The direct cost to originate a mortgage in 1995 - $2,000 - was almost unchanged from 1994, according to KPMG Peat Marwick's sixth annual mortgage production performance study.
The average number of loans closed per employee in 1995 was 45, up from 42 in 1994. In 1995, revenue for all channels on an average loan totaled 95 basis points, down 26%.
However, the net loss per origination increased by 34% to $1,730, equivalent to 145 basis points. This loss excludes the value of servicing rights, but this value still might not cover net production losses.
This year, mortgage companies selling loans to investors are required to implement new valuation rules under FAS 122. As a result, many companies could become more sensitive to the impact of production costs on profits.
The study, called Morpro, looks at the profitability, cost, and productivity of residential mortgage lending operations. It captures comparable performance indicators and industry data to measure performance, a key component of process change, strategic planning, budgeting, and goal setting.
The 1995 study was based on participating companies' responses to a comprehensive questionnaire.
Participants accounted for more than $46 billion in loan originations. Loan volume ranged from $500 million to $11 billion. This is the only study that compares companies as individual entities, not as part of generalized strata.
With companies scrambling for production volume, fee and point income - which averaged 140 basis points in 1995 - have been controlled more by market forces than by the mortgage companies. Companies are probably more likely to improve profits by cutting costs than by increasing revenues.
In Morpro, company data are segregated by channel of production, functional area, and line item. Participants were asked to categorize their channels of production as follows:
Traditional retail - loans originated through a loan officer of the company through a branch network.
Nontraditional retail - telemarketing, direct-to-consumer, or corporate and affinity groups.
Broker wholesale - loans originated through a broker, generally underwritten by the participant company, and closed in the participant company's name.
Correspondent - participant company performs no processing and the loan is closed in the correspondent's name.
The survey showed that 49% of respondents originated loans through traditional retail, 4% through nontraditional retail, 25% through broker wholesale, and 22% through correspondents.
Among channels of production, broker/wholesale declined most sharply, with net origination income of 50 basis points in 1995 compared with 106 basis points in 1994. Any fees paid to brokers are excluded.
The correspondent channel also showed a significant decline, dropping from 80 basis points in 1994 to 24 basis points in 1995.
Two key factors could lead to reduced production costs in the industry:
Automation - Fully 28% of companies surveyed had new or enhanced software systems, ranging from automated underwriting to complete production system conversions.
Restructuring - Of the traditional retail participants, 28% closed more branches than they opened; 35% of respondents made significant corporate acquisitions; and 28% had undergone significant reorganization, usually regionalizing or centralizing their back-office operations.
Automation and communications tools can be very useful in today's intensely competitive mortgage industry. Borrowers and realty agencies want loan decisions made quickly, and borrowers want to close their loans within their own time frames, not those of their mortgage companies.
Reducing the time it takes to originate a mortgage also reduces the cost of the loan, important in a market where very small differences in loan costs are very important to consumers.
The traditional retail channel is under scrutiny today because it tends to have the highest direct costs - especially loan origination commissions - and require the most investment by a company.
This channel's average direct cost per loan for 1995 was nearly $3,000 per loan, 11% higher than 1994 ($2,700) and 50% higher than 1993 ($2,000). Origination costs, the largest of all the functional costs, were $1,500 per loan, against $1,245 in 1994 and $970 in 1993.
Back-office costs rose slightly in 1995 to $1,275, compared with $1,250 in 1994 and $900 in 1993. These figures suggest that these companies must reduce their point-of-sale costs as much as their processing costs.
The relatively small increase in 1995 costs was matched by virtually no change in productivity. Total loans closed per employee stood at 25 in 1994, compared with 26 in 1995.
These figures do not challenge our conclusions that productivity is inversely related to cost in the industry. This relationship was made clear by the big jump in costs from 1993 to 1994, accompanied by a serious decline in productivity - from 40 loans closed per employee in 1993 to 25 in 1994.
Productivity is affected by product mix, utilization of technology, and outsourcing or automating, creating a flexible cost structure that can adjust to volatility in interest rates.
The high costs of the traditional retail channel might be associated with the location of certain activities. Centralized companies had lower costs and high productivity in loan processing, underwriting, and closing - particularly processing.
The average processing cost per loan closed for centralized companies was about $460, compared with $660 for decentralized processing sites. Likewise, the average time to process a file in a decentralized operation was at least five days longer than in those operations that were centralized.
Next: A look at other origination channels
Mr. Oliver is a partner and co-director of KPMG Peat Marwick's mortgage and structured finance group, based in Washington. Ms. McDonald is a senior manager there.
