Mortgage volume has been relatively slack over the last two years. As a result, lenders have tried to supplement volume in various ways - reviving old products, adding some new hybrids, expanding their marketing of reverse mortgages, putting new emphasis on home equity loans and subprime lending, and attempting to change their delivery channels.
Now the mortgage market is entering a different phase. Volume is expected to pick up substantially this year - assuming interest rates do not climb sharply - and 30-year fixed-rate loans seem to be dominating the market.
American Banker recently convened a panel of experts in Washington to discuss the niche markets. They were Donna Callejon, senior vice president for single-family marketing at the Federal National Mortgage Association (Fannie Mae); Alan Hardester, a consultant and marketing manager for Coastal Mortgage, Baltimore; David Lereah, chief economist of the Mortgage Bankers Association, and Regina Reed, a senior manager with KPMG Peat Marwick in Washington.
What is the status of the niche markets, and are they going to be damaged by the relatively low level of interest rates?
LEREAH: Fixed rates are again dominating. My latest projection for origination volume is $810 billion for originations in 1996. It is a substantial increase. My estimate for 1995 was around $650 billion.
In a fixed-rate environment, when we are in a down cycle, companies have the tendency to ease credit and to reach out and diversify into other product lines. The B and C market, or subprime market, has really taken off.
In 1993, when we had record originations of more than $1 trillion, B and C was about 6% or 7% of the market. In 1994, it was over 16% of the market. In 1995, given the securitization that we have seen, it seems like it was another good year thanks to the down cycle.
Now the cycle is going up. Rates are down. Fixed rates are dominating, and I would suspect that companies will move away from niche markets. But some companies that have found profitable niches will stay.
With securitization of B and C products, that market is here to stay.
REED: To the extent that there are mortgage companies who are in B and C and have an investment in it in the last few years, they will definitely stay in. Some of the people who are getting geared up and thinking whether it's a profitable business to warrant the risk - those are the ones who will shy away from investments at this point. Most of the larger banks and mortgage companies have made a very large investment, are seeing good profits, and will not pull out. I think this is true in the home equity as well as subprime market.
HARDESTER: I think you will see that at last count there were 300 new entrants into the so-called subprime market. It's like 300 people trying to rush toward a keyhole. In reality, there is only so much money available for total production. Many people have found that the substantial players in this market for a long time still are hard to dislodge, and they have become nothing more than conveyors to conduits.
What you are going to see is that that area will become less of a focus for mortgage bankers and perhaps more of a focus for banks and thrifts.
It's a bigger world than just B and C. What about home equity loans and reverse mortgages, grandpa and grandma loans? Are they dead? Or will they still have life?
LEREAH: I am including home equity loans in the B and C category.
CALLEJON: We see it as a completely distinct market with distinct players and opportunities.
To define it as B and C makes the market a fairly finite opportunity. But if you look at equity in the marketplace, there is $5 trillion of untapped equity. There is a wide array of products that can fill that gap to the extent that the consumer or homeowner desires. Some of those markets are well beyond niche - $5 trillion is more than niche.
Will the niches be blown away by the ascending desire for 30-year fixed- rate loans?
CALLEJON: We have received about 100,000 phone calls (to Fannie Mae) from consumers inquiring about the Home Keeper - our reverse mortgage for seniors who own their own homes and want to tap the equity in that home for additional income.
We hear people and companies saying they are going to try different markets. We think there is definitely an interest in innovating.
HARDESTER: One of the problems of that is, how do you make any money? With the home equity lines of credit, we have never really gotten much above 50% utilization, and it took 10 or 15 years to get there. If a customer takes out a $50,000 line and only uses $3,000, you still have to reserve for the entire $50,000.
When you see George Mason Bank and their ads for a half under prime rate for the life of the loan, it is impossible to make any money if the person pays no closing costs, no points, no appraisal fee.
LEREAH: There are lots of ways to make money on home equity loans. The bank itself brings in the customer. The bank is making money in many indirect ways.
But $5 trillion is an overinflated figure. That is not the potential - it is going to be a lot less than that. But there is still a lot of potential out there.
The people that refinance are candidates. They are somewhat more sophisticated and more in tune with what the market is going to do.
We keep hearing that despite all the consolidation, there are more lenders than ever. A lot of them are niche players and specialists in one way or another. Does this mean there will be more competition that will squeeze margins?
HARDESTER: We just completed a study of 25 mortgage bankers and we could not find an originator that could make any money out of smaller loans. The problem also becomes, as far as profitability goes, that the service industry becomes more concentrated.
The ability to make that loan is going to hinge on servicing rights, and to a great extent on the cross-selling of other products.
But it is very difficult to cross-sell from a mortgage loan. Mark Korell is trying to do that at Norwest Mortgage Corp. Candidly, it is going to be a tough sale. But people have found that the customers do want the second mortgage.
REED: Do you believe that there are no cross-selling opportunities? My clients would probably disagree with you.
