Today the mortgage business is a mature but volatile industry marked by concentration, shrinking margins, interest rate volatility, a changing risk profile, and major technological advances. What these all add up to is unpredictability.
But unpredictable doesn't have to mean unprofitable. Despite the challenges, residential mortgage origination can be a powerful retailing tool.
Done well, it can create and reinforce a profitable relationship with current and prospective customers. But lenders who do it poorly risk losing not only money, but customer relationships and prospects-forever.
How can you tell whether your mortgage origination business approach helps or hinders the bank's creation of shareholder value? Ask yourself the following questions. If the answer is no to any one of them, then your business is likely putting near-term profits and long-term shareholder value at risk.
At your institution, does mortgage origination:
Generate good ROE as a stand-alone business?
Feed qualified, satisfied customers to other retailing businesses?
Set up sales of other products within the homeownership transfer event?
Qualitatively support your relationship with existing customers?
Minimize the impact of cyclical volume through high-cost variability?
Traditional Model Breaks Down
What was once a single cohesive business has split into three: origination, intermediation/securitization, and servicing.
The servicing and securitization businesses are increasingly becoming concentrated in the hands of nationwide participants. Origination remains more fragmented with local, small-scale players because the barriers to entry are low and economies of scale less important.
Most mortgage lenders lose money in origination, hoping to make it up in warehousing, secondary marketing, and servicing. Commercial banks achieve little appreciable revenue from cross-selling other products to mortgage borrowers.
Over the past 10 years, the mortgage market has been extremely volatile due to interest rate movements. Tax code changes also spurred an increasing volume of home equity lending.
Future baseline demand for home loans is uncertain; the slow decline due to changes in U.S. demographics is offset only somewhat by increased immigration and Generation X household formation. Net new housing starts are marginally adding to current volume but are not likely to make a major difference in the near future.
Leaders increasingly pursue nonconventional lending business opportunities to inflate margins and capture fees, assuming that a secondary market for such loans will remain open and that servicing costs can be managed. Though servicing-related premiums have historically held at generally high levels, portfolio owners and stock market investors have much in common these days, as all are watching for the long-predicted "big correction."
Shifting Market Position
Given all these factors, many financial institutions are rethinking their participation in the mortgage business. A number of banks, including some industry leaders, are actively considering getting out of the business, given its thin margins, volatility, and labor intensiveness. To put it another way, who needs a business that often produces losses, unhappy customers, and has a negative impact on the efficiency ratio?
Another group (also including some industry giants) continues to commit to creating large, vertically integrated mortgage banking businesses capable of competing on cost and quick service.
Still others are looking to outsource origination and secondary marketing to be able to serve current customer demands. And sub-servicing continues to grow as a business practice.
Reinventing the Process
Though the real estate broker referral today remains the most important source of first mortgage loans, mortgage originators must find a cost- effective way of capturing such leads. The traditional approach-commission- driven, realtor-targeted calling officers whose expense has largely created the current cost crisis-is not a viable option. A variety of strategies are now being employed to end the cost structure crisis and create competitive advantage.
Consumer-focused promotion: Countrywide. At Countrywide, loan demand is created through extensive advertising and aggressive pricing. Customers are then served by salaried employees, significantly lowering the cost of loan origination. This approach establishes name recognition and brand awareness, and works particularly well in a falling rate market.
Customer referral capture via a multiple-listing service: Norwest, Long Island Savings Bank. Norwest acquired Boris Systems to have a point of sale presence in realty brokers' offices as a multiple-listing service vendor. This technology allows Norwest to capture mortgage opportunities in the broker's office. Clearly, Norwest management hopes that Boris will create happy, productive realty agents who make electronic referrals, and that Norwest is first in line to receive them.
Long Island Savings Bank reached an agreement with the Long Island Board of Realtors to put all Long Island listings on the Internet for no charge. The quid pro quo: Long Island Savings is the only mortgage vendor you'll find if you use the Internet to look for a home on Long Island. And many Long Island realtors are using this capability to leverage their own selling efforts.
Origination outsourcing via "800" numbers: PHH Corp. and others. For the bank, thrift, insurance company, or affinity group that wants to control the experience customers will have upon referral, PHH offers a seamless, low-cost origination service that actually makes money for the referencing institution. The catch? There isn't one: A shift away from loan officers to a centralized "800" service delivers market-price loan products faster than most locally based origination businesses.
Partners or Adversaries?
In addition to being expensive and hard on a bank's efficiency ratio, most traditional mortgage origination approaches fail the primary-purpose test: Does this activity make current customers happy and/or capture new customers to whom many things can be sold?
For most banks, consumer financial services retailing remains a mainstay business-one that delivers profits and appears competitively defensible. If mortgage origination cannot support this business, it is, in fact, destroying shareholder value.
Viable alternatives exist: Management attention and action to this potential problem would seem mandatory.
