The nation's top mortgage companies have shrugged off the effects of higher interest rates this year, turning to income from loan servicing to make up for lost lending volume.
In the first quarter, Norwest Mortgage's net income increased 11% to $33.8 million; Countrywide Credit Industries', 19% to $68.3 million; and Chase Manhattan Mortgage's, 109% to $46 million.
The stunning results for the top three were all the more remarkable because they came in the face of an 8% decline in origination volume, as estimated by the Mortgage Bankers Association. Rising rates discouraged people from refinancing their home loans. One reason for continued income growth was substantial business in administering, or servicing, mortgages. The companies service more than $160 billion of loans apiece.
"Clearly the trend in the industry is to build servicing. That's what creates value," said David Lereah, the Mortgage Bankers Association's chief economist.
Mortgage servicers perform functions such as the collection of loan payments, answering customer calls, and acting on defaults and foreclosures. Larger companies, especially banks, see value in servicing because they can try selling other products to these customers.
Mr. Lereah said that since the servicing side of the business is more profitable than production, larger servicers can "better subsidize the origination function than those that don't have a large servicing portfolio."
But the benefits of servicing-a scale business-are not available to all players in the market. Some smaller players have been turning to higher risk loans to keep up profits.
The importance of servicing was evident in the differing results posted by some other large originators:
First Tennessee National's FT Mortgage division, PNC Bancorp's mortgage unit, North American Mortgage, and Resource Bancshares mortgage group were among the nation's top 25 originators last year; each produced over $1 billion of loans in the first quarter of 1997.
But FT and PNC both benefited from big servicing businesses, while the other two did not.
The two bank-owned companies each had income increases of more than 10% despite loan volume decreases of more than 20%. FT Mortgage's servicing portfolio increased 25% to $23.4 billion, while PNC, servicing over $40 billion, is the nation's 15th-largest servicer.
Income decreased for North American and was unchanged for Resource, two companies that are known more as origination shops. North American, which prefers to sell many of the loans it originates rather than hold them, saw its portfolio shrink.
Resource's portfolio did increase by 28%, but at $7.4 billion, the company is still a relatively small servicer. Last year, Resource originated more than it serviced, making it a rarity among large originators.
Still, building up servicing isn't the only way to increase profitability. Mr. Lereah said some companies are choosing to enter the higher margin subprime lending area as an alternative to building a large servicing portfolio.
Gareth Plank, an analyst with UBS Securities, said Resource and North American are likely to increase their profits by expanding in the so-called B and C loan business of lending to people with blemished credit histories.
Resource is in the process of merging with a subprime lender, and North American began originating B and C loans last year with the help of Contifinancial, a leading subprime lender.
Mr. Plank said that for the large commercial banks building servicing makes sense as opposed to entering the subprime sector because many banks are "publicity averse when it comes to the high rates" associated with making B and C loans.
Some larger lenders have been finding ways on the originations side to boost profits.
Laura L. McDonald, senior manager of the mortgage and structured finance group of KPMG Peat Marwick, said the thinking of many larger mortgage companies has shifted.
Rather than concentrating on the volume of loans they produce, many lenders have decided to focus on originating the most profitable loans, even if that means a decline in volume.
"You don't have to have a certain level of volume to show profits; you need to have profitable volume," Ms. McDonald said.
This strategy is reflected in the incentive packages that lenders are giving their employees. Ms. McDonald said that at all levels, from loan officers and branch managers to the highest-ranking officials, more lenders are basing compensation packages on hitting certain profit targets rather than volume targets.
