How can managers start to look for ways to restore the profits they were enjoying two short years ago?

Let's skip a discussion of overhead. Presumably, managers have already taken the necessary steps in this area.

Instead, how can we analyze profitability in a way that helps us manage better?

We must first get away from discussing volume for volume's sake. There are still too many managers believing that if they can only get volume up, they'll be profitable again.

Unfortunately, this isn't just missing the forest for the trees. It's missing the forest as well as the trees.

A first step to is to know the profit per product. This may sound obvious, but it is not being done by many mortgage bankers.

Clearly, the profit on a 30-year loan is greater than on a five-year balloon loan. A fixed-rate loan is obviously more valuable than an FHA adjustable.

Each company must work out its own calculations for profitability. It could be an internal rate of return for holding the servicing; it could be based on servicing-released premiums for those that sell everything. But however it is done, it must be calculated.

Having done this, mortgage bankers must rationalize their use of a subsidy. In time, one hopes, the idea of a subsidy will go away. But for the present, companies must subsidize their loans to get production - that is, put some of the servicing value into the price of the loan.

There are still companies that subsidize all loans by the same formula. This will stop, however, once a company understands how much - or how little - profit there is on a given loan product. Obviously, more subsidy is available on a highly profitable 30-year loan of $150,000 than on a five-year balloon of $75,000.

The third step is to look at true profitability by branch. The obvious example would be that a branch doing a lot of heavily subsidized loads is not as profitable as one doing loans with minimal subsidies.

In 1993, there were too many branches with unanalyzed profits. They were branches that were not only doing mostly refinances; they were also refinancing their own refinances. Such branches were generating false profits, and one could certainly have slated them for early extinction the moment the refinance boom ended.

The fourth step is to gear compensation to the origination of profitable loans. Why should a loan officer get the same split for a marginally profitable loan as for a highly profitable one?

We tend to look at the loans officers according to their volume. In reality, a loan officer doing $10 million a year may be much more profitable to the company than one doing $25 million a year. It depends on what kinds of loans the loan officers are producing.

Clearly, there is a need to develop a matrix to measure total volume as a function of the profitability of the loans originated.

Fifth, management must look at which customers are the most profitable. The customers could be realty agents, builders, mortgage brokers, or affinity groups. What is the average subsidy per customer? What about prepayments, delinquencies, or fallout rates per customer?

Let's take one example. Mortgage Broker A generates $30 million a year. However, the average subsidy he obtains is 41 basis points, he tends to deliver ARMs and balloon loans, his loans have a delinquency rate of 3.98%, and he delivers only 58% of the loans he locked.

Numbers like these should not just be done once a year. They should be done on a year-to-date basis as well as a trailing 12-month basis. The industry is dynamic; our analysis should be nothing less.

On the surface, the broker who delivered $30 million looks much more attractive than the broker who delivered $18 million. But a glance below the surface tells another story.

This, in the end, is the story that mortgage bankers need to concentrate on to hasten the return to profitability.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.