HARDESTER: Making the sale is one thing and making a profit is a lot harder. At Maryland National, we had 600,000 customers. Unfortunately, we had no luck at all selling credit lines. It was strange - we offered everything under the sun. We had absoluely no success with everything from checking to savings accounts to safe deposit boxes. You name it, we tried it.
REED: I would think that there are a lot of banks that are having a lot of success cross-selling. It has to do with data-base mining, knowing who your customers are and how to focus in on those characteristics that make a person a better potential customer for those products - as opposed to mass- marketing to all of your mortgage customers something like a home equity loan when some of them might have very little equity.
HARDESTER: Back then we had no such thing as data-base mining. We had a huge master list of everyone on the face of the earth and we mailed it to everybody three or four times a year.
LEREAH: I would agree that there is a struggle in cross-selling. It's not easy and it doesn't work all the time. But you need to do it. We are headed toward the natural evolution of this strategy - one-stop shopping, complete financial services.
But the problem has been that the originations side of the business is not that profitable. You look at the numbers and you are incurring losses in loan production. Servicing value is supporting the business, and to the extent that you can cross-sell, you're adding value - you are almost cross- subsidizing value. I think it is a necessity, at least for the bigger banks that have opportunities to do it.
CALLEJON: It seems like there is a trend toward more partnerships with entities that have a myriad of expertise that a bank doesn't traditionally have.
Five or 10 years ago, there was fairly little of that. If a lender wanted to determine what data they had access to, they'd ask, what are my products and services and what is my own area of expertise?
It didn't go beyond that into who else is good at this. Where are there places in the value chain where people are making money? Let me match up my skills - which may be data, the borrower access, the monthly relationship, deposits - with someone who has an expertise in a different type of financial product. For example, we are seeing more realty-related partnerships. The banks are doing it - the Norwest-Wells Fargo partnership is a very interesting example. I think we're waiting to see how these relationships develop.
LEREAH: Some things will work and some things will not work. There are companies that have tried to link mutual fund business with the mortgage business and it doesn't work that well.
Let's discuss those products that are working well. Are there any product success stories, like the piggyback second mortgage, that seem to be working well?
REED: I think it depends on the data base and the customer, not necessarily the product. In terms of where you get that customer list from, what their characteristics are. I think second mortgages are one product that leads itself more to cross-selling than perhaps some other products because you know there is available equity.
LEREAH: Fleet Financial Group comes to mind. They have a successful cross-selling program. If a person applies for a residential mortgage and doesn't make it, they are referred right over to a B and C unit.
CALLEJON: My reaction is maybe off the exact topic. Whether you consider it a niche or not, there are an awful lot of folks out there who have the financial wherewithal to get in the homebuying process who don't know it. Certainly there is a lot of opportunity in bringing these people with the finances into the process. And we see this as a growth area for mortgage lenders.
We at Fannie Mae have been doing a lot of product development in that area: communiy homebuyer programs and various rehab products. There is always going to be more product development.
But the mortgage market is fairly mature. My view is that it is now more about information, education, and outreach. Our surveys indicate that most people who feel disenfranchised or intimidated by the process actually find that they, more likely than not, can qualify for a loan. But they often feel unsure about doing it. Education and counseling efforts are key to doing business with consumers today.
How about some other products? Affinity lending, or third-party-lending associations? Affinity lending is a different kind of marketing and requires different tools - direct mail or telemarketing. Does that mean there is a different cast of characters?
REED: Yes, a company that will have more emphasis in technology will be more successful in affinity lending or telemarketing - a company that's more technology-focused and not all decentralized with all its people out in many different locations.
The technological company would do something like the relocation business very well. You have the relationships, and you have a fairly well- oiled process.
CALLEJON: Prudential clearly had an expertise in the area of telemarketing and relocation, and - to a certain degree - affinity-group lending. So Norwest has bought it lock, stock and barrel as opposed to building an expertise or entering a new market. I think the barriers to entry, because of relationships, are fairly high.
So what does all this add up to?
CALLEJON: There are very few who have similar views. I find it fascinating just to watch and to be a part of dialogues like this one because everybody has their take on where things are going. This applies to us versus Freddie Mac, where we see ourselves in a totally different frame of reference regarding outreach and bringing more people into the system.
What I know for sure is that it is an interesting time to be in the business - and that everything is moving so fast that some of the folks are going to be right and some will be wrong. It strikes me that people who focus on where they bring service, where they have a capability or competency and where they bring value will be compensated. This is going to make people successful in the long run.
LEREAH: I agree with what you are saying, but the reason is that we are in the most cyclical industry you can have in America. Some companies just don't have the stomach for it after awhile.
What they are saying is also that they don't have the stomach for the cyclical ups and downs of this industry, especially the mortgage head who needed to report to the parent and have to explain to them why they aren't making any money because interest rates happen to be going in a different direction.
And, says the mortgage head, "You are not permitting me to hedge properly." But that is a problem with a lot of the parent-subsidiary relationships.
With each company, there are different strategies for the year 2000, and they are figuring out what they are going to look like. But it's a cyclical industry. And you are going to have a mishmash of strategies because this is not an easy business to be in.