Magazine article American Banker

How Profitable Is Your Loan Portfolio? Look at the Details

Magazine article American Banker

How Profitable Is Your Loan Portfolio? Look at the Details

Article excerpt

It is not uncommon to find mortgage banking companies that know -- down to the basis point -- what their profitability is. Some loans are more profitable than others, and knowing average profitability per loan is rarely of much help.

The first step to truly understanding the income statement is analyzing profitability per loan according to loan-level attributes. Even within very specific loan types -- say, conforming loans sold to Fannie Mae -- profitability must be broken down by characteristics.

Is your profit the same on owner-occupied as it is on nonowner ones? What about second homes? High-FICO borrowers? Low loan-to-value loans?

It's quite possible that an owner occupied, 40 LTV loan to a borrower with a 763 FICO will be 20 to 25 basis points more profitable than a loan to someone getting the same coupon but with a 87%-LTV and a 651 FICO.

The point is that managers should look at profitability by product and loan characteristic. They should know their profitability for fixed-rate loans versus intermediate ARMs, for jumbos versus conforming loans, and for government loans versus conventional ones.

Having done that, look at the returns on invested capital. Let's use a simple example -- profitability per delivery channel.

There is an unending retail-versus-wholesale debate within a company. The retail side argues for more resources because of its wider margins; the wholesale side counters that it makes up for its smaller margins with more volume at a lower cost.

Let's assume that the retail side generates a profit of $400 per loan, while the wholesale side generates $200. We'll also assume that this net profit adjusts for all loan-level attributes, including LTV, occupancy status, and so on.

Less sophisticated managers would see that retail lending is twice as profitable as wholesale, but the more sophisticated manager will demand to know how much capital each division uses. …

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