Lessons Learned

By Lederman, Jess | Mortgage Banking, October 1993 | Go to article overview
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Lessons Learned


Lederman, Jess, Mortgage Banking


A look back over recent industry history reveals that major changes made the business landscape rocky in the 1980s. The secret for success during the decade proved to be perfecting the art of survival.

WHEN I ENTERED THE BUSINESS OF MORTGAGE finance, in 1980, it didn't take long to master the tools of the trade. Thirty-year, fixed-rate mortgages were the norm. Mortgage bankers had only recently begun venturing beyond government lending into conventional production, and jumbo lending was tried only by a daring few.

Because of the rapid home price appreciation experienced during the late 1970s, credit risk was considered an oxymoron. In fact, the mortgage insurance company I worked for was embarrassed to report a 5 percent loss ratio for the previous year, and several executives wished for just a few more loans to go bad so our clients would better appreciate the value of our service.

The typical mortgage banker was a small, independent, retail originator that packaged FHA/VA loans into Ginnie Maes or sold whole loans to thrifts. Pricing was based on a 12-year prepay assumption, and cash flow yield was only a glint in Dexter Senft's eye. The Fannie Mae MBS did not yet exist, while private mortgage-backed issues were rarer than sightings of Elvis.

Because interest rates had been on a steady uptrend for years, pipeline fallout and negative convexity were merely academic concepts. Servicing traded infrequently, and when it did, valuation was simple: it was worth 1 percent.

I produced my first financial forecast with a pencil, a hand-held calculator and a large green accounting pad. Later that year, when we bought personal computers and I transferred my numbers to a Visicalc spreadsheet, that was considered state-of-the-art.

How times have changed.

The 1980s

In retrospect, the 1980s was a transitionary decade, a time of unprecedented challenges, of experimentation and consolidation. The smartest and toughest players learned quickly and adapted to the new environment, while the rest were casualties that shrunk or sold out or simply closed shop.

The first great challenge was the high level of interest rates that all but shut down origination volume. Creative lenders took advantage of liberalized lending regulations, and the result was a vast expansion in the menu of mortgage products. The new product list included more than 200 types of adjustable-rate mortgages (it took several years for the industry to decide between ARM and AML as the preferred acronym) and a sometimes bewildering profusion of graduated payment, growing equity, shared equity, wrap and second mortgage loans. I remember long debates with colleagues about which of these loans would survive.

As so often happens, the wishes of consumers and investors were diametrically opposed: investors demanded loans that would adjust immediately to market, while consumers sought out loans that looked as fixed as possible--only with lower interest rates. For a long while, mortgage bankers despaired as thrifts dominated the origination market with teaser-rate ARMs (loans with starting rates well below the fully indexed accrual rate); getting a whole loan standby to sell such ARMs to a thrift investor was often the difference between sitting on the sidelines and being a player on the street.

The marketplace eventually winnowed the product menu down to a manageable few choices, and the lower interest rates of the later 1980s brought back the popularity of fixed-rate loans. The competitiveness of mortgage bankers was enhanced not only by the return of a fixed-rate environment, but also by two other factors that dramatically changed the industry: the demise of the thrifts and the rise to dominance of the mortgage-backed security.

The decline of thrifts

The thrift industry was at once a blessing and a bane: while thrift investors were a primary outlet for whole loan product, thrift originators were frequently unbeatable competitors.

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