In the last few years, commercial banks have shown an impressive appetite to acquire mortgage banking operations. Some transactions, such as Chemical's recently announced agreement to purchase Margaretten Financial Corp. and PNC Bank Corp.'s 1993 acquisition of Sears Mortgage placed those acquirers among the largest mortgage bankers.

Other significant transactions, including Keycorp's acquisition of Coldome and Chase's acquisition of Troy & Nichols, have demonstrated a solid commitment by commercial banks to the business of mortgage banking, a commitment that appears to be lasting.

Indeed, industry pundits almost unanimously predict further consolidation of the mortgage banking industry, citing commercial banks as the organizations with some of the most voracious appetites.

Recognizing the banking industry's penchant for smooth, predictable earnings, some may question the sense of plunging into the mortgage banking business. The ride has been anything but smooth recently.

Mortgage originators are doing quite well, while some owners of purchased servicing rights have huge charges against earnings because prepayments vaporized their servicing assets. But a closer look at the situation reveals some compelling reasons for commercial banks to enter or expand their involvement in mortgage banking.

For many years bankers have complained about the erosion of their traditional product base, commercial loans. U.S. banks have steadily lost this business to the commercial papermarket, investment banks, foreign banks, and a host of other competitors.

Spreads Adversely Affected

And even though banks have generally benefited from the dramatic decline in interest rates in the past few years, this intense competition is beginning to have an adverse effect on interest rate spreads. To address these adverse trends, bankers have sought to expand their offerings of products and services that generate noninterest revenues.

Mortgage banking- once dominated by thrifts and independent mortgage companies has become increasingly attractive. In addition to the interest spread that is earned between the time a loan is funded and sold to investors, mortgage banking operations can produce origination and marketing revenues, as well as loan-servicing income.

An operation that has both origination and servicing capacity can, to a large degree, protect itself from interest rate changes. That is, as interest rates decline, origination volumes (and revenues) tend to increase. However, in an increasing rate environment, mortgage prepayments generally slow, enhancing the value of the servicing portfolio and producing greater servicing revenues.

Thus, a fully integrated mortgage banking operation, with both efficient origination and efficient servicing capabilities, can provide the steadier earnings that banks strive for.

Commercial banks also have some inherent advantages over many of their competitors in the mortgage industry. One of the principal advantages is the substantial capital that banks have available to invest in technology. As the mortgage banking industry becomes increasingly competitive, it will be critical to effectively deploy technology to gain cost and service advantages.

It is commonly observed that the mortgage origination process is too slow and too manually intensive. Industry observers predict a revolution in this area that will rely on electronic information capture and flow to reduce the time required to take a mortgage application to funding.

Already, laptop computers are becoming common tools of the trade for producers and the sales staffs of mortgage companies. These laptops are replacing paper and calculators as the medium for providing interest rate quotes, performing prequalification calculations, and completing applications.

But there are a myriad of other technological applications that are currently in their application infancy. These include direct information linkages to credit bureaus, banks (for balance confirmations), employers (for employment verifications), real estate brokers, and appraisers.

Some of the largest and most technologically innovative mortgage companies are experimenting with other creative uses of technology. For example, some companies report that they are moving rapidly to the use of artificial intelligence to perform underwriting functions. This has several advantages, including speed of processing and the application of uniform underwriting standards.

Underwriting through the use of artificial intelligence could substantially mitigate a company's exposure to charges of lending bias, an issue that all lenders must be aware of in today's environment.

Technology will also play an increasing role in servicing. As with other businesses that are characterized by high transaction volume, such as credit card processing, considerable cost advantages are enjoyed by those who have made the investments in such things as high-speed processing equipment, imaging technology, and sophisticated telecommunications applications related to delinquency follow-up and customer service.

Branch Advantage

Commercial banks also can enjoy a significant advantage over other competitors, because many have extensive branch networks that can facilitate retail mortgage production. The mortgage banking industry has always been plagued by the cyclical nature of the business; as origination volume heats up, origination capacity, including retail networks, is expanded.

When the inevitable contraction occurs, layoffs and branch closings follow. Banks, on the other hand, are not purveyors of a single product like most independent mortgage companies, so they are not as exposed to a decline in origination volume.

Banks also have an edge because they can cross-sell other banking products and services such as credit cards and automobile loans, certificates of deposit, trust services, and mutual fund or annuity products - to their mortgage customers.

Banks to date have not aggressively exploited this advantage, but increasingly creative crossselling approaches are being implemented. One approach has been to use monthly statements rather than coupon books to bill mortgage customers. Monthly statements provide an excellent vehicle for communicating with mortgage customers about products and services.

Next: The risks and challenges that banks face in the mortgage business.

Mr. Swegle is national director of Ernst & Young's mortgage banking practice in Washington. Mr. Votta and Mr. Leeds are partners based in Detroit and Baltimore, respectively.

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