DBRS Morningstar Assigns Long-Term Issuer Rating of ‘B’ to loanDepot, Inc. with a Stable Trend

DBRS, Inc. (DBRS Morningstar) assigned a Long-Term Issuer Rating of ‘B’ to loanDepot, Inc. (loanDepot or the Company). At the same time, DBRS Morningstar assigned a Long-Term Issuer Rating of ‘B’ to the Company’s operating subsidiary loanDepot.com, LLC. The trend for all the ratings is Stable. The Company’s Intrinsic Assessment (IA) is ‘B’, while its Support Assessment is SA3, resulting in the Company’s final rating being equalized with its IA.

KEY RATING CONSIDERATIONS
The ratings reflect loanDepot’s franchise as one of the top nonbank mortgage loan originators and servicers in the U.S., with proper liquidity and acceptable capitalization. The ratings also consider the Company’s earnings generation volatility given its concentrated and cyclical business model, as well as a primarily asset-based funding profile, and heightened exposure to operational and market risk.

The Stable trend reflects our expectation that the Company will successfully execute on its strategic initiatives, including cost reduction and business restructuring as it copes with the challenging mortgage origination environment while maintaining a sound balance sheet. Nonetheless, a material weakening in the housing market accompanied by a sharp economic downturn constitute key downside risks to our expectations.

RATING DRIVERS
The ratings would be upgraded if the Company improves and sustains its earnings generation capacity while maintaining a similar risk profile and sound capitalization. Conversely, a prolonged period of weak operating results would result in a ratings downgrade. Additionally, a material reputational damage associated with weak operating risk management practices, regulatory oversight, or litigation would result in a ratings downgrade.

RATING RATIONALE
loanDepot’s franchise is underpinned by its positioning as one of the top retail-focused nonbank mortgage lenders in the highly fragmented U.S. residential mortgage market. The franchise also benefits from a growing set of mortgage lending, servicing, and other complementary products and services, as well as a sophisticated proprietary technology that provides loanDepot with increased efficiency and scale. Historically, loanDepot has focused more on refinance originations (refi). However, as a result of the shifting mortgage market dynamics, loanDepot is transitioning towards less interest rate sensitive purchase mortgage originations. Moreover, the Company has launched new products and services in 2022, including HELOCs and purpose driven lending for the underserved population in the U.S. through new joint ventures. In 2021 spurred by the significant demand for mortgage refinancing, loanDepot originated $137 billion of mortgages equating to 3.4% of the market however, with mortgage rates rising reducing demand for mortgage refinancing, the Company’s market share moderated further to approximately 2.6% in 9M22.

The Company’s earnings power is constrained in today’s operating environment since a sizeable portion of revenue is generated from transactional sources such as gain on origination and sale of loans (70% of net revenue in 9M22 and 88% in 2021), exposing earnings to the volatility and cyclicality of the housing market and the overall interest rate environment. As a result of significantly higher interest rates that have dramatically slowed both the refi market and the overall housing market, the Company reported net losses of $452.6 million in 9M22, compared to a net income of $608.4 million in 9M21. This follows record earnings of $2.0 billion in 2020.

The Company has experienced significant growth in its servicing portfolio as a result of extensive investment in its in-house servicing capabilities, which resulted in the successful transition to fully in-house servicing in 3Q22. Overall, loanDepot’s servicing portfolio totaled $139.7 billion in unpaid principal balance (UPB) in 9M22. Revenues from servicing are recurring in nature and can partially offset the decline from gain on origination and sale of loans leading to a less volatile earnings profile, which would be viewed favourably. We see the change in revenue mix with the increasing share of servicing fee income, which represented 31% of net revenue in 9M22 from the past five-year average of around 9% as evidence of progress in the investment to grow in-house servicing. To address the much more difficult operating environment, the Company has taken steps to reduce costs through business process optimization. Indeed, as part of its Vision 2025 strategy, loanDepot reduced its headcount to approximately 6,100 employees as of September 30, 2022, down 46% from YE21. Furthermore, the Company is on track to reduce non-volume related expenses by $375 million to $400 million by YE22, which should help the Company return to profitability.

The Company is primarily subject to market risk and specifically interest rate risk, as it holds a substantial portion of assets at fair value (FV), which are interest rate sensitive. Indeed, at September 30, 2022, approximately 70% of the Company’s total assets were marked to fair value. However, loanDepot utilizes derivative instruments to mitigate such risks for the interest rate lock commitments and loans held for sale as well as for its mortgage servicing rights (MSRs). Credit risk is limited due to the Company’s originate-to-sale business model, but it is subject to the risk associated with the representations (reps) and warranties. The Company has historically registered low credit losses and non-accrual loans associated to sold loans’ reps and warranties. Nonetheless, following a fairly stable level of charge-offs during the past three years, in 9M22, charge-offs totaled $69.5 million, up from $9.3 million in 9M21, while at the same time, the Company built its reserves for loan obligations to $68.9 million from $27.0 million in the same prior year period. We see credit losses as likely to increase should the U.S. economy weaken over the next year.

loanDepot’s funding profile is limited as the Company primarily sources its funding needs through secured borrowing resulting in a highly encumbered balance sheet. Indeed, secured funding constituted approximately 81.5% of total debt outstanding at 3Q22, though lower compared to a five-year (2017-2021) average of approximately 92%. As of September 30, 2022, the Company had $5.4 billion total debt outstanding comprised of short-term warehouse credit lines (47.1%), securitizations (24.1%), senior unsecured notes (18.5%), and repurchase agreements (10.3%). Funding is largely aligned with its asset base, and is sourced through established relationships with a diverse group of participating financial institutions. Meanwhile, at September 30, 2022, loanDepot’s liquidity position was strong with $1.1 billion of cash and equivalents representing nearly 16% of total assets and well exceeding the Company’s target cash balance of between 5%-7% of assets. We view this excess liquidity as prudent given the weakening economic outlook that raises the potential for a sharp increase in delinquencies in the Company’s servicing portfolio, where it would need fund servicing advances for delinquent customers.

loanDepot’s capitalization is acceptable with a tangible equity-to-tangible assets of 14.6% at September 30, 2022, providing a sufficient cushion to absorb operating losses while still meeting the pertinent covenant requirements. To preserve capital, the Company suspended quarterly dividend distributions back in March 2022.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
There were no Environmental or Social factors that had a significant or relevant effect on the credit analysis.

Governance (G) Factors
Governance and specifically the sub-factor Business Ethics is a relevant factor on the credit analysis but it does not affect the ratings or the trend assigned to loanDepot. As of September 30, 2022, there were multiple lawsuits pending against the Company and some of its senior management. Allegations include non-compliance with loan originations and investor and employee related matters. While the Company believes these allegations are meritless, a negative outcome could result in significant financial penalties and/or a material reputational damage, which could adversely impact credit risk.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (May 17, 2022).

Notes:
All figures are in U.S. Dollars unless otherwise noted.

The principal methodology is the Global Methodology for Rating Non-Bank Financial Institutions (September 2, 2022): https://www.dbrsmorningstar.com/research/402314/global-methodology-for-rating-non-bank-financial-institutions. Other applicable methodologies include DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (May 17, 2022): https://www.dbrsmorningstar.com/research/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings.

The primary sources of information used for this rating include Company documents and Morningstar Inc. DBRS Morningstar considers the information available to it for the purposes of providing this rating was of satisfactory quality.

The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. DBRS Morningstar’s outlooks and ratings are under regular surveillance.

For more information on this credit or on this industry, visit www.dbrsmorningstar.com.

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