First in a series
There have been plenty of headlines about mortgage banking over the last few years, and not all of them have been good. The climate has changed to a higher cost environment, with operational pressures to deliver quality loans in a compliant manner. Low rates have driven high demand for mortgages, and high revenue on the loans that close. These factors have combined to create a climate of high costs but even higher revenue, which has created some banner years for mortgage bankers who have ridden the refinance wave to record earnings.
But as I travel this fall to visit clients, I am seeing many originators that are worried the climate is changing quickly. Margins are shrinking and volume is tightening. Smaller regional and community banks are asking how they can survive in this tougher climate. These banks have strong consumer franchises, but do not always have strong mortgage origination operations. That is a shame, because banks and strong bank-owned mortgage companies should survive in this climate.
In this new world of mortgage lending, the successful companies need to have a balance of sales, marketing, financial, technical and operational capabilities that generate consistent and profitable mortgage volume. Over the next several weeks, I will describe critical success factors for bank-owned mortgage lenders. But first, let's address why the mortgages matter for regional and community bankers.
The first reason has to do with the bank's top line. Mortgages can be profitable. Really profitable.
Most originators get to this revenue by selling off their loan volume to third-party investors, like Fannie Mae and Freddie Mac. These sales generate current-period gain on sale, or fee income, which often helps offset reductions in fees that are being experienced in other parts of the bank due to the Durbin amendment and other regulatory pressures.
So, while mortgage banking has its regulatory challenges and interest rate volatility, a well-structured mortgage bank will generate strong top-line revenue that can help offset declines elsewhere.
My firm's most recent data suggests that banks should be able to consistently deliver a new mortgage to at least 1% to 2% of their customer households each year. So, for banks that have 100,000 household relationships, this means at least 1,000 to 2,000 new loan originations per year.
Very often, the cost of originating a loan for a current customer is less than for a new one as marketing costs and commissions are lower. According to the Mortgage Bankers Association/STRATMOR Peer Group Benchmarking Program, the typical well-run midsize bank-owned mortgage entity in 2012 could expect to generate over $3,000 per loan in pretax income. That adds up to $3 million to $6 million in net production income just from cross-selling mortgages to the bank's existing households. Based on current mortgage banking capital requirements, the well-balanced mortgage company is generating a return on required equity of over 250%.
Mortgages should also matter for bankers because they obviously matter to consumers. A mortgage is a foundational product for the consumer relationship, representing the most important financial decision that the typical consumer makes in their lifetime. Big mortgage companies of the past (especially the megaservicers) have not always done a great job with those consumer relationships, creating tarnished brands and often leading consumers to look for more trusted advisors for their next loan.†
I have recently been meeting with bankers who report customers walking into branches (or calling their "800" numbers) over the past couple of years, looking for mortgages. The banks did their best with these leads, but relying solely on walk in traffic means the bank is totally unaware of the opportunities with bank customers who don't seek them out.† For every customer who walked into a branch, our data shows there were 10 to 20 bank customers who got their loans elsewhere. That's a lot of bank customers who are heading elsewhere with the important mortgage relationship, which ultimately may put the total bank relationship at risk as the new mortgage company starts their cross-sell effort. †††
Each bank's demographics are different and some banks may be more focused on using the mortgage product to acquire customers. My next column will discuss the pros and cons of mortgages as an acquisition product compared to a cross-sell product, and, over the next few weeks, I will lay out a fuller case for why a well-run bank-owned mortgage company should be able to survive (and thrive) in this climate.