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

DBRS, Inc. (Morningstar DBRS) confirmed the ‘B’ Long-Term Issuer Rating of loanDepot, Inc. (loanDepot or the Company). At the same time, Morningstar DBRS confirmed the ‘B’ Long-Term Issuer Rating of 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 CREDIT RATING CONSIDERATIONS
The credit ratings reflect loanDepot’s franchise as one of the top non-bank mortgage loan originators and servicers in the U.S., with a diverse set of mortgage lending products and a large servicing portfolio. Further, supportive of the credit ratings is the Company’s proper liquidity and acceptable capitalization. The credit ratings also consider the Company’s earnings generation capacity, which is impacted by the volatility and cyclicality of the residential mortgage origination market. The Company’s key reliance on asset-based funding and heightened operational and market risk exposure are also credit rating constraints.

The Stable trend reflects our view that the Company should benefit from the forecasted improvement in mortgage origination volume in 2024, as mortgage rates are expected to moderate from the historically high levels reached in 2023. Further, LoanDepot has gained significant operating efficiency through cost cutting and business process optimization that the Company has undertaken since mid-2022 because of the implementation of its Vision 2025 initiative. As a result, we expect earnings pressures to soften for the Company, which, along with the expected gradual pick-up in mortgage origination activity, should help the Company return to profitability. Nevertheless, a lackluster recovery in the housing market due to an economic downturn and persistent affordability challenges are key downside risks to our expectations.

CREDIT RATING DRIVERS
LoanDepot’s credit ratings would be upgraded if the Company restores its profitability while demonstrating a similar risk and funding profiles and strengthening capitalization. Conversely, a prolonged period of weakening operating performance or reduced access to the capital markets would result in a credit ratings downgrade. Additionally, material reputational damage and/or financial damage associated with weak operating risk management practices, including the recent cybersecurity incident, regulatory oversight, or litigation, impacting its franchise would also result in a credit ratings downgrade.

CREDIT RATING RATIONALE

Franchise Strength Building Block (BB) Assessment: Moderate/Weak

loanDepot’s franchise is underpinned by its positioning as one of the top retail-focused non-bank mortgage lenders in the highly fragmented and cyclical U.S. residential mortgage market. The Company’s franchise is further supported by a growing set of mortgage lending products, with an increased focus on purchase originations, which are less interest rate sensitive. Furthermore, the Company benefits from a large servicing portfolio, which was successfully transferred in-house during 2023. The Company also benefits from a sophisticated proprietary technology platform that provides loanDepot with increased efficiency and scale. Impacted by high mortgage rates and persistent affordability challenges, in 2022, loanDepot originated $54 billion of mortgages, down 61% year-over-year (YoY), equating to only 2.4% of the market. As a result, the Company’s market share slipped further in 3Q23 to 1.4% with total originations of $18 billion through 9M23, down 63% YoY.

Earnings Power Building Block (BB) Assessment: Weak/ Very Weak

The Company’s earnings power is considered weak, given that a sizeable portion of revenue is generated from transactional sources such as gain on origination and sale of loans, subjecting earnings to the cyclicality of the U.S. housing market and the overall interest rate environment. Indeed, 67% of the Company’s net revenues in 9M23 was derived from such transactional sources, albeit lower than a historical five-year (2018-2022) average of 82%, reflecting growth in the servicing platform and associated revenues. As the Company continues to enhance its in-house servicing capabilities further, we expect the Company’s earnings to benefit due to scale and operating efficiencies.

Earnings remained challenged in 2022 and through 9M23, as historically high interest rates created a locked-in effect, eliminating the demand for refinancing and dramatically slowing overall housing market activity. Following a sizeable loss in 2022 of $610.4 million, the Company focused on operating efficiency and streamlining business processes, leading to narrowing losses. Consequently, gain on sale margin improved to 2.66% in 9M23, compared to 1.66% in 9M22. For 9M23, the Company reported lower net losses of $175.7 million, compared to a net loss of $452.6 million for 9M22, primarily driven by a significant decrease in operating expenses. Indeed, operating expenses were down 44% YoY in 9M23, following a 41% YoY reduction in 2022. We see loanDepot as being on track to cut expenses by an additional $120 million annually through mid-2024, which should help soften earning pressures until a meaningful rebound in originations materializes. Overall, we anticipate that financial performance will improve as 2024 progresses as cost cutting initiatives improve efficiency and mortgage activity improves driven by latent demand for housing and a moderating rate environment.

