Vision is the art of seeing the invisible," Jonathan Swift said.
That is a pretty high standard, but by understanding the recent history of the mortgage business and identifying powerful agents of change already at work, it is possible to construct a vision of the industry in the not- too-distant future.
Until the early 1980s, traditional financial institutions dominated the residential mortgage business.
Mortgage banks were small players, focusing on the FHA/VA market. In fact, from 1980 to 1982 the entire mortgage banking industry did less than $30 billion a year, resulting in a market share of about 25%. As late as 1984, mortgage bankers had a 23% market share, with volume of less than $50 billion.
By the mid-1980s, many if not most financial institutions were reeling from bad lending decisions. Restoring their balance sheets and rebuilding capital ratios was the order of the day. By then, real estate was a dirty word.
As the Resolution Trust Corp. shut down the walking dead, the independent mortgage bankers began to fill the void and gain share.
These new lenders were initially cut off from traditional sources of capital. Warehouse lending had dried up as banks pulled in their reins.
Well-capitalized conduits, such as Prudential's Lender Express, were in a particularly strong position to take advantage of the coming volume boom, because of the capital shortage in the mortgage banking industry. In addition, the equity markets were not quite ready for the mortgage banking story.
By providing economies of scale in securities issuance, and by bringing liquidity to illiquid markets, well-capitalized conduits grew rapidly and prospered.
With the dramatic and basically continuous fall in rates from 1988 to 1993, the mortgage banking industry benefited from both the relative absence of its traditional competitors as well as the explosion in volume.
That great success, however, brought a case of tunnel vision that included ignoring some of the factors behind their success.
By 1994, the vast majority of financial institutions had restored their balance sheets to a healthy state. They could once again focus on expanding their asset bases.
They also came to realize that mortgage banking was consumer lending, not real estate lending.
With capital and earnings problems behind them and Wall Street now ahead of them in terms of servicing corporate clients, many institutions refocused on their strategic missions. Once they chose the consumer route, a commitment to the mortgage business seemed obvious, since taking out a mortgage is the largest transaction most consumers undertake.
But mortgage banking is commodity-like, with thin and volatile margins and wide swings in volume.
In addition, the industry depends heavily on expensive technology and telecommunications. Huge volumes will be needed to justify investments and spread fixed costs.
A 100,000-loan servicer may not be able to justify the productivity enhancements that an imaging system could bring, but a million-loan servicer could. Productivity enhancements translate into cost savings and pricing advantages that are tough to overcome in a commodity business.
This brings us to the phase of strategic decision-making that is now unfolding - and again splitting banks into two groups.
The first group says, "I need to be in the mortgage business because my focus is consumer banking. If I must be in the business, I must be big enough to get the economies of scale and to afford the technology required." These institutions are on the acquisition trail. They include BankAmerica, Barnett, Chase, Chemical, NationsBank, and Norwest.
The second group has discovered that mortgage banking is volatile and capital-intensive. These banks are also skeptical of the cross-selling. Not willing to commit the capital necessary to get very large, they will sell their mortgage banking and servicing units while continuing to originate out of their branches. Some banks that have made this decision are AmSouth, Bank of New York, Keycorp, U.S. Bancorp, and Wachovia.
A third trend will soon emerge. Some banks will decide, like Wells Fargo, that they must be in the business to protect their franchise but need to outsource processes to entities that can provide more cost- effective service.
We will shortly see institutions willing to align strategically with providers of origination, marketing, and servicing capabilities in private- label, cobranding, or joint-venture transactions.
Next: The future of the mortgage banking companies.
