Residential Mortgage Finance 2025

January 21, 2025 | Premium Service | Over the past year and more, the sharp upward moves in the market value of the Fannie Mae and Freddie Mac, those high-flying penny stocks, have distracted some observers from the changes underway in the land of mortgage finance. With the nomination of Bill Pulte to lead the Federal Housing Finance Agency, however, maybe the GSE trade is done. Below for readers of our Premium Service, we dig into the mortgage finance complex as a year of 7% plus residential mortgages looms ahead.

The first, big picture question to ask is about the outlook for new production of 1-4 family loans and mortgage-backed securities (MBS). The answer is that average production in the industry was running below $1.5 trillion in 2023 and at $1.7 trillion in 2024. Estimates for production in 2025 were above $2 trillion based upon the assumption of interest rate cuts that are no longer anticipated. We expect the actual production in 2025 to be below $2 trillion. 

Source: Mortgage Bankers Association

Profitability in the industry is likewise improving from the lows of 2023, but only just barely.  Not quite three quarters of all IMBs were profitable in the first 9 months of 2024 (h/t Joe Garrett), according to the Mortgage Bankers Association. But being barely profitable is a long way from financial stability and soundness.

Source: Mortgage Bankers Association

The profitability of IMBs at the loan level us improving, but only just barely. The majority of the actual cash profit generated from lending is found in the mortgage servicing rights (MSRs), especially in the conventional loan market. The premium for selling the MSR with the loan is so attractive, and gain-on-sale profits are so hard to generate, that many sellers that might have preferred to retain servicing are simply compelled to sell to cover operating expenses. 

Ginnie Mae volume growth continues to outpace both of the GSEs individually, accounting now for 40% of total MBS issuance. Many lenders lean towards the government market because the execution is far better than in conventionals. Volumes in Q4 were down low double digits, Inside Mortgage Finance Reports, with a 15% decline observed in December. The table below shows the TBA market for Ginnie Mae MBS as of the close on Friday.

To-Be-Announced (TBA) | Ginnie Mae MBS

Source: Bloomberg (01/18/25)

Notice that the premium contract is a 6.5% for February delivery, one reason why 30-year fixed mortgage rates are rising above 7%.  Effective rates in the VA market, however, are far lower, driving refinance volumes.  As mortgage rates increase, lenders are leaning even more into the VA market to generate returns.

“Securitization of VA loans was up 14.6% in the fourth quarter, and FHA volume rose 6.1%,” reports IMF. “While the GSEs reported a 3.4% increase in conventional loans with no mortgage insurance, the quarterly volume of loans with private MI fell 1.3%.”  But the single biggest negative factor on volumes remains home prices, which continue to rise in most markets nationally, as shown in the chart below.

One of the more notable aspects of the FOMC under Jerome Powell was the refusal to raise interest rates enough to force home prices down significantly. Because of concern about Treasury market liquidity, the FOMC did not even force system reserves down (h/t Bill Nelson), even while engaging publicly in “quantitative rightening” by reducing the balance sheet.

The residential housing market softness observed in 2023 lasted barely a year, followed by a resurgence of lending volumes and home prices in 2024. The boom in new loan production in Q3 2024 was not very long lived, however, and was visibly collapsing by the end of December. Despite weak production volumes, the larger issuers continued to bid aggressively for servicing assets in 2024. 

The standard reason advanced for the aggressive behavior by players such as Freedom Mortgage and Rocket Mortgage (RKT) in the bulk MSR market is that superior recapture allows for higher valuations for MSRs. Rising interest rates is another reason often advanced for paying up for MSRs. But one key reason for higher MSR valuations is the growth in escrow balances for taxes and insurance, a systemic phenomenon that means much higher custodial balances and float earnings on MSRs. The chart below shows the fair value of bank owned MSRs with the average valuation around 160bp.

Source: FDIC/WGA LLC

The Mortgage Issuers

The table below shows our enlarged real estate surveillance group, both public and private issuers. We have captured all of the public and private 144a deals available on the Bloomberg and from other sources to give readers some idea about what these firms pay for debt and equity capital. If there is no data, the field is left blank. Below we discuss selected issuers and REITs, and how we think they will fair in 2025. 

The good news is that the larger Ginnie Mae issuers have taken advantage of a positive investor reception in the bond market to issue substantial amounts of term debt to finance servicing portfolios. As you read through this list, however, notice how many issuers with ~ $100 billion in servicing assets and marginal profitability are waiting to either sell the MSR or get bought out entirely. In 2025, consolidation is the name of the game in residential mortgage finance. 

Mortgage Finance

Source: Bloomberg (01/18/25), WGA LLC

Annaly Capital Management (NLY) is a REIT that has historically focused on agency MBS, but more recently has followed the herd into investing in conventional MSRs. The REIT is trading about book value, but is at a bit of a discount to some other REIT comps in terms of P/E ratio. The equity features a 13.5% dividend yield, which is the primary reason for investors to hold the shares. REITs are essentially passthrough vehicles that have difficulty accumulating capital, thus while we have owned NLY in the past, it is not part of our portfolio today. There are better ways to get exposure to MSRs.

