Originators Lend Less But Profit More on Mortgages

US Banker | July, 2010

A combination of historically low interest rates and reduced competition are fattening home lenders' profit margins, making up for lost volume.

Though falling rates have failed to stimulate homebuyer demand — the Mortgage Bankers Association's index of purchase loan applications hit a 14-year low this month — they also mean lenders make more money on each loan they originate. This is largely because a loan with an above-market rate will fetch a higher price in the secondary market. Especially when there are fewer sellers.

"There's a ton of [investor] demand, very little supply, and what I'm selling has huge margins," said Matthew Pineda, the president of Castle & Cooke Mortgage LLC in Salt Lake City. "This year we're doing better than we did last year, and there's no stress."

More surprising is that the juicier gains on sales of new loans are more than offsetting the increased costs of origination. Tougher regulation has added expenses like licensing fees, and tighter underwriting standards have forced lenders to spend more on things like marketing — to find qualified borrowers — and back-office staffing, because they must hire more processors and underwriters to review loans.

Pineda said 80 percent of his business is now purchase loans, where margins are especially rich. "We're closing less volume and making more money," even though he contends that aggregators are not paying him enough for his loans.

Michael Isaacs, the president and chief executive of Residential Finance Corp. in Columbus, Ohio, said he expects to earn an average of $1,167 per loan in the current quarter, a 40 percent increase from the first quarter, because of reduced competition, lower interest rates and bigger spreads on the sale of loans to investors. "The overall net effect is an increase in profits per loan and an increase in basis points on volume," Isaacs said.

Some of the largest lenders would have posted strong mortgage banking profits had they not had to set aside significant reserves for bad loans.

The outlook for most lenders is a major turnaround from early this year. Lenders thought interest rates would rise because the Federal Reserve said it would stop buying mortgage-backed securities.

Instead, rates fell, sparking a jump in refinancings in early April that, combined with the first-time homebuyer tax credit, helped inflate volumes (though they did not reach last year's ultra-high levels). Though purchase volume has fizzled since the tax credit expired, refi applications are now at record levels.

Mike Cook, a senior vice president at Capital Markets Cooperative, a Ponte Vedra Beach, Fla., provider of secondary marketing services to banks, said that since April lenders have been building a higher margin into the rates they charge so that they will not be overwhelmed with applications or have to hire more loan officers.

Historically, the spread between mandatory and best efforts pricing has been roughly 25 to 35 basis points, but in recent months this spread widened to 80 basis points, Cook said.

“We have seen initial profit margins increase, pipelines double in volume and mandatory sellers realizing huge profits on their loan sales,” he said.

— American Banker