The subprime mortgage industry has grown rapidly during the past 12 to 18 months.
But with the growth has come increased competition, which has led many subprime originators and servicers to be more concerned about their costs and productivity than in past years.
KPMG Peat Marwick's second annual benchmarking survey for subprime mortgage originators and servicers collected data from 14 lenders-which collectively originate more than $1.2 billion of subprime mortgage loans- and eight servicers, with portfolios totaling 300,000 loans and principal balances exceeding $2 trillion.
On the origination side, data were gathered according to four distinct production channels-traditional retail (branch network), nontraditional retail (telemarketing), broker-wholesale (purchase of processed loan applications), and correspondent (loans closed in the correspondent's name).
As expected, loans originated through the retail channel were the most costly, in part due to the low volumes of subprime loans originated in this channel.
However, direct costs of originations through a nontraditional retail channel were $1,700 per loan while broker-wholesale loans' direct costs were $1,850. This may be due to the centralized operations of many nontraditional lenders by contrast with the decentralized broker-wholesale structure. In addition, a greater percentage of nontraditional retail loans were refinancings, further reducing production costs.
Direct costs in the correspondent channel averaged less than half those in broker-wholesale and showed significant variation among the participants based on what functions were performed by the lender rather than the correspondent.
To examine economies of scale, we divided lenders into size groups based on the dollars originated in a particular channel. The groupings differed among the channels based on the number of participants in that channel and their volumes.
The largest lenders exhibited substantial economies of scale in the correspondent channel; lenders originating more than $400 million had direct costs less than half those of their smaller counterparts. Economies of scale were not as evident in the broker-wholesale channel, where larger lenders (those with volumes greater than $500 million) had higher direct costs than midsize or small lenders.
The correspondent channel wasthe most productive, followed by nontraditional retail, broker-wholesale, and traditional retail.
Productivity results for conforming lenders, based on data gathered in a similar KPMG study focused on A-credit, conventional lenders, were two to three times higher than for the subprime lenders in all but one channel of originations. Nontraditional subprime retail lenders were almost twice as productive as their conforming counterparts.
Nontraditional subprime retail lending also cost less than nontraditional conforming retail lending: $1,700 in direct costs per loan compared with $2,500. This may be in part due to volume; subprime lenders who originated loans in the nontraditional channel averaged 12% of their volume there, but conforming lenders averaged less than 5% (or less than 2% if one large lender were excluded).
Although costs are obviously higher in nonconforming lending, across almost all channels, the revenue side gives nonconforming lenders a positive advantage.
Total revenues (including points and fees, secondary marketing income, and net interest margin, net of fees paid to brokers or correspondents) ranged from 880 basis points for nontraditional retail to 350 basis points for correspondent lending. Given the direct and indirect costs by channel, the resulting net production income ranged from 150 to 330 basis points, with non-traditional retail being the most profitable.
