A Case for Revving Up in Mortgages as Others Scale Back
The mortgage business continues to lure new disciples even though new regulation and the potential for rising rates have shaken the faith of other banks.
Mercantile Bank in Grand Rapids, Mich., is the latest convert. The $2.9 billion-asset company, which has traditionally focused on commercial lending, is looking to significantly expand its mortgage operations by hiring lenders and improving internal systems to speed up the application process.
Mercantile wants "to build a residential mortgage machine capable of producing robust mortgage volumes that are sustainable during a variety of economic cycles," said Robert Kaminski Jr., the company's chief operating officer.
It's hard to decide which is more surprising: that the largest U.S. bank has almost abandoned the business of making home loans insured by the Federal Housing Administration, that lots of big banks could be right behind it, or that the FHA might not even need to care.
Other banks have announced plans to add scale, including Bank of Botetourt in Buchanan, Va., and PS Bank in Wyalusing, Pa., which created new mortgage subsidiaries in recent months.
At the same time, companies such as BankUnited in Miami Lakes, Fla., and Ditech Financial have pulled the plug. JPMorgan Chase, meanwhile, has all but stopped making home loans backed by the Federal Housing Administration. Regulation — including rules to tied "Know Before You Owe," commonly known as TRID, and qualified mortgages — has factored into many decisions to scale back or step away.
So why jump into the business now?
For many banks, a commitment to enter residential lending follows a market shift where purchase activity replaces refinancing. Purchase volume topped $880 billion in 2015, and the Mortgage Bankers Association expects it to approach $1 trillion this year.
Though a third less than the pre-crisis peak in 2005, this year's expected activity would nearly double the amount of business generated in 2011.
Some banks' decisions are likely based on dynamics management teams are witnessing in specific markets, too.
Banks typically prefer purchase mortgages since those loans tend to produce higher yields, while refinancing often becomes a competition to see which lender will offer the lowest rate. Higher-yielding mortgages should generate higher fee income when the loans are sold, industry experts said.
Mercantile is eager to tap into higher-yielding loans as a way of boosting fee income, an area where the company has underperformed in recent years, said Damon DelMonte, an analyst at Keefe, Bruyette & Woods.
Noninterest income amounted to 13.7% of Mercantile's total revenue last year. In comparison, most banks of its size derived roughly a quarter of their revenue for fee-related income, DelMonte said.
First Bancshares in Hattiesburg, Miss., attributed last year's decision to buy a mortgage lender in Jackson, Miss., to positive housing trends in Mississippi and neighboring states. The deal was "a great opportunity … to enter a fast-growing market," Ray Cole, the $1.1 billion-asset company's president and chief executive, said at the time.
At Mercantile, marketing efforts will focus on the four biggest markets it serves in Michigan: Grand Rapids, Holland, Kalamazoo and Lansing.
The timing of Mercantile's mortgage play is propitious, said Brian Long, an economist at Grand Valley State University who produces a monthly survey of economic conditions in western Michigan. Unemployment in Mercantile's other big markets is running at 4% or lower, and "the good times should continue for most of the remainder of 2016," he said.
"The consumer market is booming," said Long, who has been surveying western Michigan business leaders since 1968. "Real estate people tell me they're very busy, but they're also quite frustrated because they don't have enough houses to sell."
Mercantile passed on an opportunity to dive into mortgages two years ago. That's when it bought Firstbank, a retail-oriented institution. Though the acquisition increased the company's mortgage book sevenfold, to $218 million in mid-2014, management allowed the portfolio to shrink over the next 18 months.
"Our focus has primarily been commercial lending," Kaminski explained. "That's what we led with. It was our mantra for many, many years."
Mercantile changed its tune when management realized it was leaving money on the table.
"We would talk to many of our business customers, only to find out they had refinanced their home with a competitor," Kaminski said. When asked why, many customers said they were unaware that Mercantile made mortgages, he said.
"It's an opportunity that we didn't take advantage of," Kaminski said. "Shame on us."