The mortgage market is expected to change dramatically in the coming year as some of the largest banks cede loan-origination market share to regional banks and non-bank mortgage lenders.
Big mortgage players, including Bank of America Corp. and Ally Financial Inc., are pulling back their correspondent lending and other operations in the face of regulatory scrutiny, bond investors' lawsuits, and the dismal state of the housing market. At the same time, the subprime lenders who dominated a large part of the mortgage market before the financial crisis have largely disappeared, carving out a bigger void for the remaining mortgage companies.
Now some smaller competitors are stepping into that void and expanding, selling loans directly to the government-sponsored enterprises and even considering retaining the servicing of the loans they originate. Since 2007, regional banks and independent lenders including BB&T Corp., Fifth Third Bancorp, PHH Corp., Provident Funding, and U.S. Bancorp have each more than doubled their market share, according to FBR Capital Markets analyst Paul Miller.
"Given the cost to the large banks to service mortgages, we expect the smaller players to continue taking share," Miller wrote in a report this month, adding that large banks are allocating less capital to mortgage banking and have a limited ability to originate mortgages "at the pace they have in the past."
"This has created an opportunity for smaller players to step up and fill the void," he wrote.
Bob Walters, chief economist at Quicken Loans Inc., agrees that the mortgage industry is going through "systemic and structural changes," and "the prices being paid for servicing rights and whole loans has dropped dramatically."
" It's not necessarily [just] that Bank of America is writing fewer loans, but the bigger part is smaller to mid-sized lenders are dramatically affected by what's happening with the Big Five lenders," Walters says, referring to B of A, Ally, Citigroup Inc., JPMorgan Chase & Co., and Wells Fargo & Co.
Large banks are worried about the impact of proposed Basel III capital rules, which would allow banks to count mortgage servicing assets as only 10% of Tier 1 capital at most — much more stringent than the current 50% cap. If implemented, the new cap could hurt the capital ratios of mortgage-heavy institutions.
Regulatory changes are also reshaping the market. Large lenders are wrestling with revisions being made to the risk-retention rule mandated under the Dodd-Frank Act, attempts to eliminate Fannie Mae and Freddie Mac and changes to mortgage servicing fees.
Jim Deitch, chief executive of mortgage bank TeraVerde Financial LLC, says new regulations have created a niche for community banks and credit unions, because the larger banks are distracted by mortgage servicing and legacy loan issues.
"Mortgage lending is the only scale business that can generate significant fee income, so it's the only place left that community banks have [an advantage] against non-bank competitors," says Deitch, the former CEO of American Home Bank.
"That message is being pushed around to depositories," he says. "Banks that concentrated on business lending, particularly commercial real estate, are getting strong suggestions to balance commercial with consumer to have a more balanced portfolio."
But the opportunity to expand also comes with pitfalls for regional banks and other smaller mortgage lenders.
Shares of SunTrust Banks Inc. fell more than 6% this month after CEO Bill Rogers said the Atlanta bank spent $440 million buying back problem loans from Fannie Mae and Freddie Mac. Similar repurchase-request problems are expected to hit other banks in the coming year.
And then there is the issue of capacity, and whether smaller companies can really fill B of A's shoes. Mortgage experts say that while there has always been talk of regional banks increasing correspondent lending, they may not have the capital (or stomach) to do it. Even if the 10 largest regional banks bought from correspondents, it still would not be enough to take over B of A's share of the market, analysts say.
The large lenders are leaving behind a massive void. Loans purchased from correspondent lenders accounted for 48% of Bank of America's $33 billion in mortgage operations in the third quarter, and 84% of Ally's $16 billion in mortgage production in the third quarter, according to representatives for the two lenders. Analysts say that among the largest banks, only Wells Fargo & Co. has increased market share in correspondent lending (and other types of mortgages) recently.
Smaller banks are also more likely to stick to their own local footprint, rather than try to expand nationally, given that many lenders got into so much trouble moving into sand states like California, Nevada and Florida during the boom years, Deitch says.
Bill Dallas, the chief executive of Skyline Financial Corp., a Calabasas, Calif., mortgage bank, says the big banks' pullback from correspondent lending also has created "a rare opportunity" for independent well-capitalized mortgage bankers "to take market share back from the banks."
"The question is, what is their strategy?" he says. "You have to go [sell] directly to the agencies and bypass the aggregators."
Many non-banks lenders are doing just that.
Brett McGovern, president of Bay Equity LLC, a San Francisco mortgage bank, says he is selling loans directly to Fannie Mae, calling it "a huge feather in our cap."
Glenn Stearns, founder and chief executive of Stearns Lending, is one of the non-bank lenders picking up market share at the expense of big banks.
"We're picking up where all the banks pulled out and that's where a lot of our growth is going to come from," says Stearns, whose top-25 mortgage lender is headquartered in Santa Ana, Calif.
Since 2008, Stearns has added nearly 70 offices and 1,000 employees. The company took in $100 million in correspondent loans in the first 10 days of December, after B of A pulled out of correspondent lending.
"We have a lot of cash and net worth, so we can take advantage of that right now," Stearns said.