Small Mortgage Players Should Unite
Large regional and national financial institutions are going after mortgage-loan share with predatory pricing, lenient credit standards, and aggressive marketing. Their use of extensive advertising, large loan solicitation staffs, and extensive branch networks makes it difficult for small lenders to compete.
And the competition will only increase. Nonbanks like General Motors Acceptance Corp. and General Electric Capital Corp. have recognized the attractive returns available on loan servicing. Having purchased large servicing portfolios from the Resolution Trust Corp., these large servicers are buying or establishing mortgage loan origination offices throughout the country to replace servicing lost through repayment.
Other traditional mortgage bankers, such as Margaretten & Co. and Countrywide Credit Industries, are expanding nationwide.
Regionals in the Mix
Add to the fray large regional banks that, bereft of alternative loan opportunities, are seeing residential mortgage loans as a safe haven for unutilized funds.
Thus, as savings and loans disappear, all types of residential mortgage lenders are rushing to fill the vacuum. This obviously makes it extremely difficult for small community financial institutions to compete profitably.
So how can a small institution be effective? One solution may be to pool resources with several other local institutions. A commonly owned residential mortgage origination, processing, and secondary marketing company can provide many of the benefits that larger originators enjoy.
Consider the advantages. The first is that such a company could afford a qualified mortgage banker with a proven track record in loan origination and knowledge of secondary market operations.
Another advantage is economies of scale. With five or six institutions feeding one processing operation, there would be obvious efficiencies in processing and underwriting. More savings are available in rent, utilities, and data processing. Management expense will be spread over more loans, further reducing cost per loan.
Coordinated marketing is another benefit. The pooling of resources in the mortgage company would, in itself, reduce competition among the members. It would also allow a concerted advertising effort with common mailers, lobby displays, and media ads. The larger advertising budget could attract more competitive bids among ad agencies and provide professional results.
Loan officers would be assigned noncompeting territories.
Another benefit is in start-up costs. A subsidiary with several owners requires less initial capital from each institution. It also means that losses do not have to be upstreamed every month.
The Secondary Market
Another advantage is in the secondary market operation. Since the accumulation of loan servicing is the goal in mortgage banking, most loans will be sold in the secondary market. The larger the commitments negotiated with the Federal National Mortgage Association and the Federal Home Loan Mortgage Corp., the better the pricing and underwriting concessions that can be negotiated. Large volumes also make security formation possible.
Other secondary market sources, not normally available to the smaller institutions, will also open up.
Such secondary marketing clout is especially important because it can make the company more price competitive on the retail level. And finally, a larger secondary operation will allow the use of sophisticated hedging techniques to reduce interest ate risk.
The owner institutions are not to be overlooked as buyers of loans. Each institution will have portfolio investment needs and can look to generate loans for this purpose. Each member may offer loan products through the mortgage company and purchase loans originated through the company.
These portfolio products will serve to increase the range of loan products offered at the retail level and enhance the company's ability to compete.
Pooling of loans to one borrower is another benefit. Today, regulatory limits make it impossible for small lenders to provide builders with construction loans. By pooling funds from owner institutions, the mortgage company can open the door to many builders.
Given the scarcity of construction money, such loans can be priced profitably and at the same time satisfy a real community need.
Another advantage is quality control. With a larger loan volume available, it is easier to say no to marginal loans. With more competitive pricing and a larger variety of loans, better credit risk are attracted.
Conversely, institutions with high rates, a small market, and a narrow range of loan products may encourage adverse selection by limiting the field of applicants to those with no other alternative.
Secondary market investors require high underwriting standards and a formal quality control program. These same standards would apply to all loans processed through the mortgage company. Those member institutions that purchased loans though the company would benefit from these standards.
Lower Unit Costs
Loan servicing provides another advantage. In this function, which relies heavily on labor and data processing, large volumes can reduce unit costs significantly. Investor accounting is also most efficient when large pools of loans are sold to investors.
Although there are real advantages to pooling the servicing function, it need not be part of the mortgage company. Alternatively, all servicing can be sold either by selling loans with the servicing or accumulating servicing and selling it periodically. Both of these strategies increase short-term earnings at the expense of long-term profits.
Each institution will have to decide its own needs and compare the advantages of both strategies.
Another alternative would be for the company to sell servicing to member institutions in the same way it would sell loans to other financial intermediaries. Thus each institution would benefit from the sale of servicing, and those choosing to do so could reinvest in servicing for their own portfolio.
Mr. Crum is executive vice president of Charter Savings and Loan Association of Florida, Delray Beach.