As expected, the FOMC maintained the Federal Funds rate at a target range of 5.25% to 5.50% at its November meeting, remaining unchanged from the previous September pause.
Looking ahead to December’s final meeting of the year, Fed futures contracts suggest a 20% chance of a rate hike, according to the CME FedWatch tool. This brings a few questions readily to mind: Are we at the cycle’s peak, and if so, how long will it last? And if there are more hikes to come, how might this affect the already beleaguered home lending market?
What This Could Mean For Home Lending
Even if the Fed’s battle against inflation has peaked, we shouldn’t anticipate a sudden drop in home lending rates. It takes time for key inflation and macroeconomic indicators to play out, so rate relief is unlikely until late next year or early 2025.
Interest rates for new mortgages have remained above 7% – their highest in over two decades – since August 2023, and Treasury yields are in the 5% range, a level not seen in nearly as long. Bond market turbulence and reduced demand for mortgage-backed securities (the Fed is no longer a buyer) have significantly widened the spread between mortgage rates and Treasurys – the current 300 bp is close to double the typical spread. Narrowing this spread would lower rates, but the most likely path to lower rates would be for the Fed to again become a major MBS buyer.
Even With Fed Pause, Deposit Rates Likely To Stay Elevated
Asset yields have stabilized and, absent a major structural change, they will likely not decrease in the near term. The likelier scenario is that yields increase across all deposit segments even if the Fed holds, which would add to compression in net interest margin through a plateau environment. Significant drivers of incremental deposit pressure through the plateau include a high volume of rollovers of lower-rate consumer CDs and the ongoing rotation of commercial balances from non-interest-bearing, ECR products into higher-rate interest-bearing accounts.
Fee income presents both challenges and opportunities. On the asset side, fees are under pressure as high rates have led to lower origination volumes. Any opportunity is primarily in the commercial space, where banks remain intently focused on monetizing treasury management services through a greater focus on pricing.
The result is continuing challenges to profitability. Financial institutions will need to be surgical in identifying opportunities for growth in lending, and they’ll need to find pockets of pricing power across both loans and deposits. Deepening customer relationships will remain a key priority, as it typically accompanies lower levels of price elasticity across the relationship. And managing expenses will be key, but not to the extent that it inhibits acquiring low-cost deposits or future growth.
Finally, FIs have to be prepared to act if and when interest rates shift. If rates drop, which lending products will provide the most incremental volumes with a competitive rate advantage? And which pockets of higher beta deposits on the way up can be managed quickly as betas drop? Conversely, given remaining back books and tight funding conditions, which deposits will need to lag on the way down?
Home Equity Loans Are A Potential Bright Spot For Lenders
A potential area of opportunity for banking institutions is in second-lien, closed-end (HELoan) lending. Curinos data has identified a strong resurgence in this market segment due to rate-sensitive consumers – 110% growth from January to September 2023 (Figure 1). With weighted-average booked rates above 9%, this represents a potentially attractive cash-out opportunity for consumers, and thus for lenders.
Figure 1: Rate-Sensitive Customers Have Revived Home Equity Lending
Curinos has also observed a steady increase in demand for adjustable-rate mortgages (ARM) due to their initial lower interest rates. Since January, ARMs have comprised just over 10% of mortgage locked units and represented nearly a quarter of all mortgage origination volume in October (Figure 2).
Figure 2: Volume Of Adjustable-Rate Mortgages Has Spiked Since June
Higher interest rates have repressed the supply side of the housing market, both for the sale of existing units and for new construction, and driven up prices. Where inventory is available, some home builders are offering incentives like temporary buydowns to boost sales rather than lowering prices, which would hurt nearby valuations. Curinos data indicates that temporary buydowns represented close to 7.5% of total sales volume in October, the highest percentage since tracking began in June 2022 (Figure 3).
Figure 3: More Builders Are Using Temporary Buydowns As A Sales Incentive
Other opportunities also exist. Millennials, today’s largest demographic for household formation, are reaching peak age to purchase homes, which stands to elevate housing demand for several years to come. But to capitalize on it, lenders need to be tactical. They’ll need to adapt their strategies to know which customers to attract, to reinvent their balance sheet and to commit to approaches in a higher-for-longer environment that are disciplined and focused on the long term.
High Rates, Elevated Demand Drive Credit Card Competition
More U.S. consumers are carrying credit card debt from month to month. This has increased competition among providers that have supplemented headline rates with flexible repayments options, personalized rewards and a streamlined digital onboarding experience.
The numbers are worrying: A recent Bankrate survey found that 47% of U.S. cardholders carry debt from month to month, up from 39% in 2021, and that 60% of those have been doing so for a year or more, a 10-percentage-point increase from two years ago.
Credit demand has spurred innovation as providers focus on flexible customer needs to broaden their appeal. New repayment offers, for example, include the ability to split payments retrospectively into installments, a nod to the growing competition from buy-now pay-later companies. And highly competitive (often 0%) merchant-based and cashback offers are becoming increasingly personalized and relevant to the customer, based on occasion (such as birthdays), needs, location and previous activities.
To ensure conversion, many providers are tweaking their digital onboarding journeys to simplify the application process. In app, some are experimenting with screen-by-screen application formats, moving away from forms that are text- and scroll-heavy.
More than a third of U.S.-based credit card providers tracked by Curinos’ Digital Banking Analyzer allow new customers to apply in the app. Live agents, chatbots and integrated FAQs are available to guide users through the application, with additional support options such as video demos to help manage expectations. Leading brands encourage users to add a virtual card to the device’s wallet when the application is complete, so they can begin spending instantly.
Consumers are facing higher rates and strained finances, but these challenges are being matched by much more optionality in user experience and flexible repayment options. Longer term, the trend can only benefit borrower and lender.