Academic journal article ABA Banking Journal

Is a Mortgage Bank in Your Future?

Academic journal article ABA Banking Journal

Is a Mortgage Bank in Your Future?

Article excerpt

Is a mortgage bank in your future?

Consolidation in the financial industry has impacted the mortgage banking business. New capital requirements, the increasing sophistication of the mortgage customer, and the breaching of traditional geographic barriers have also affected the market.

These factors are taking mortgage banking businesses away from the thrift domination that typified the 1980s. The bulk of these businesses will be in the hands of more diversified, better-capitalized financial services providers in the 1990s.

What it's all about. Mortgage banking is not a single business, but a combination of two functions that may or may not be performed by the same company. Loan production is the retail-oriented process of originating, packaging, and selling mortgages on the secondary market with the view of making a profit or creating valuable servicing rights. Servicing is the investment-oriented process of administering the mortgages for secondary market investors.

Recent changes in risk-based capital rules encourage the securitization of mortgages. A by-product of securitization is that it creates valuable and marketable servicing rights.

The loan production business depends on profits per loan. These profits come from origination fees, gains on the sale of the mortgage, and the value of servicing rights, less the total costs of originating and marketing the loans. Volume and returns tend to be highly cyclical.

When a mortgage bank is sold or liquidated, its loan production operation has a market value only if the market value of the servicing rights it produces significantly exceeds the production costs.

Loan production people usually are presented the choice between holding the servicing rights for a time or selling them immediately into the servicing secondary market. Most bank-owned mortgage companies must periodically sell some of the servicing rights they produce in order to meet demands for current reportable income.

The capital-intensive servicing operation is far more predictable than the production side. It can achieve high total return (a combination of net servicing income, reinvestment income, and any change in market value), capital efficiency, and low yield volatility. Servicing today trades at pre-tax yields of 15% to 20% and more. This is attracting a large number of yield-minded enterprises--such as finance companies and insurance companies--that previously would not have considered buying a mortgage banking company.

The value of servicing rights is usually the largest part of the market value of an integrated mortgage company, and typically accounts for 80% or more of total value. …

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