Kyle Joseph, a specialty finance equity research analyst at Jefferies, believes that the worst of the current mortgage cycle may be behind us, a sentiment shared by most analysts covering this industry.

“Barring any sort of unforeseen consequences, I’d like to think so,” Joseph said in an interview. “Obviously, this cycle was fast and furious – for lack of a better term – in terms of how quickly rates went up, and volumes basically got cut into a third of what they were two-plus years ago. It really sent shockwaves through the industry.”

Joseph anticipates potential growth in originations next year, both in purchase and refis. 

“If anything, every day seems to be a higher likelihood that rates are not going higher next year,” he said. 

Warren Kornfeld, senior vice president of the financial institutions group at Moody’s, provided a detailed forecast, stating, “We will see three to four decreases in the Federal Reserve funds rate next year, starting sometime in the second quarter. Mortgage rates will moderate down to about 6% to 6.25%.”

Kornfeld expects mortgage originations to range from $1.8 trillion to $2 trillion in 2024. On the refinance side, he predicts a moderate increase in cash-out activity as rates decline, with customers using the resources to consolidate debt and extract some home equity build-up. 

Kornfeld said that for companies under his coverage, including major U.S. lenders, “The horrible period was the last half of 2022 and Q1 of this year. In Q2 and Q3, they’re okay. Q4 will be down. But once again, not a horrible year for 2023, and with the Fed pivot we’ll see further improvement next year.”

Bose George, managing director at Keefe, Bruyette & Woods (KBW), has adopted a more cautious stance for the coming year. He estimates the 10-year Treasury yields may average 4% for the full year, mortgage spreads should tighten “a little bit more,” and mortgage rates will average around 6.75% for the year. 

Regarding origination volumes, George said, “Even the MBA numbers, to be honest, look a little bit high.” The Mortgage Bankers Association (MBA) on Dec. 18 released a $2 trillion forecast for one-to-four family loan originations in 2024.

According to George, there will be “a small amount” of cash-out refinances, and the purchase market might see “a little bit of an improvement,” but overall, 2024 “doesn’t look better.” Additionally, predicting the market recovery’s timing is challenging. “We’re not saying 2025. But it’s possible. It might really be 2026,” George said. 

Given these distinct macro forecasts for 2024, what should originators keep in their playbook for next year? HousingWire spoke to analysts covering mortgage companies to gain insights into the challenges ahead. 

The macro challenge: Still not much inventory

Analysts unanimously agree that inventory will continue to be a significant issue entering 2024. There are also lingering questions about where home prices will settle, a crucial factor in the current affordability challenges.

Eric Hagen, managing director and mortgage analyst at BTIG, said the “biggest anomaly in the whole episode of rising rates is that we would normally expect housing prices to have some sensitivity” – meaning, a tendency to decrease. 

However, in the current market downturn, home prices “had almost the opposite sensitivity that you’d expect,” Hagen said. To exacerbate the situation, he expects the trend could persist in 2024 while “affordability is still tight for the marginal homebuyer.”

Kornfeld agrees that “the biggest wildcard” in 2024 will be related to home sales, with the current “lock-in effect” in place. Individuals with mortgages at 2-3-4% rates are less inclined to move and sell their homes in a higher-rate environment, further limiting the number of homes available for sale.

“The average time to sell is still 3.5 months. Homes don’t remain on the market for very long, which is just so surprising, given how horrible affordability is because of rates and prices. So, the big wildcard is when do homeowners start putting their homes on the market,” Kornfeld said.

Kornfeld added: “We’re talking about our scenario of a mortgage rate of about 6.0% to 6.25% by the end of the year. I think people are still gonna be pretty locked in. And it’s really going to take several years to start seeing more housing activity or existing home sale activity.”

George agrees that inventory will remain a problem. “Unfortunately, a big part of the housing supply issue seems to be related to the fact that all these borrowers are sitting on three-and-a-half percent mortgages, and they don’t want to give that up and move. If rates stay with our expectation here, whatever high six is, that piece doesn’t change.”

The KBW 2024-2025 housing forecast calls for home price growth of 2%, which is below wage inflation, but anticipates home sales growth of just 2%, marking a 41-year per capita low. Meanwhile, it expects a structural supply shortage of 1.5-2.5 million homes.

According to KBW analysts, affordability is 30% below the long run with payment-to-income of 27% compared to 20% between 2002 and 2004. Alongside lower mortgage rates and 3-4% annual wage growth, the estimate suggests it would “take two to three years to normalize affordability.” 

The originations challenge: Addressing overcapacity

Reducing capacity may still be a feature of the mortgage lender playbook in 2024, but in a more nuanced approach, analysts said. 

According to Kornfeld, “finding continued areas to cut costs without hurting franchise and quality of origination” will be a challenge. 

“If you look at companies that we rate, the massive job cutbacks happened last year and into this year. But in the last several quarters, the headcount and compensation have been very flat. We’ll see some additional selective cost-cutting, but not a heck of a lot. For most large companies that we rate, the cost-cutting is over,” Kornfeld said.

Does this suggest these companies will experience stronger profits? It’s possible, but analysts believe that any rise in profit will be due to a slight growth in volume next year, not because there’s room for significant cost reductions.

According to the analysts, many top mortgage lenders retained a bit of excess capacity, anticipating numerous refi booms in the coming years.

“Capacity has come down quite a bit. And I think the best indication is that margins have been somewhat stable – gross margins for the last couple of quarters. In Q4 2023 and Q1 2024, the net margins will probably be lower just because of seasonality,” George said. “It seems like there’s probably more [capacity] that needs to come out. But there are large originators who want to keep some capacity as well.”

Hagen also believes that for the top nonbank originators, “a lot of the capacity has been pretty much right-sized for this rate environment.” Meanwhile, less-scaled companies have tried to “hang on to their stuff for as long as possible in the hopes the market comes back.”

According to Joseph, analysts’ conversations with mortgage executives have shifted from “How much more do you have to cut?” to “Are you going to be able to participate if the industry regrows?” or “Have you cut too much?”

“The outlook, at least from investors, is better, and I would also highlight that if you just look at gain-on-sale margins, they are really stabilized. To us, that implies that supply finally caught up with demand and that there’s an equilibrium in the market.”

The servicing challenge: Managing the MSR portfolio size 

According to analysts, lenders facing liquidity issues may have opted to sell their mortgage servicing rights (MSRs) throughout 2023, putting them at a disadvantage when the next refi boom emerges.

Kornfeld anticipates an increase in MSR sales in 2024, driven by the ongoing financial challenges some lenders face. However, according to him, lenders are “getting a short-term gain in liquidity, but at the expense of a weaker franchise in the future.”

Jefferies’ Joseph said, “We’re taking a little bit of a contrarian [view] that if you have a high coupon mortgage that you’re servicing, it’s actually going to be beneficial next year to the origination segment and more than offset any potential negative impacts on the servicing side.”

Regarding these negative impacts, analysts at Fitch said in a report issued in late November that rate declines expected by the end of 2024 could pressure MSR valuations, which could drive modest increases in leverage, especially if earnings from originations remain weak. 

According to the report, the balance sheet exposure to market risk is rising above historical levels for some companies, with MSRs as a share of equity up to 180% in some cases. 

George adds that regulation will also weigh on the decision of selling MSRs, mainly the Basel III Endgame rules, which increase capital requirements for banks.

“The Basel III Endgame seems to be one catalyst for some of the MSR sales,” George said. “On the other hand, we’re still waiting to see what the final version is going to look like. It’s possible that they make some of that a little less onerous on the banks in terms of MSR holdings and the LTV on mortgages. So, we have to see how that plays out.”