Academic journal article ABA Banking Journal

The Profitability Riddle; We Know What It's Not, but Not What It Is

Academic journal article ABA Banking Journal

The Profitability Riddle; We Know What It's Not, but Not What It Is

Article excerpt

Low costs, high tech', sheer size--none guarantee that a mortgage firm will be profitable. That's the bottom line from the latest, annual mortgage-industry surveys by the Mortgage Bankers Association of America and KPMG/Peat Marwick. The traditional ways of gauging profitability are being called into question, and little is known with certainty besides the fact that while the mortgage industry is more profitable, the performance of individual firms is highly variable.

Douglas Duncan, senior economist with MBA, says both it and KPMG had "surprisingly consistent" results considering that they surveyed a different type and size of institution. MBA surveyed nondepositories, though 58 of its 213 respondents were bank subsidiaries and 12 were thrift subsidiaries. KPMG surveyed mostly large depository subsidiaries. Its findings represent a composite of surveys conducted during 1996 that involved close to 50 companies, out of the top 150 servicers.

Both surveys contradicted conventional wisdom, which in recent years has stated that to be in the mortgage servicing business one must be huge. As in past years, both surveys found, in 1996, that the very biggest servicers (those over $20 billion) as a class were less profitable than their slightly-smaller peers.

Two shifts in 1996 may reflect attempts to gain scale and to cut servicing cost, respectively, even though neither alone guarantees better net income. These findings emerged from a number of sub-surveys conducted by MBA, in addition to its servicing survey, and an origination survey.

One of the shifts was the growth in subservicing, which grew about 50% from the previous year. Duncan reads this as an attempt to gain scale, but questions what scale achieves considering that those with the lowest direct costs were not necessarily the most profitable. (Direct costs include staff and overhead directly related to the loan, and exclude, for instance, legal fees and administrative expenses.) The average amount of loans being subserviced in 1996 was about 7,400.

The other shift was toward second mortgages, a cheaper product to service, which grew 96% year-over-year. However, seconds--still "a relatively small element" of the servicing market--tend toward higher delinquencies, Duncan notes.

Is bulk a burden?

"What's the point at which economies of scale are exhausted? Where between $20 billion and $100 billion?" Duncan asks. He adds, "For the second year in a row the data resoundingly shows that, for us, the $1 billion to $20 billion portfolios are the most profitable."

KPMG's findings were not so clear-cut. Geoffrey Oliver, the partner in charge of its mortgage and asset finance group, said, in presenting its findings, "Basically those with over 100,000 loans are less profitable because of their bigger infrastructure."

However, in a follow-up interview, Laura McDonald, senior manager in the practice, said, often, those under 100,000 loans and over 400,000 loans fare better than those in between. The middle group has invested in the technology and infrastructure to be major servicers, but has not, as yet, at least, sufficient servicing volume to recoup their investment.

Servicers of over $20 billion in mortgages collectively were not the most profitable, but some individually were more profitable than their competitors, she adds.

KPMG categorized respondents according to those with more than 500,000 loans (the "major average") and those with less than 500,000 loans (the "middle average"). From these two, it derived a third category, the "most profitable." That group doesn't correspond directly to servicing portfolio size, but it's generally true that the larger a servicer is the more profitable it is--to a point. Net profit per loan was $226 for the middle average, $183 for the major average, and $284 for the most profitable.

When it comes to mortgage origination, "There are no clear economies of scale," says Tiffany Rowan, assistant economist at MBA. …

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