Community mortgage lenders adapt to higher-rate cycles

Mortgage lenders are battling a more challenging mortgage market, with a slowdown in originations that is well underway.

The jump in interest rates over the past year has priced many would-be homebuyers out of the market. Compounding the problem further is a shortage of for-sale homes in many markets across the country. 

However, although community banks are feeling the impact from less activity among both new home purchases and refinancing, the lull is not entirely unexpected after record activity and a nearly 10-year run of historically low rates.

“I think it’s going to feel worse than what it is, just because 2020 and 2021 were so elevated that it became the new norm,” says Harry Hayes, vice president and director of mortgage origination at $882 million-asset Clear Mountain Bank in Morgantown, W.V. 

During the refinance boom of 2020, Clear Mountain Bank originated a record level of residential loans—nearly $275 million. Although its annual mortgage volume dropped sharply to $220 million and $128 million in 2021 and 2022 respectively, the past two years still represent the second- and third-highest origination volumes in the bank’s 125-year history.

According to the December 2022 Fannie Mae Housing Forecast, single-family mortgage originations are expected to decline to $1.7 trillion in 2023, down sharply from the high of $4.6 trillion in 2021 and a further slide from $2.3 trillion in 2022—but these were true outlier years.

“People have gotten used to these incredible mortgage origination numbers, but it also is important to put that in perspective,” says Ron Haynie, ICBA’s senior vice president of housing finance policy. The forecast volume of $1.7 trillion in 2023 is still a very big number, he adds, and there is significant pent-up demand for housing across the country.

Now, community banks are looking at ways to bring new business in the door and protect the profitability of loans on their balance sheets.

Creative ways to generate business

Mortgage lenders are taking different steps to generate business and offset some of the sticker shock that exists in the current high-rate market. One tool making a comeback is temporary buydowns to reduce the initial loan rate. 

The 2-1 buydowns available allow a borrower to pay a lump sum to reduce the mortgage rate by 2% for year one and then 1% for year two before it reverts to the full rate in year three of the loan. “It’s not a perfect solution, but it helps, especially for first-time homebuyers who might have tight cash flow,” says Haynie. 

Another strategy is to offer customers alternatives, such as adjustable rate mortgages (ARMs) or home equity lines of credit (HELOCs.) Instead of moving, people may choose to invest in their current home.

“Typically … people take out that home equity line,” says Andrew E. Silsby, president and CEO of $1.6 billion-asset Kennebec Savings Bank in Augusta, Maine. “They wait a few years, and then they refinance their mortgage to wrap the home equity and first mortgage together.” Community bankers are also educating borrowers about resources from local housing assistance programs, including down-payment assistance. 

Portfolio lenders can also be more creative and flexible with the loans they put on their books. For example, Clear Mountain Bank developed Max Speed mortgage, a product which will debut at the end of the month and provide a fast closing on home purchase loans within 21 days. That speed is largely accredited to a new loan operating system the community bank introduced early this year. 

The system will create process efficiencies, which play a big role in the bank’s ability to offer new products. The system will also include a new customer-facing point-of-sale system and offer greater integration with some third-party services the bank uses.

Protecting profits

Kennebec Savings Bank anticipates that its 2023 mortgage origination volume will drop by about half compared with 2021. As a portfolio lender, the community bank currently has more than $880 million in residential mortgage loans on its books. “We’re definitely getting squeezed on net interest margin, because deposit rates are going up,” says Silsby.

That is concerning from an income standpoint, but Kennebec Savings Bank is continuing to generate steady income from its existing portfolio. “We did a ton of loans last year, and those loans are all paying us this year, and the year after and the year after that,” says Silsby. “So, our profit is going to stay fairly consistent, despite the drop in volume.”

Another factor helping to insulate community banks from the negative financial impact of lower mortgage originations is that higher interest rates also have reduced prepayments and refinancings. So, banks that opt to hold loans need fewer originations to maintain or grow their portfolios.

To protect profitability, community banks are keeping a close eye on stress that might emerge if we go into recession. As of January, 99.6% of the loans at Kennebec Savings Bank were current. However, high inflation, especially on essentials such as food, gas and energy bills, could put pressure on borrowers’ ability to make their mortgage payments. 

When cases of distress do arise, Kennebec Savings Bank takes the approach of separating delinquency conversations from its lending officer by quickly moving them to its collections staff. Collections staff are better equipped to deal with questions, and it also helps to preserve the relationship between lender and customer. “It’s a lot about knowing your customers,” says Silsby. “We have very low delinquency. That is part of our relationship banking, and we have a really good handle on stress that may be emerging.”