Mortgage

Why Breakeven Forecasting is Critical Now More Than Ever

Reading the daily mortgage headlines these days feels a little like a story we have all heard before. The familiar themes of rising mortgage rates, Fed rate hikes, decreased production, compressed margins, staff layoffs, liquidity concerns, fear of existing investors, recession, etc. continue. The COVID mortgage boom has come to a screeching halt, with lenders left to quickly adapt to another changing environment. The silver lining this time is that lenders have likely retained a large portion of loans over the past couple of years; these now have a lucrative MSR value with an active market. But with all the uncertainty in the economy and if the Fed can avoid a recession while still aggressively taming down inflation, the cash influx from selling a servicing portfolio will only take one so far.

Increasingly, news stories are passing through our feed with mortgage companies shutting down operations or forced to go through a merger or acquisition as a solution to the madness. Owners across the nation are racking their brains not only to survive but to not reverse the accomplishments or growth they have achieved in the past couple of years. Can basic cost-cutting and forecasting navigate these conditions? Forecasting the financial performance of mortgage companies even in the best mortgage origination years is a challenge.

Forecasting should be viewed as a compass; without it, there will always be uncertainty of survival. With the current set of conditions and volatility present in the mortgage ecosystem, breakeven forecasting is more critical than ever.

Top performing lenders are not made during high times, they are made during trying times. They run lean regardless of the environment which gives them that competitive advantage in the opportunities that arise during the harder times.

The ability to forecast an accurate breakeven point, as well as profitability levels, is critical for both internal and external stakeholders.

In addition to trying to manage profitability, mortgage companies must have a clear understanding of the current and potential long-term cash needs of the company. If one sold their servicing portfolio, how is that cash to be used? Can it only be used for operational needs to ride out the storm, or can this cash be used to acquire a new region, branch, or loan officer?

A critical element to understanding the break-even and profitability level of a company is to have a strong understanding of the current and potential results using an active benchmarking process. The ongoing ability to benchmark the financial and operational results is more critical in times of stress versus “the boom years.”

In addition to the challenges present in the overall mortgage ecosystem, mortgage companies need to ensure that financial ratios are in line with covenant requirements, HUD and agency net worth requirements are met, and cash is manufactured at adequate levels to pay debts. In addition, if servicing is maintained, an understanding of the potential changes to the FHFA capital requirements is required.

From a tax perspective, it is important to understand the tax planning implications of reduced profits and MSR sales. There is a chance that estimated tax payments may be reduced.

Mortgage companies are facing numerous near and longer-term challenges. In the short term, companies need to return to profitability; undue risks mustn’t be incurred in the quest to return to profitability but in a position to prosper as the market shifts.

Currently, many warehouse lenders are monitoring and evaluating clients who are not profitable and asking for detailed plans to achieve break-even status and return to profitability. Warehouse lenders are in a tough position as they want to be solid and consistent business partners, as well as not incur unnecessary risks. Mortgage companies that are proactive in communicating their cash, net profit position, and forecast with their warehouse lenders tend to have stronger relationships that lead to better rates, products, and flexibility in usage amounts as production expands and contracts.

Mortgage originators who are interested in obtaining their “Agency Tickets” must also show profitability; otherwise, their agency approval will not occur. For companies that are in process of the approval, the current financial environment at a minimum is a delay to the approval and in some cases an outright inability to have their application approved. Being proactive with a detailed, sophisticated forecast will only improve the odds of approval.

It is uncertain whether 2022 will be the low water mark for many mortgage companies for profitability as the uncertainty in mortgage rates, concerns about housing supply, and the overall economic environment remain murky. The clear consensus opinion is that the mortgage market will remain in a purchase-dominated mode for the foreseeable future. As many mortgage companies have taken action to reduce staffing levels and costs throughout 2022, the impact of these actions can take time to be reflected in the financial results. While the outlook for 2023 is uncertain in many ways, understanding the break-even and profitability levels is critical not only in surviving but coming out stronger as conditions improve.

Please reach out to us at info@richeymay.com  to schedule a call with Richey May to learn more about breakeven forecasting, benchmarking, and strategies to help manage these challenging mortgage market conditions.