Wave after wave of mortgage refinance activity has produced incredible origination volumes and an unprecedented opportunity to build quality servicing, not to mention profits.
However, wise lenders are planning for the inevitable end to the current activity. The mortgage refinance boom will slow significantly in early to mid-1994 and then disappear altogether.
In fact, the remaining refinance volume may be overestimated.
A case can be made that the real reason some loans haven't been refinanced is that the borrowers are having problems they feel could keep from requalifying. In other words, loans that still have high rates should be reviewed for quality problems.
Of course, some portion of the refinance demand falloff may be replaced by an increase in new home purchases. But even a substantial increase would be modest compared with refinance boom volumes.
Further, we fear many mortgage market observers are ignoring the potential long-term lock-in effects of the refinance boom.
Indeed, if the economy begins to build momentum and interest rates increase, many homeowners may decide they do not want to give up the low-rate loans they now have as a result of the refinance boom. In other words, the boom could easily lead to less new-purchase activity in the future.
So originators uneasy about the current boom have good reason to be concerned. The refinance boom cannot last, nor can the volume be replaced by the new-purchase market.
Of course, everyone associated with mortgage origination realizes that it is somewhat cyclical. Capacity increases as activity increases and shrinks as volumes decline.
Boom-bust cycles are nothing new, but the recent rate declines are unprecedented in modern U.S. history. As a result, the refinance waves and the mortgage origination boom they have stimulated are unprecedented.
Thus, the excess mortgage origination capacity that will exist when the current boom ends will be enormous.
Furthermore, the origination process has changed. Mortgage bankers have greatly increased their share of the conventional market. In addition, many financial institutions now do all their mortgage originations in mortgage-banking subsidiaries.
During past cycles, many institutions, particularly thrifts, maintained excess origination capacity during downturns. The idea was to keep the skilled people who had been developed, and to maintain the relationships they had established with others in the marketplace.
Few firms, if any, will adopt such an attitude during the next downturn in originations.
The point is that mortgage originators should recognize that the current boom is not the same as those in the past. The current boom is unprecedented, and the bust will be much more severe than any in the past.
Management should make contingency plans for a tremendous bloodletting in mortgage origination capacity. Such planning might include:
* Structuring agreements with outside originators so that they can be easily adjusted to a sharp downturn in origination volumes.
* Discounting the potential value of any purchase of added origination capacity by the fact that much of it may shortly turn into excess capacity.
* Ensuring that any mortgage origination subsidiaries are designed with minimal fixed costs, so they can be significantly reduced in size or eliminated as market conditions dictate.
* Building in-house origination capacity based on volumes far below current levels.
* Cross-training those who are part of any in-house origination effort, so they can be shifted to other areas when origination declines.
* Establishing a plan for reducing your origination capacity as specific market signals indicate that the market is dictating such action.
Many financial executives already have these ideas in the back of their minds. It is time to bring them to the foreground in planning for next year and 1995.