After NLY, we have Better Homes & Finance (BETR), a mortgage platform that debuted in 2023 after a long and painful gestation period that culminated in a SPAC merger. The stock had the bad fortune of coming out when the mortgage market was going through one of its most difficult periods in many years. The BETR stock did show signs of life in 2024 and even flirted with $30 per share in July, but closed last week below $10 per share. 

After BETR on our list are two private placements for Bayview, the privately-held mortgage issuer that is paired with Lakeview Loan Servicing, the largest owned servicer in the mortgage industry. Bayview is active in the bulk MSR market and is one of the more sophisticated mortgage issuers.

Bayview caters specifically to the insurance industry for the management of 1-4 family loans and MSRs. Bayview owns several insurers, giving the group access to the Federal Home Loan Banks for funding. Bayview just settled a 50-state inquiry regarding alleged deficient cybersecurity practices, but generally the firm has a very low profile. Bayview was recently involved in Everbank's acquisition of Sterling Bank of Michigan.

Next on the list is Cherry Hill Mortgage Investment Corporation (CHMI), an agency REIT that has also begun to invest in conventional MSRs. Because REITs cannot become government issuers, they are forced to either focus on conventional assets only or purchase a seller/servicer, which is operated as a for profit appendage of the REIT, as discussed below. CHMI has a dividend yield of 20% and a P/E or just 3, both a reflection of the fact that the REIT trades at 0.75x book value. 

Chimera Investment Corporation (CIM) follows after CHMI and again we have a REIT that focuses on residential mortgage assets. CIM has only a 10% dividend yield, thus no surprise that the stock trades at a steep discount to book or 0.64x. During COVID, CIM surged up to nearly $50 per share, but at Friday’s close the stock was below $15 per share. The all-time high was $296 in 2008. Go figure. 

After Chimera, next on the list is Finance of America Companies Inc. (FOA), one of the smallest public issuers in our group. FOA is focused on originating and servicing reverse mortgages, and has been suffering from a lack of profitability.

Of note, Onity Group (ONIT) acquired the reverse mortgage assets of Mortgage Assets Management (MAM) from Waterfall Asset Management in August 2024. FOA is now the only other independent reverse issuer and Reverse Mortgage Funding is owned by the US Treasury. FOA has rallied strongly over the past year, when the stock was trading well less than half of book value, and is near the 52-week high. Today FOA trades over 0.8x book, but faces the possibility of another year of high interest rates and low volumes.

One of the largest lenders and servicers in the US is Freedom Mortgage, a private issuer located in New Jersey. Freedom had over $600 billion in owned servicing as of Q3 2024 and saw MBS issuance rise over 300% YOY as the firm leaned into the conventional and government markets. Although the equity of Freedom is private, it has issued significant amounts of term debt in the bond market and earned steadily declining credit spreads. The average yield on the “BB-” (Fitch) Freedom debt is below 8%.

Like Lakeview Loan Servicing, Freedom typically does more government loans than conventionals, and is especially adept at recapturing loan prepayments in FHA and VA assets.  In the past several years, however, Freedom has been the bid to beat in the MSR market and has also increased lending activity overall based upon the belief that MSRs are still not fully valued in the markets. As we’ve noted in past missives, compared with commercial real estate, residential MSRs still trade at relatively low cap rates.

Guild Holdings Company (GHLD) is one of the best managed companies in the mortgage sector. Despite the ebb and slow of Fed interest rate policy, GHLD has managed to trade within a narrow range. The recent high was $17 in  early 2021 and the low was $7 in 2022. GHLD was near the highs in Q3 2024 when many thought that further rate cuts were coming from the Fed, but the stock closed at $12.74 on Friday or 0.68x book value.

A top-20 issuer, GHLD did $14 billion in mostly purchase volume in 2024 (IMF), a 20% increase YOY, but lost money on a GAAP basis in the first nine months of 2024. The firm has $90 billion in unpaid principal balance (UPB) of servicing. 

After GHLD comes loanDepot, Inc. (LDI), a top-20 issuer which has been struggling to align expenses and falling revenue since 2021.  LDI had $114 billion in UPB of servicing at the end of Q3 2024. LDI saw volumes fall 10% in 2024 and 24% in conventionals last year. LDI ran up to 1.7x book in Q3 2024, but has since retreated to just above book value at Friday’s close.  The chart below comes from the Q3 2024 LDI earnings presentation.

With just over $100 billion in MSR remaining, the obvious question is why doesn’t CEO Frank Martell simply sell the company? The answer is that at 1.2x book, there probably is not anybody other than retail investors willing to pay that price. LDI is a classic example of an issuer that has struggled to make expenses fit the greatly reduced level of volumes flowing through the firm. But the problems at LDI are deeper than mere indifference to a lack of profitability. 

