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 and assigned a B Long-Term Issuer Rating to the Company's holding subsidiary LD Holdings Group LLC, which benefits from certain guarantees from its wholly-owned subsidiaries. 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 credit rating being equalized with its IA.

KEY CREDIT RATING CONSIDERATIONS
The confirmation of 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 strong asset quality metrics, proper liquidity, and acceptable capitalization. The credit ratings also consider loanDepot's earnings generation capacity, which is impacted by the volatility and cyclicality of the residential mortgage origination market, as well as the Company's key reliance on asset-based funding and its heightened operational and market risk exposures.

The Stable trend reflects Morningstar DBRS's view that the Company should benefit from the lower interest rate environment as the Federal Reserve begins its easing cycle, supporting a pick-up in mortgage origination volume in the coming quarters. Further, through its Vision 2025 initiative loanDepot has attained significant operating efficiency through cost cutting and business process optimization. As a result, Morningstar DBRS expects earnings pressures to soften for the Company, which, along with the expected gradual pick-up in mortgage origination activity, should underpin the Company's return to profitability. Nevertheless, a lackluster recovery in the housing market due to a weak economic activity or a downturn and/or persistent affordability challenges are key downside risks to Morningstar DBRS's expectations.

CREDIT RATING DRIVERS
loanDepot's credit ratings would be upgraded if the Company restores and is able to sustain improved profitability while demonstrating a similar risk profile and strengthening capitalization. Conversely, prolonged losses, along with sustained weakening of the Company's capital position and/or insufficient liquidity would result in a credit ratings downgrade. Additionally, material reputational damage and/or financial damage associated with weak operating risk management practices, 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 offers a growing suite of mortgage loan products focused on purchase, refinance, and home equity lending, with full in-house servicing capabilities. loanDepot's underwriting and servicing businesses are supported by proprietary technology-driven platforms, offering the Company enhanced efficiency and scale. Further strengthening loanDepot's franchise is the Company's experienced management team, who has successfully positioned the Company to navigate the historical contraction in the housing market over the past two years through cost cutting initiatives, restructuring, and mortgage lending products, with a heavy emphasis on purchase originations, which is somewhat more stable than interest rates sensitive refinance originations. Over the past three years, high mortgage rates and persistent affordability challenges have diminished demand for mortgages. As a result, in 2023, loanDepot originated just $22.7 billion of mortgages, down 58% year-over-year (YoY), while during 1H24, originations totaled $10.6 billion, slightly lower from the $11.2 billion volume originated during the same prior year period.

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, 72% of the Company's net revenues in 1H24 were derived from such transactional sources, albeit lower than a historical five-year (2019-2023) average of 80%, reflecting growth in the servicing platform that generates solid recurring revenues. As the Company continues to enhance its in-house servicing capabilities further, Morningstar DBRS expects the Company's earnings to benefit due to scale and operating efficiencies.

While earnings remained challenged in 2023 and through 1H24, losses have narrowed significantly, aided by operating efficiency gains as part of the Company's Vision 2025 rightsizing cost structure initiatives. Consequently, the gain on sale margin improved notably to 2.97% in 1H24 from 2.6% in 2023 and 1.63% in 2022. For 2023, the Company reported significantly lower net losses of $235.5 million, compared to a loss of $610.4 million in 2022, driven by a 40.6% reduction in operating expenses to $1.0 billion, in part due to cost reduction initiatives along with reduced origination volume-related expenses as lower originations resulted in a 35.8% YoY decrease in net revenues (excluding interest expense) to $808.1 million. Similarly, for 1H24, loanDepot reported a net loss of $137.4 million, down from $141.5 million in 1H23, driven by marginally lower operating expenses which were partially offset by a net revenue decline of 6.5% YoY. Results were also impacted by non-recurring expenses of $54 million, which were mainly due to expenses related to the cybersecurity incident the Company experienced at the beginning of 2024. Overall, Morningstar DBRS anticipates a gradual improvement in financial performance over the near-to-medium term, supported by improved efficiency and a pick-up in mortgage activity.