Risk Profile Building Block (BB) Assessment: Moderate/ Weak

loanDepot is primarily subject to market risk, specifically interest rate risk, as it holds a substantial portion of assets at fair value (FV), which are interest rate sensitive. Indeed, at 3Q23, approximately 80% 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 (IRLCs) and loans held for sale (LHFS), 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. In line with historic levels, credit losses continue to remain manageable with a LHFS non-accruals rate of 1.2% at 9M23, compared to 1.0% from the same prior year period. Meanwhile, reserves for loan loss obligations stood at $43.7 million in 9M23, lower from $68.9 million in 9M22, reflecting lower charge-offs of $37.0 million in 9M23, compared to $69.5 million in 9M22. Finally, 90+ days delinquency of the servicing portfolio has stayed relatively stable at 0.8% of the UPB, below the industry average rate of 0.98%. We see asset performance as likely to weaken should expectations of slowing economic activity materialize in 2024 and the unemployment rate ticks up from currently low levels.

Operational risk continues to be elevated. Recently, loanDepot was the subject of a cyberattack, which resulted in several of the Company’s platforms, including those that interface with customers to be offline for a period of nearly two weeks. While the Company has brought the platforms back online and has cyber insurance to mitigate some of the costs, the Company will likely face costs associated with litigation from the incident as well as reputational damage, the level of which may take time to become clear.

Funding & Liquidity Building Block (BB) Assessment: Weak

The Company’s funding profile is limited as the Company is mainly reliant on secured borrowing, resulting in a highly encumbered balance sheet. Indeed, secured borrowing comprised 79% of total debt outstanding at 3Q23, though lower than a five-year average of approximately 90%. As of September 30, 2023, the Company had $4.7 billion of total debt outstanding, comprised of short-term warehouse credit lines (40%), securitizations (26%), senior unsecured notes (21%), and repurchase agreements (13%). Funding is largely aligned with its asset base and is sourced through established relationships with a diverse group of participating financial institutions. Refinancing risk is elevated with most warehouse facilities having one-year term, but we note these have historically been extended while the next term debt maturity of $498 million is in November 2025. Meanwhile, at September 30, 2023, loanDepot’s liquidity position was solid with $717.2 million of cash and equivalents, representing approximately 12% of total assets, well above the Company’s typical target cash balance of between 5%-7% of assets. We view this excess liquidity as prudent, given the uncertainty in the economic outlook, as a potential spike in delinquencies in the Company’s servicing portfolio would result in increased fund needs for servicing advances.

Capitalization Building Block (BB) Assessment: Weak/ Very Weak

loanDepot’s capitalization is weak with a tangible equity-to-tangible assets ratio of 12.7% at September 30, 2023, lower from 13.9% at YE22, as reported losses in 2022 and 9M23 has amounted to an increased accumulation of retained deficit, eroding the Company’s capital levels. However, at current levels, the Company still maintains a reasonable cushion to absorb operating losses while still meeting the pertinent covenant requirements. Leverage (debt-to-equity) was elevated at 6.2x at September 30, 2023, compared to 5.5x at YE22.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
There was no Environmental factor that had a significant or relevant effect on the credit analysis.

Social (S) Factors
Social, specifically the sub-factor Data Privacy and Security, is a relevant factor in the credit analysis, but it does not affect the credit ratings or the trend assigned to loanDepot. On January 8, 2024, the Company disclosed that it had been the subject of a cybersecurity attack, which resulted in the breach of approximately 16.6 million customers' sensitive information. This substantial loss of private data could potentially negatively impact the Company’s reputation, resulting in financial penalties and costs and impeding the Company’s financial performance, which could adversely impact its credit risk. This S factor is new and was not present in the prior credit rating disclosure.

Governance (G) Factors
Governance, specifically the sub-factor Business Ethics, is a relevant factor in the credit analysis but does not affect the credit ratings or the trend assigned to loanDepot. As of September 30, 2023, multiple lawsuits remain pending against the Company and some of its former 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 Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at (January 23, 2024) https://dbrs.morningstar.com/research/427030/morningstar-dbrs-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings.

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

The principal methodology is the Global Methodology for Rating Non-Bank Financial Institutions https://dbrs.morningstar.com/research/420144/global-methodology-for-rating-non-bank-financial-institutions (September 1, 2023). In addition, Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings https://dbrs.morningstar.com/research/427030/morningstar-dbrs-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings. (January 23, 2024) in its consideration of ESG factors.

The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.

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

The credit rating was initiated at the request of the rated entity.

The rated entity or its related entities did participate in the credit rating process for this credit rating action.

Morningstar DBRS had access to the accounts, management, and other relevant internal documents of the rated entity or its related entities in connection with this credit rating action.

This is a solicited credit rating.

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

For more information on this credit or on this industry, visit dbrs.morningstar.com.

DBRS, Inc.
140 Broadway, 43rd Floor
New York, NY 10005 USA
Tel. +1 212 806-3277