Volume without profits is a sure way to have a short future.

Mortgage finance operations are dealing with decreased origination volumes in 1994. However, the industry has always struggled to produce profitable results, even in high-volume years. Mortgage bankers are looking for creative ways to increase bottom-line profitability, particularly at this time of year, when budgeting and planning for 1995 are pressing issues.

Increases in profitability can take two forms: revenue enhancements and cost control. Although the trend is to emphasize cost controls, opportunities to enhance profits through the revenue side should not be overlooked.

The sharp drop in production volume has left most mortgage finance companies with excess capacity -- too many unprofitable branches with too many loan officers, processors, underwriters, closers, etc. In the 1987-1988 downturn, many companies chose to ignore the overcapacity issue, but in 1994 most companies are working to reduce capacity.

However, the industry is also focused on developing new channels and sources of business, particularly nontraditional retail (for example, corporate relocation, affinity relationships, and telemarketing), wholesale, correspondent, and realtor ventures. The question remains whether the issue of overcapacity has been adequately addressed.

Nontraditional retail business can generate fee income. It can also utilize excess capacity and reduce the overall cost per loan. The fee schedule for retail loan originations should be scrutinized to identify potential opportunities.

A competitor analysis of companies in your primary markets will assist in this determination. The analysis should include the following fees/charges: application, rate-lock, underwriting, document preparation, tax service, appraisal, credit report, and miscellaneous fees. A complete fee analysis should not only review the standard fee schedule, but also the actual fees collected by loan officers. A competitor analysis in key markets should also focus on rates, especially for your most popular products.

The company should also test market new fees to determine just how much negative impact will result.

A mortgage company should continually assess its risk appetite. In 1993, many companies lost revenue opportunities by maintaining a very high hedging coverage percentage when the rate environment was flat or declining. Wholesalers of mortgages have had some success during rising interest rate markets in collecting hedge fees from brokers or correspondents. This fee income defrays the cost of the hedge when nondelivery occurs.

Furthermore, when lenders are able to charge lock-in fees, more typical in a rising rate environment, such fees help predict closure rates, which should reduce hedge costs or secondary losses.

Deduction of monthly payments directly from the borrower's checking account can improve profits, and biweekly payment programs can have a similar impact to your bottom line.

Depending on the specific program, a processing fee may be charged to the customer for setup on a biweekly program.

Companies will struggle in 1994 to ensure full utilization of float balances because warehouse borrowings are decreased. The new HUD rulings regarding escrow balances and aggregate analyses may not be seen as positive in regard to increasing profitability; however, the timing of escrow analyses can be adjusted to minimize the negative impact.

Assuming the final rules do not require the annual analysis to be performed at yearend, escrow balances and the associated float benefit may be maximized by performing all escrow analyses immediately after the largest disbursement, as opposed to on the loan's anniversary date.

Use of credits derived from interest income related to escrow balances should be analyzed to ensure maximum value. Generally credits derived from interest income are used to buy down the cost of a company's warehouse line.

Due to excess lending capacity, some mortgage companies have successfully renegotiated the use of their income credits to receive a lower rate on their warehouse line. Other mortgage companies have developed ways to earn interest on their escrow balances through the use of a third party.

In one particular case, the mortgage company has its escrows at Bank A, and its warehouse line through Company B. Bank A pays Company B interest on the mortgage company's escrow balances, which are then paid by Company B to the mortgage company. In this instance, the arbitrage income derived was about $1 million.

A competitive analysis of fees related to servicing should also be performed to ensure maximum profitability. This would include late charges, assumptions fees, conversion fees, and fax fees for payoff statements. Additionally, actual fees collected should be reviewed to ensure compliance with corporate policy, especially in regard to waiver of late charges. Ancillary income related to optional insurance and fees for other product cross-sell opportunities should also be analyzed for methods to increase fee income.

In cashiering/payment processing, there are also some opportunities to increase revenue and decrease costs. For example, arrangements can be made with an overnight delivery service to receive payments directly at the lockbox.

Receiving the overnight payments directly at the lockbox reduces cost by reducing the number of payments that require manual processing and increases cash balances, and thus interest and credits on those balances. Some mortgage companies are researching the use of multiple lockbox sites.

What revenues can be generated from cross-selling? A mortgage company gathers more income and asset-related information than any other lender. For this reason, there are many opportunities to use such data to approve a mortgage applicant for other products, such as home equity loans, credit cards, auto loans, and student loans.

Few companies have utilized the wealth of data to cross-sell other credit/financial services. While bank-owned mortgage companies may have an inherent advantage, nonbank entities can mirror this advantage by developing alliances with issuers of such credit.

A parallel example is the many working partnerships between airlines, with no credit card access, and credit card issuers.

Adding profitability to a company may mean abandoning certain loan products or closing certain branches. Although revenues may shrink, expenses will usually shrink faster if such loan products or branches are too expensive to maintain.

Mr. Horn and Mr. Oliver are partners at KPMG Peat Marwick in Washington. Ms. Reed is a senior manager

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