The mortgage market is already undergoing dramatic transformations, but within five years the nonbank mortgage industry will look completely different than it does today.
The term mortgage bank refers to independent firms not affiliated with an FDIC-insured bank that sell a majority of their loans (directly or indirectly) to Fannie Mae and Freddie Mac. The overall mortgage market today is huge, with $10 trillion-plus in outstanding mortgages and annual production estimates as high as $2 trillion for this year. This year's production is approximately twice the size of the total outstanding balance of credits cards, as well as that of student loans.
The nonbank mortgage banks in question originate approximately 50% of all mortgage loans – representing a $1 trillion market this year alone. This is a seriously large and important market.
What are the underlying drivers that will force the industry to change its way of doing business? The political, regulatory and environmental factors having a large impact on housing finance over the coming five years include: a new presidential administration and its associated policy changes; the winding down of the Federal Reserve subsidy of Fannie and Freddie via "quantitative easing" (the QE program has ended, but principal runoff from the Fed's portfolio is being reinvested); continued progress toward an automated mortgage experience for the borrower; and the continued relentless increase in regulatory costs driving up the cost to produce a mortgage.
Furthermore, the mortgage industry is experiencing the beginning of a massive consolidation. Firms such as Blackstone, PIMCO and larger stand-alone retail firms are buying mortgage-related companies outright as well as rolling up others to increase their footprint in the market and economies of scale.
Where does all this leave us in five years? We believe that once consolidation picks up in earnest – most likely when interest rates pop up a bit – firms will then look to expand their product menus beyond mortgages in order to develop deeper, more comprehensive, financial relationships with their customers.
There will not be one model of what a buffet of products and services looks like. The resulting expansion of products and services will shape the mortgage industry into a collection of very large firms originating massive amounts of differentiated products – going beyond mortgages to consumer loans, car loans, small business loans and commercial loans – and then there will be everyone else.
Investors in these large firms will see them as massive asset gatherers and massive fee generators. The large firms will enjoy multiples in their valuations unavailable to the smaller firms left behind. Regulatory penalties will cease to become extinction events and will mirror how the too-big-to-fail banks manage regulatory risk.
This does not mean the smaller firms will fail to be competitive, but it does mean that the owners and operators of smaller firms will need to restructure how they manage their company in order to pay more attention to what their competitors are doing – what is working and what is not working as firms experiment with different product and service mixes.
What skill sets will the current industry incumbents need to acquire or develop in the coming years? First and foremost is a higher level of sophistication in data analytics and customer segmentation. Secondly, firms will need a more generalized knowledge of other loan products—their underwriting criteria, how the rating agencies look at the product, and the breadth and depth of the investor base for such products. Third, management will need to decide whether to build their own nonmortgage product platforms, buy someone else's platform, or partner with a compatible, noncompetitor provider of nonmortgage products.
Given the newly developing complexity in offering multiple products to a common customer base, it seems the retail mortgage banking firms that already engage directly with borrowers will have a competitive edge in connecting customers with other types of loans. The mortgage loan officer can be the go-to person to answer questions, and sophisticated digital marketing efforts will also be important. Given that the retail loan officer will have become intimately involved in the customer's financial life, it is an easy transition for that person to be trusted with directing the customer to other appropriate products.
This rewiring of retail mortgage banking will result in mortgage loan officers eventually becoming generalized "lending officers." Their professional status will increase and licensing regimes will recognize and certify these newly professional skills.
What about the other firms in the mortgage business, specifically correspondent lenders and wholesale firms – that lack a retail presence – and the mortgage brokers they serve? The correspondent channel will likely not be affected given that correspondents are aggregators for other mortgage banks and typically don't have direct contact with borrowers. However, to the extent that the industry consolidates and there are less smaller and midsize firms to buy loans from, then the correspondent channel will shrink or shift to the larger FDIC-insured banks.
Wholesalers and the brokers they serve have been clawing back market share post-crisis. Third-party originators (e.g., mortgage brokers) were seen during the crisis as a problematic channel with regard to loan quality. But this perception was wrong. Brokers were scapegoated during the crisis and large banks made a big show of terminating broker relationships. Yet in hindsight, it was the products offered by banks that fed the securitization machines of Wall Street; the brokers were just following market signals, like every other firm. Since then, the segment's comeback has been robust, as evidenced by an increase in mortgage market share for broker/wholesalers to around 10%. United Wholesale Mortgage in Troy, Mich., is a good example of this resurgence. The firm has estimated it will originate at least $20 billion in mortgages this year.
Wholesalers and brokers will still need to determine how they will offer nonmortgage products to customers. The brokers will be too small to take on the responsibility and the wholesale firms will have to make the argument that once they fund a loan, they hold on to the customer relationship. Assuming brokers/wholesalers have a fix for this first concern, the question then becomes: Is it really possible to create a business around potentially very competitive products by inserting another party into the mix (i.e., the broker)? Finally, with new products being offered in the market, will brokers join retail shops and leave the wholesalers in the lurch? There are no easy answers to these questions.
At the end of the day, all mortgage bankers will need to figure out a strategy to becoming consumer direct lenders.
Loren Picard is managing executive of G5, a consulting firm in the marketplace lending industry. Joe Flanagan is a senior director with Marlette Funding LLC.