The big servicers will get bigger, the small will survive and many mid-sized providers-thanks to sharpened strategies and cost performance- will remain in the game.
Today, the mortgage servicing business is a healthy environment for commercial and mortgage banks. For starters, mortgage servicing is highly attractive to capital-rich banks clamoring for assets, according to Brenda B. White, managing director of UBS Securities, based in New York City.
Even so, as the industry consolidates, the future of mortgage servicing is destined for further change. Players in the mortgage banking industry continue to engage in debate as to whether it's still profitable to service mortgage loans and the ultimate ownership structure of mortgage servicing.
In its annual mortgage servicing performance study, KPMG Peat Marwick LLP found that higher profitability was a result of portfolio characteristics, not size. KPMG's MorServ study focuses on single-family mortgage servicing data that includes both quantitative and qualitative information. The study analyzes factors such as portfolio characteristics, use of technology, management structure, and compensation structure against the profitability of the servicers to identify best practices within the industry.
According to preliminary statistics in the Mortgage Bankers Association of America's 1996 Cost Study, the direct cost to service mortgage portfolios up to $250 million is $209 per loan; $142 per loan for portfolios ranging from $250 million to $1 billion; $101 per loan for portfolios of $1 to $4 billion; $85 per loan for portfolios ranging from $4 to $20 billion; and $82 per loan for portfolios greater than $20 billion. The industry average direct cost to service is $86 per loan.
what the future holds
Some sources argue that economies of scale achieved by mega- servicers will so dominate the market that small- and mid-sized lenders will be squeezed out. Others contend that servicers of all sizes will survive well into the future. The question of mortgage servicing's future was put to several industry experts for their "crystal ball" prognostications-and their answers are telling.
Industry experts interviewed reached near consensus on their predictions for the over-$20 billion portfolio servicer group: Giant lenders will continue to grow at a rate faster than small- and mid-sized lenders. "Large servicers get huge economies of scale, so servicing will gravitate toward the large (players)," says James M. Cosman, director of mortgage banking, BankBoston.
Cosman isn't alone in his thinking. Michael A. Hyman, senior vice president of Wendover Funding, Inc., an $11 billion subservicer located in Greensboro, NC, agrees, adding that the cost efficiencies of large servicers coupled with the fact that technology is driving the growth of the industry support this argument. "The mega-servicers will maximize their cost efficiencies," he says.
Walter C. Klein, Jr., CEO of First Nationwide Mortgage Corp., a top ten, $65 billion servicer based in Frederick, MD (a subsidiary of California Federal Bank), points to large lender retail origination strategies, arguing that most large lenders, with a few notable exceptions, have ceded the retail origination channel to local banks, mortgage companies and realtor joint ventures.
That aside, some experts are forecasting big changes within this group. Douglas Duncan, senior economist, Mortgage Bankers Association of America, predicts dynamic changes in ownership structure among the top 25 companies. The most striking change, says Ross M. Strickland, executive vice president of $6 billion Webster Bank, CT, is what he predicts will be a driving consolidation to only five or six mega-servicers.
Experts are split on the small servicer group, defined as having portfolios under $1 billion. Community banker Randolph P. Snow, senior vice president of $417 million-asset Bank of Newport, RI, is bullish about the opportunities for small servicers in the future. Believing that some small banks under $300 million may exit the business to avoid technology investments and prepayment risks, Bank of Newport is looking at creating a subservicing department to leverage its excess capacity. Snow also sees a tremendous opportunity to cross-sell current and future bank products to the banks' mortgage customers. Strickland takes the opposite view, arguing that it will be difficult for the small servicer to continue to compete because of its high cost to service. He predicts that "it will be hard for the small servicers to get their fully allocated costs under $100 per loan, which will still be more than double the large servicer cost." Most experts, however, believe that the small servicer-focused on its niche and extremely knowledgeable of its lending area-is here to stay.
The mid-sized category-$1 to 20 billion in portfolio size-produced the most disagreement among sources. White says that there are some efficient servicers with portfolios ranging from 10,000 to 30,000 loans. Duncan believes that "size is not a panacea," pointing to the preliminary results of the 1996 MBA Cost Study, an annual examination of lender costs, to buttress this viewpoint (see chart). Preliminary 1996 profit margins for the $1 to 4 billion and $4 to 20 billion servicer categories are 32 percent and 21 percent respectively, solidifying the hold the mid-sized servicers have had on profitability for the last three to four years, he says.
In contrast, preliminary profit margins for the less than $250 million servicers (10.7 percent) and greater than $20 billion servicers (4.4 percent) lag far behind. He does point out that the over-$20 billion group includes a number of bank subsidiaries that may follow strategies of profit minimization for tax planning purposes. Duncan believes the keys to future mid-sized servicer success include superior management and strategic portfolio restructuring-selling off the inefficient servicing and retaining the efficient servicing. Hyman, on the other hand, is more pessimistic; he believes that the mid-sized servicer will "get squeezed out." He offers a solution to these lenders: Outsource parts or all of the administrative servicing tasks to drive costs down, maintain ownership of the servicing and retain the critical link to the customer. "The mid-sized servicer will either manage its costs to service down or sell its servicing," says Nationwide Mortgage Corp.'s Klein.
One such case is BankBoston, a mid-sized lender that recently exited the servicing business. Cosman says that BankBoston's relationship with HomeSide Lending, whereby BankBoston originates mortgages and sells the loans "servicing released" to HomeSide, fulfills the bank's desire to remove the "specter of prepayments and write-offs" from its balance sheet. BankBoston retains the ability to cross-sell the customer any bank product and receive current information about each mortgage customer. He estimates that BankBoston will originate $700 million in 1997.
Webster Bank's Strickland, who is responsible for a $3.9 billion portfolio, believes that the mid-sized servicer must do a few things to succeed. First, servicers must "create some sort of recognized value-added local servicing for customers." Combined statements, listing all of the customers bank relationships, is one example. Secondly, mid-sized servicers must add revenues to the relationship by aggressively cross-selling third- party and bank products including insurance, long-distance telephone service, home equity loans, and deposit and investment products using targeted-not mass marketing-approaches. Finally, the mid-sized servicers must continue to cut servicing costs. Webster Bank's current direct cost to service of $78 per loan is the result of a full cost study conducted in 1996 that led the bank to outsource its real estate tax function.
Looking ahead, servicing giants, emphasizing low costs, technology and economies of scale, will increase their market share and consolidate. Small servicers, willing to accept risks and make the necessary investments, will continue to hold on. And mid-sized servicers, although thinner in ranks, will employ superior managers, cost management and cross- selling, to maintain their stake in the servicing market.
James Jones is president of Massachussets-based First Wellesley Consulting Group, which assists mortgage bankers with strategic planning, technology and operational improvement programs.