Nonbank mortgage companies are increasingly turning to unsecured debt as the recent rise in interest rates has heightened borrowing needs, and wariness of the short-term, secured financing they typically use has grown.
Three large players returned to the unsecured debt market in the third quarter for the first time since 2021, the Fitch Ratings said in a recent report, citing examples like Mr. Cooper’s recent $1 billion issuance, which pushed its stock price to an all-time high.
Others include Freedom Mortgage, which issued $500 million this quarter and $1.3 billion in the third quarter of last year, and Pennymac, which issued an upsized $750 million unsecured note offering in the fourth quarter.
“Unsecured debt is more stable and isn’t subject to margin calls if we have a significant interest rate rally,” Dan Perotti, Pennymac’s chief financial officer, said in an earnings call when asked about the motivation for its use and whether it reflects bank pullback from servicing financing.
“We have not seen a pullback in MSR financing for banks. In fact, it’s really been the opposite,” he said. “We want to continue to diversify the number of things we have that are financing our MSRs, just for risk management purposes, but we don’t see a pullback there.”
Unsecured debt, which can have a higher cost than its secured counterparts, is not a cure-all, but as Perotti notes, it can have less refinancing risk. And if it’s utilized in ways that appeal to credit analysts, it can lead to higher ratings which can, in turn, reduce the costs.
“I think we can drive down the cost over time as we move more toward unsecured,” Perotti said. “It has a more favorable sort of rating and capital profile.”
The Fitch report indicates that analysts positively regard the use of unsecured debt to pay down some secured financing and that they’d like to see more of it.
Nonbank mortgage firms’ unsecured-to-total debt ratios are still below those of some other finance companies that have higher ratings, according to Fitch.
Fitch encourages nonbank mortgage companies to improve the management of their warehouse lines of credit used to fund mortgage pipelines in addition to MSR financings due to interest rate risk.
“Refinance risk is constant as facilities, particularly warehouses, must be amended or extended on an annual basis,” the Fitch report said. “Only 21.6% of warehouse capacity committed, on average, for rated issuers at 3Q23, which serves as a meaningful rating constraint.”
But there also is a unique risk related to MSR financing to be wary of this year.
“MSR valuations decline with falling rates, which could weaken liquidity profiles,” the Fitch analysts said.
However, that risk may be limited because many outstanding loans have much lower interest rates than the ones currently prevailing, so they’re less likely to be exposed to the refinancing incentive that reduces MSR valuations.
“We expect rates to decline before year-end 2024 but not drive significant mortgage origination activity, as refi opportunities on the majority of existing mortgages will remain firmly out of the money,” the analysts said.
