem with both of these strategies is that aggressive pricing and underwriting is not going to help.  Rates will eventually rise and the overall market will still shrink.  We ask the CEOs of every company we review today the same question:  What is plan B?  What will you do if and when rates rise and volume drops by 50%?  What is your breakeven production number? 

Today more than ever, managers should be generating granular reports on branches, loan officer and employee performance to determine were the cuts can be made. Marginal branches and loan officers will not survive in a tough market.  Review employee productivity to help determine employees you need to keep when production declines.  Ditch the deadwood quickly when the market turns. 

Our industry is cyclical and we need to be reminded of the need for a "Plan B" quite often.  When things are really good, chances are they will turn ugly sooner than you think. Don't get complacent, be prepared and have a plan when rates turn higher.