LDI looks a lot like other firms that exist to preserve industry employment rather than generate returns for investors. The $1.5 billion MSR at Q3 2024 is 3x the market cap of the company. The obvious trade is to sell the MSR, dividend most of the proceeds to shareholders, delist the issuer, and then sell or downsize the remaining business. When you notice that LDI has no term debt or preferred, the obvious answer seems to be that management is waiting for the phone to ring. Competitive issuers that want to survive the next year need to be buying MSRs and raising new funding aggressively.

Mr. Cooper Group (COOP) is one of the larger servicers in the US and also one of the few issuers in the industry that has been consistently profitable and has also built shareholder value. Since 2020, COOP has steadily built shareholder value by adding to book value through earnings, bulk purchases of MSRs and the acquisition of other businesses and valuable assets. The stock stood at 1.4x book as of Friday’s close. 

COOP ranked fourth in owned servicing at the end of Q3 after JPMorgan (JPM), Wells Fargo (WFC) and Lakeview. Along with Freedom and PennyMac (PFSI), COOP is likely to be one of the key consolidators in the mortgage sector. Notice that COOP has a substantial presence in the bond market and can easily access new capital to drive further acquisitions. The acquisition of Roosevelt Management Company gives COOP asset management capabilities and thereby additional scope for future growth.

Another issuer that is looking for a new storyline is Onity Group Inc. (ONIT), f/k/a Ocwen Financial. ONIT is a top twenty issuer but had just over $119 billion UPB of owned servicing at the end of Q3 2024. PHH Mortgage is one of the largest servicers in the country, with 1.3 million loans with a total UPB of $288.4 billion on behalf of more than 3,900 investors and 115 subservicing clients. The Liberty unit of ONIT is one of the nation's largest reverse mortgage lenders and, significantly, does only HECM loans.  

The ONIT stock has been dead in the water for years. On Friday it was trading at 0.5x book value. Like LDI, the best thing for the ONIT shareholders would be the sale of the MSR and subservicing portfolio, and a wind up of the business. The servicing operation and Liberty may also have some value, but ultimately the owned servicing is the primary asset of ONIT. 

PennyMac Financial Services (PFSI) and its paired REIT, PennyMac Mortgage Trust (PMT), are two of the more efficient and well-valued businesses in the mortgage sector. PMT is the lower yielding vehicle for holding conventional exposures while PFSI is the issuer and also holds the Ginnie Mae exposures. Since the end of 2021, PFSI has steadily climbed in terms of market value and closed Friday at 1.4x book value.

PFSI had $650 billion in owned servicing at the end of Q3 2024, making the issuer one of the top players in the world of MSRs. The stock is near the all-time high and has been rising since 2020, due in large part to growing awareness by investors of the value of the large MSR portfolio. Like Freedom and COOP, PFSI has made extensive use of the debt capital markets to build a solid foundation for the firm’s liquidity and MSR funding. 

We expect that PFSI will also be one of the winners in the coming consolidation of the industry. First, the firm is well-run and generates solid returns from both issuance of MBS and servicing. Second, PFSI has access to funding for bulk purchases of MSR or acquisitions, and also to build their own servicing platform. And third, by having the issuer/manager separate in PFSI from the conventional balance sheet at PMT, the firm has an advantage over Rithm Capital (RITM), Two Harbors (TWO) and other ersatz REIT/issuer constructs. 

Back in December, IMF speculated on whether the long-discussed spinoff of the NewRez lender might be in the cards for Rithm Capital Corp. (RITM). At present, NewRez is the taxable appendage of the REIT known at RITM.  For some time now, shareholders have been agitating for a spinoff of NewRez as a way to unlock shareholder value. Specifically, the PFSI issuer model at PennyMac trades at a considerable premium to the REIT PMT.

Based on price to book, RITM has not really moved in years. We think that moving forward with a spinoff would be good for RITM because the issuer could become the external manager of the REIT, which would include conventional, commercial and other exposures. Unlike PMT, RITM has a multi asset focus and can serve as a balance sheet for any mortgage related exposures that Mike Neirenberg and his team source.

Post-spinoff, the RITM/NewRez binary could outperform PennyMac. The Ginnie Mae exposures and MSRs, however, must be housed inside PFSI and not the REIT. RITM acquired Shellpoint and then Caliber to solve a problem with Ginnie Mae. For the same reason that federal regulators will not allow a REIT to buy a bank, Ginnie Mae does not allow REITs to be issuers. The passthrough structure of the REIT does not allow the accumulation of capital needed to be a source of financial strength a depository or an issuer.  

But if Nierenberg has the courage to go forward with the spin of the manager and the lender/issuer, we think that will unlock value for both RITM and NewRez. The accepted model in the industry is the issuer PFSI with the REIT PMT, a model that RITM ought to emulate. The broader, multi-asset mandate for RITM, however, could make it more attractive than the deliberately pedestrian conventional portfolio of PMT.

We will talk about some of the other issuers in the world of Mortgage Finance in a future edition of The Institutional Risk Analyst. 

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