FinTech advancements, digital banking and lending, AI and machine learning are all the buzz in financial services and will likely remain a highlight for 2019 discussions. However, analysts across Situs companies are looking at asset behavior, balance sheet risk and economic indicators that impact the foundation of the financial services industry. Here are five areas our analysts and advisors are watching in 2019:
1. Interest Rates Make an Impact
Low interest rates are becoming a story of the past, and the new story of rising rates brings new questions. How will the rising rates affect bank and credit union customer behavior, business growth plans, credit, earnings and capital?
“The rising interest rate environment does not mirror rising rates environments of the past,” said Chris Mills, Managing Director at MountainView Financial Solutions, a Situs company. “Over the last 10 years, we’ve seen a significant growth of total deposits and non-maturity deposits, changes to the funding mix, new regulations, technologies and demographics. How rate changes will affect the balance sheet is far more nuanced.”
The key to reducing risk, said Mills, is for financial institutions to 1) fine-tune their assumptions so they are based on their history combined with management’s expectations for future supply and pricing pressures. And 2) quantify the exposure to key risk assumptions. Management must understand how the alternative assumptions due to unexpected market fluctuations will impact earnings and interest rate risk (IRR) management.
2. Credit Unions and Small Institutions Put on their Boxing Gloves and Prepare to Fight for Deposits
Many credit unions will need to work hard for deposits this year.
According to Karen Schwall, Managing Director-Credit Union Partner Development at MountainView Financial Solutions, “I’ve had a number of conversations with credit union clients and have found that deposit growth and funding decisions are critical to loan growth. Many have a loan-to-deposit ratio between 80% and 90%. As the credit unions edge closer to 100% loans to deposits, they need to evaluate funding options and may need to put on their boxing gloves to fight for deposits.”
Schwall stated that the fight for deposits is not new. Digitally driven banks have increased their market share year after year and have proved to be a formidable opponent for smaller institutions and credit unions. In this context, a small institution may be tempted to take an assertive approach to deposit pricing, or otherwise invest in online capabilities, sell off investments or identify borrowing lines. Each of these strategies has distinct implications to balance sheet management decisions.
Schwall added, “Institutions should continue to make such decisions based on data and analysis because each institution is unique. Depositor behavior is often highly specific to each institution, and a study of that behavior can prove incredibly valuable to boards and leaders tasked with balance sheet risk management.”
3. Lenders Shift to Margin Management
As origination volume decreases and costs to produce a loan increase, mortgage lenders (and other lending institutions) will grapple with tightening margins.
As home prices increase and rates rise, there is less incentive for homebuyers to make their move. Moreover, homeowners are sitting tight and hanging onto their homes, leaving less inventory for those buyers who are ready to invest. Lenders will need to focus their energy on identifying ways to trim costs and manage margins.
Stephanie Schader, Vice President, Managing Consultant at Collingwood, Situs’ mortgage advisory firm, stated, “As less business comes through the doors, lenders will need to identify ways to bring costs down. One possibility is that lenders will be reviewing Loan Originator (LO) compensation. As simple as this sounds in theory, lenders will need to work with the Consumer Financial Protection Bureau (CFPB) to evaluate how changes to LO compensation will work with Dodd-Frank protections.
4. Financial Institutions to Test Resilience in Preparation for Possible 2020 Recession
“I think there is a high and growing risk of a recession in 2020. You know, put it at odds of something like 1 in 3,” said Mike Fratantoni, Chief Economist and Senior Vice President of Research and Industry Technology at the Mortgage Bankers Association (MBA), in a webinar hosted by MountainView Financial Solutions, a Situs company.
Fratantoni further stated, “The expectation is that the global economy is going to slow, and that’s true regardless of what part of the globe you’re looking at.” He predicted a slowdown in China, parts of Europe and the US. To read more about Fratantoni’s outlook, check out the NewsWatch residential article or view the article on MountainView’s RiskView blog.
Recession is clearly on the roster for 2020, and that means that 2019 will be a year of preparation. As financial leaders monitor the yield curve, rising interest rates, slowing origination volumes and global trade decisions, they will likely begin the process of stress testing portfolios and balance sheet behavior and looking at a range of economic scenarios.
5. Market for Mortgage Servicing Rights (MSR) Remains Healthy and Strong
Prospective sellers of mortgage servicing rights (MSR) can look forward to another strong year for MSR execution with demand heavily outweighing supply.
According to Matt Maurer, Managing Director of Sales at MountainView Financial Solutions, “Demand from banks and non-bank MSR investors is multiples higher than expected supply. And unfortunately, the supply shortfall is expected to increase in 2019, given the recent move down in mortgage rates and lower expected production volumes.”
MSR demand is expected to remain high in 2019 as the risk-adjusted unlevered yield for MSRs in the 8% to 11% range is still attractive. In addition, over the last five years, the industry on average has produced a 2.5% net return on MSR hedges, according to an analysis of the average net hedge performance for 18 of the largest MSR holders, further boasting overall MSR returns. MSR hedge carry has decreased as the yield curve has flattened, but a majority of MSR hedgers are expected to still have positive hedge results.
“As originators and servicers move forward in a tough production environment, 2019 may be the year that widens the gap between the haves and have nots,” Maurer said. “Company’s weaknesses in regards to technology, capital market execution, and risk management have a tendency to show up when margins compress.”
In next week’s Newswatch newsletter and RIskView blog, we’ll offer up some more areas to watch in 2019.