Addressing problems that contributed to a fiscal first-quarter loss for its U.S. operations, Royal Bank of Canada is changing the way it compensates its mortgage unit's loan officers and branch managers.
RBC Mortgage, which is based in Chicago, says it suffered from a sales culture in which loan officers had an incentive to do as much volume as possible, with little regard for the lender's profitability.
Though commissioned salespeople are standard in the industry, RBC Mortgage's originators were allowed to broker out loans to other lenders. This had the effect of forcing the company to compete on price for its own customers' loans.
"The loan officers felt like independent contractors, with very little loyalty to the company," Jonathan Threadgill, the unit's president, said at a presentation Tuesday for analysts and institutional investors.
RBC Mortgage says it will now tie the compensation of branch managers to profitability, and that of its loan officers to quality control. It is also remaking its sales force by firing 200 underperforming loan officers and hiring 400 to 500 others.
"Everyone now understands that this is not a volume business, but a margin business," Mr. Threadgill said.
He and other senior Royal Bank executives outlined the changes in the presentation. They also said a post-closing backlog and other inefficiencies exacerbated problems.
Royal Bank entered the U.S. mortgage business in 2000, when it bought Prism Financial Corp., a top 20 originator that acted as both a broker and a lender. Prism, which was renamed RBC Mortgage, was a pioneer in net branching, an arrangement in which the managers of retail origination offices retain some of the profits.
Analysts said the volume-driven setup seemed to be the root of the problem.
"It would appear that the Prism Financial business model was largely flawed from the beginning, but overwhelming mortgage origination activity helped to hide the weaknesses until late summer," analysts at Canadian Imperial Bank of Commerce's CIBC World Markets wrote in a report Wednesday.
Royal Bank's management admitted as much.
"Frankly, if you look at the volumes the industry experienced ... I think the performance ... facilitated us in taking our eye off the ball in terms of ensuring that we had the right operational controls and processes in place," Gordon M. Nixon, its chief executive officer, said during the presentation. "But we've moved a long way toward turning this around, and we're strongly committed to ensuring that this is fixed."
Mr. Threadgill said that in addition to aligning employees' interests with those of the parent, the "new" RBC Mortgage plans to improve technology and processes and continue to expand channels it recently entered in an effort to improve margins.
For the first nine months of last year the unit's profit margin, before corporate expense allocations and income taxes, was about 33 basis points, Royal Bank said in a press release following the presentation. It hopes to boost that figure to 82 basis points.
In August, RBC Mortgage bought Bank One Corp.'s wholesale first mortgage and home equity businesses for an undisclosed sum. The following month it acquired the retail originator Sterling Capital Mortgage Co. from Sterling Bancshares Inc. of Houston for $100 million.
Mr. Threadgill, who was Sterling Capital's chief executive until the purchase, became RBC Mortgage's president in October. He succeeded David J. Matthews, who left abruptly. Some of the unit's operations moved to Houston, where Sterling Capital was headquartered, and executives said it has taken on Sterling Capital's software and methods and put other Sterling Capital managers in senior positions.
The purchase more than made up for the loss of 80-plus offices unloaded when RBC Mortgage dropped the net branch model. It had sold its net branches to two separate buyers shortly before the Sterling deal.
According to National Mortgage News, RBC Mortgage funded $26 billion of loans last year, making it the 22nd-largest mortgage lender. In a record year for the industry, fundings grew by just 8%, the second-slowest growth rate among the top 25. RBC Mortgage says that its 2003 originations - including loans it funded and brokered ... totaled $35 billion, and it will still broker some loans.
Mr. Threadgill said heavy volume and "systemic problems" with technology and loan tracking led to delayed deliveries and bungled paperwork. As a result, RBC Mortgage was forced to buy many loans back from investors and sell others at discounts, and its hedging costs ballooned.
In part to address those problems, it plans to give its loan officers technology that will enable them to process, underwrite, and close loans locally and to compete on service instead of price, he said. New products, including some it will offer through a relationship with Fannie Mae, will also help sales.
In a recruitment video on RBC Mortgage's Web site, Mr. Threadgill says: "We're bringing to our people … the ability to deliver speed" as well as "control."
It plans to continue expanding the wholesale channel it acquired from Bank One and the joint ventures with real estate brokerages and homebuilders it inherited from Sterling Capital. Mr. Threadgill said that channel carries the highest margins of all. By 2006, the video said, RBC Mortgage hopes to become a top five originator in the United States.
Some analysts wondered about why Royal Bank's management was paying so much attention to the unit's performance.
The CIBC World Markets analysts wrote, "Despite RBC Mortgage's relative size, preoccupation with putting it back on the rails will likely keep the bank on the sidelines rather than pursue U.S. expansion."
Management's comments suggest that any turnaround could take at least "a few more challenging quarters," the report said.
