The mortgage industry's continuing profit squeeze is forcing lenders to redefine their businesses.

To build volume, lenders have been making loans with smaller down payments. To raise profit margins, they have turned en masse to loans for people with blemished credit records. And to build fee revenues, they have been adding ancillary products such as title services and lender-paid mortgage insurance.

Companies from giant Countrywide Credit Industries to small regional lenders have diversified their businesses to lessen their dependence on conventional lending.

Countrywide, the biggest independent mortgage company, is now offering title insurance, lender-paid mortgage insurance, and other services to prop up profits. Its typical loan-to-value ratios on conventional loans have risen, and the company has made a big push into subprime lending.

Every mortgage lender has looked toward the subprime market to boost profits, and the trend is only going to continue, said Michael McMahon, an analyst with UBS Securities, San Francisco.

"In next few years, mortgage companies will become just mortgage companies, not prime or subprime companies," Mr. Mc-Mahon said. "With the advent of credit scoring, Freddie and Fannie have the ability to legitimize the subprime market."

Offering a broader range of products to correspondents has also helped boost their contributions to Chase's mortgage origination mix, chief financial officer Glenn Mouridy said. The company now offers subprime products to brokers that already sell traditional Chase mortgage loans.

As traditional mortgage companies have filed into the subprime business, profits margins in that arena are being squeezed slightly, said Mr. McMahon, but they are still significantly higher there. In fact, traditional mortgage companies may be even better at wringing profits from subprime lending than the veterans of the industry, he said.

"We think that prime companies, like a Countrywide, that are used to managing a low margin business are forced to manage tightly because there isn't room for error," he said. A lender that has only lent to subprime borrowers, and is used to fat profit margins, is bound to have "a different set of management skills," he said, and be less aware of inefficiencies.

Another important profit booster: increasing direct-to-consumer lending, said Laura McDonald, senior manager at KPMG Peat Marwick's mortgage and structured finance group in Washington. "Direct to the consumer is going to become more important in the future," she said.

Being as close to the consumer as possible is the "key to building franchise value," said Mr. McMahon. When lenders originate their own loans, rather than purchasing them from coorespondents, they can cross sell other products when they make the loan.

"If you have direct access to a client, then you own them," said Mr. McMahon. "Once you establish the direct access, you have the opportunity to sell them mortgages, credit cards, mutual funds, annuities, second mortgages, home improvement loans ... "

That strategy has helped Chase Manhattan Mortgage improve its income more than 90% in the first six months of this year, over a year ago. Margins on the production side have increased significantly, said chief financial officer Glenn Mouridy, in part because of the company's reliance on value-added products.

Chase Manhattan Mortgage offers homeowners and personal insurance to mortgage customers, and cross sells them home equity loans, Mr. Mouridy said.

On the cost side, lenders are scurrying to chop expenses drastically, both in originations and in servicing. Most have used technology as their tool of choice to cut overhead and achieve economics of scale.

A new servicing platform allowed Chase Manhattan Mortgage to beef up its portfolio from $50 billion to over $160 billion, said Mr. Mouridy. Economies of scale drove servicing costs down more than $30 per loan, he said.

Some observers now believe that the most efficient servicers will now be hard-pressed to squeeze much more expense out of their operations.

Indeed, Mr. Mouridy say the production end has even greater opportunities for cost savings. "We haven't seen many breakthroughs, but there will be in the future."

"As the cost of technology goes down, there will be a significant increase in value from a production standpoint," he said.

Technology has also allowed lenders to streamline automated underwriting and data mining operations, optimize collections, and set up telemarketing.

Servicers have also been using technology to help them improve fee revenues by being more diligent about collecting late fees and increasing earnings on the cash balances available in escrow accounts.

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