Risk Profile Building Block (BB) Assessment: Moderate/ Weak
loanDepot is primarily subject to market risk, specifically interest rate risk, as over 80% of the Company's assets are marked to fair value (FV), resulting in volatility in earnings through realized and unrealized gains and losses. Positively, market risk is somewhat mitigated through the use of derivative instruments to hedge 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 remain manageable with a low LHFS non-accrual rate of just 0.9% in 1H23 and YE23. Meanwhile, reserves for loan loss obligations stood at $20.8 million in 1H24 and $32 million at YE23, compared to $53.5 million in 1H23, reflecting the reversal of provision for loan losses and recoveries on previously recorded charge-offs. Finally, the 90+ days delinquency of the servicing portfolio stood at 1% of the $114 billion UPB, in line with the 90+ day delinquency rate for the industry but higher from 0.70% in 1H23. Morningstar DBRS sees asset performance as likely to gradually weaken should expectations of slowing economic activity materialize in the 2H24 and the unemployment rate increases further from low levels.

Operational risk continues to be elevated. In January 2024, loanDepot was the subject of a cyberattack, which resulted in several of the Company's platforms, including those that interface with customers being offline for nearly two weeks. During the Cybersecurity Incident, an unauthorized third party gained access to the sensitive personal information of approximately 16.9 million individuals stored in the Company's systems. Through 1H24, the incident has resulted in $41.6 million in losses for the Company, net of insurance reimbursement. Of the $41.6 million, $25 million has been accrued for the 25 class action litigation cases filed against the Company by affected individuals. Additionally, the Company estimates to have lost $22 million in revenue from the two weeks that the Company's systems were down due to the incident.

Funding & Liquidity Building Block (BB) Assessment: Weak
loanDepot's funding profile is limited as the Company mainly relies on secured borrowing, resulting in a highly encumbered balance sheet. Indeed, secured borrowing comprised 88% of total debt outstanding at 2Q24. As of June 30, 2024, the Company had $4.2 billion of total debt outstanding, comprised of short-term warehouse credit lines (53%), securitizations (35%), and senior unsecured notes (12%). 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 terms, but Morningstar DBRS notes these have historically been extended with no issues. Meanwhile, at June 30, 2024, loanDepot's liquidity position was acceptable with $533.2 million of cash and equivalents, representing approximately 9% of total assets, well above the Company's typical target cash balance of between 5%-7% of assets.

Capitalization Building Block (BB) Assessment: Weak/ Very Weak
Capitalization is considered weak as the tangible equity-to-tangible assets ratio was 9.7% at June 30, 2024, lower from 11.5% at YE23 and 13.9% at YE22, as reported losses over the last two and a half years eroded the Company's capital levels. However, at current levels, the Company maintains a reasonable cushion to absorb operating losses while meeting the pertinent covenant requirements. Leverage (total debt-to-equity) was elevated at 7.2x at June 30, 2024, compared to 6.0x at YE23.

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, loanDepot experienced a cybersecurity incident, 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. Based on the Company's investigation findings, during the Cybersecurity Incident, an unauthorized third party gained access to certain sensitive personal information of approximately 16.9 million individuals stored in the Company's systems. The Company has offered credit monitoring and identity protection services at no charge to those individuals whose sensitive personal information was identified as potentially being subject to unauthorized access. Through 1H24, the incident has resulted in $41.6 million in losses for the Company, net of insurance reimbursement. Of the $41.6 million, $25 million has been accrued for the 25 class action litigation cases filed against the Company by affected individuals.

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 June 30, 2024, 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 Factors in Credit Ratings at (August 13, 2024) https://dbrs.morningstar.com/research/437781.

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

The principal methodology is the Global Methodology for Rating Non-Bank Financial Institutions (04 September 2024) https://dbrs.morningstar.com/research/438927. In addition Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings (13 August 2024) https://dbrs.morningstar.com/research/437781 in its consideration of ESG factors.

The following methodology has also been applied:

Morningstar DBRS Global Corporate Criteria (15 April 2024) https://dbrs.morningstar.com/research/431186

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.

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