The relationship between business strategies and profit expectations is prominent in the minds of mortgage banking exec-utives-and their shareholders.

Profit targets are changing because of competitive pressures, accounting changes, business procedures, types of loan products, and a company's ability to pinpoint its key profit drivers.

Business strategies, too, must undergo change. Too often a strategy either is based on what the company can do without changing or is limited by cultural barriers.

Maximum profit levels often are impacted by a company's strategy and its ability to execute ever-changing and sometimes controversial business practices.

The retail mortgage origination channel has seen numerous profitability cycles over the last 10 years.

In the 1980s, retail mortgage bankers generated sufficient volume at branches and through loan officers because there was less competition for market share.

The traditional mortgage banker, with a commissioned sales force, could reach more customers than banks and thrifts.

Profits were high because loan officers were more productive-the average mortgage officer originated more loans than today's officer, fee income was greater, loan pricing did not include today's subsidies (built-in losses on sale), and the overall costs to originate were spread across more loans per entity.

The value of servicing was not a factor in these profits.

Although the net profit from the sale of the loan then may not have been substantial, after all costs of origination were considered, there was a profit-or at least a break-even. Companies today are fortunate to reach this profit level even after considering the cash or implicit value of servicing.

In the last 10 years mortgage banking profitability has declined, and unless the retail mortgage business reevaluates the way it conducts business, the negative trend may continue.

Though nonretail channels of mortgage production are not new, variations of the nonretail theme have evolved as companies seek channels that will capture market share and be more profitable.

Nonretail channels of loan origination include correspondent lending, the broker business, and direct marketing efforts.

The correspondent business was significantly more profitable 10 years ago than today for a few primary reasons: Loan pricing wasn't as competitive, there were fewer wholesalers buying correspondent loans, and correspondents were unable to sell profitability in the secondary market.

Today, wholesalers compete for quality closed-loan packages and, as a result, pay premiums when servicing rights are sold along with the loans.

Account executives can keep the correspondent happy through commission- based compensation, and the overall sensitivity to third-party origination has caused the level of quality control/double underwriting to increase as more correspondents do business with wholesalers.

All of these factors have contributed to significant drops in profitability for mortgage bankers.

A decade ago, the broker business-buying unclosed loans at some stage in the processing effort-caused barely a ripple in most markets. Today it is a significant player in the originations business.

The broker business began with small mortgage companies that lacked licenses, sufficient net worth, or warehouse financing. It now includes many branch spinoffs of other mortgage companies.

However, as in other industry areas, profitability of the broker channel has shrunk in the face of competitive pressures.

For many companies, profitability of the overall wholesale channel has decreased more than 30% in recent years.

The direct-to-consumer channel is also not new, but it is receiving new attention as high-tech tools and outreach efforts targeted at an educated consumer base have worked to its advantage.

The direct channel took several forms in the past: refinancing units, direct telemarketing outbound, and inbound centralized call handling, from advertising or from affinity group marketing.

Recent direct channel formats include on-line computer banking and Internet access.

Although the formats have different cost structures because of varying technology investments or advertising costs, they share an underlying cost savings:

None requires a commissioned loan officer, costing 50-plus basis points per loan. Thus, companies can process, underwrite, and effectively close centrally.

Savings in a centralized process can amount to more than 25% of total costs.

Downsides to the direct channel are that companies have to spend a lot on advertising and grow large affinity-group relations.

They may also have to invest in call centers or on-line banking technology. The front-end technology investment and the ongoing advertising dollars must be well spent in order to lower the loan-origination cost and raise profits.

For this reason, consumer banks or consumer finance companies may have a competitive advantage.

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