There is only one clear winner in the mortgage industry's coming superhighway: the borrower. Electronic delivery will sharply reduce the cost of originating and servicing a mortgage loan. That means a lower price to the borrower. Electronic delivery will also dramatically reduce the time required to originate a loan. It may even make the process more pleasurable, depending upon one's feelings about dealing personally with lenders, title insurers, etc. Which do you like dealing. with better, an ATM or a teller?
Originators Lose
Loan originators are the big losers. As an example, mortgage brokers, who are essentially pure originators, earn about a 50 basis point fee today. That works out to $500 on a $100,000 loan.
Yes, the computerized system of the future also would charge a fee, but that would likely be closer to $25.
There will be a role for counselors to help borrowers choose the most suitable loan or to help a potential borrower who doesn't currently qualify for a loan to create a financial plan to achieve approval. Their charge will certainly be less than $500.
Appraisers lose one of their two roles. Their physical inspection function is still necessary, but they are not particularly needed to value homes.
Title companies are also in trouble. A computerized title data base takes nearly all of the value-added out of their business. As we said, though, the transition process should be very long.
Other Effects
Loan underwriters, including the mortgage lender and the private mortgage insurance companies (PMIs) also have their value-added reduced dramatically if most underwriting is done electronically. Their only value-addeds remaining are the capital they apply to support that risk and their regional housing economics expertise.
Even the mortgage insurers' capital risk increases for two reasons. First, price competition will be more likely than today because bids can be electronically solicited simultaneously from a number of insurers, with the business going to the lowest bidder.
Second, new competitors can more easily enter the business if all that is needed is capital, a computer program and the eventually regional housing analysis expertise. Even the latter could be computerized.
Fannie Mae and Freddie Mac are also underwriters through their guarantee that creates mortgage-backed securities.
We suspect that even they will experience some pressure from computerized underwriting.
For example, lenders buying high credit loans - say with a 60% or lower loan-to-value ratio - could end up not getting insurance from the agencies, or getting insurance for a very low fee. Also, the two agencies could be forced to bid for business loan by loan, which could increase price competition. Investors should probably end up neutral, but the role of the investor should change Significantly.
To understand our thoughts here let's step back in time. Ultimately, the owners of home mortgages are individual investors. We are the ones who buy CDs that are invested in home loans, or who buy mutual funds that invest in mortgage-backed securities.
Therefore, our investments are through intermediaries. We believe the intermediary role is about to enter a third phase. The phases are:
Phase 1: Prior to about 1980 the intermediaries were thrifts and banks. Their intermediary role is fairly expensive; CD rates are lower than mortgage rates typically by 300 basis points or more.
Phase 2: The advent of Fannie Mae and Freddie Mac allowed for more direct investment, cutting the gap between the mortgage rate and the return to the investor to 100 basis points or less.
The intermediaries that sprung up to support Fannie Mae and Freddie Mac were the mortgage bankers, private mortgage insurers, and mortgage-backed security mutual funds. Phase 3: Technology shrinks the gap between the borrower and the investor even further. The mortgage superhighway should lower the spread between the mortgage yield and the investors' return by perhaps another 10-25 basis points.
In addition, it will allow the MBS mutual funds to take an active role in the lending process because they can access the borrower by an established computer link, not through the chaotic series of steps that characterizes today's lending process.
Major Lenders
Therefore, we expect the lender of tomorrow to be a mutual fund or a brokerage house, the same people selling MBS today.
The other major lenders will be Fannie Mac and Freddie Mac, which will remain very much in business largely because of their low capital costs provided by their implied government guarantee.
Loan servicers should also be under pressure. First, electronic transmission of data will allow investors to easily shop the servicing contract. Therefore, price competition should increase, as we argue it will in other areas of the business.
Second, computer technology, which today is creating economies of scale, will likely reduce those economies of scale down the road. That is because the rapidly growing computing power of PCs should present a challenge to the cost-effectiveness of mainframes.
Therefore, it is possible that even a small financial institution, armed with a PC and a software package, could become an effective competitor to a large servicer.
We recognize that loan servicing is not simply a data management business; humans are required for customer service and delinquency management. These human functions are the most likely area where economies of scale will remain.
However, we wouldn't be surprised to see servicing bureaus spring up that can handle the human servicing relationships of multiple servicers.
We assume that the highway will be largely set up in about five years and fully implemented within 10 years.
If this sounds farfetched, keep in mind that as we speak credit card loans are marketed, underwritten and serviced with limited human intervention.
A lot of the pieces are already in place for the mortgage superhighway. For example:
* Countrywide Credit has a loan application program on Prodigy. Applications by phone are also commonplace.
* Artificial intelligence loan underwriting systems are being used by a variety of players, including MGIC, Countrywide Credit, and Household Finance. They are being developed by other players, most prominently Fannie Mae and Freddie Mac.
* Automated Home appraisal services are being offered by several specialty software firms.
The key roadblock that must be cleared is "EDI", which is the electronic data interchange, or, to the technologically challenged like myself, a common computer with common data definitions.
The mortgage industry is working hard now to implement EDI, with significant progress expected to be made by the end of this year. The next step is linking not only the systems within industries but between industries.
