Magazine article Mortgage Banking

One Step Forward, One Step Back

Magazine article Mortgage Banking

One Step Forward, One Step Back

Article excerpt

Mortgage bankers work too hard for the results they achieve. They constantly struggle with basic corporate decisions: How do they obtain adequate lending spreads? How can they reduce delinquency costs? What is the best way to respond to an increasingly burdensome regulatory compliance environment?

Each cycle in the mortgage industry brings a new set of concerns that make their way onto the management committee's agenda.

In our MORTECH 2006 study, we found lenders reporting an almost universal preoccupation with falling operating margins (see Figure 1). There were no other concerns that seriously competed for management attention. With the decimation of the subprime market, the issue of margin restoration only has intensified.

Margin compression generally is out of an individual lender's control. Major shifts are largely unanticipated. With little warning, lenders are reactive to the change in the economics of mortgage banking. Decisions are predicated on past experience.

What is comfortable and what is done in response to falling profitability is to reduce operating costs and to be opportunistic--to make the most of what current market conditions offer.

It might be that the business has arrived at a "strategic inflection point." A strategic inflection point occurs when the structure and the competitive dynamics of a business change sufficiently to diminish the effectiveness of conventional management techniques.

At the strategic inflection point, conventional management action no longer produces planned results. An adequate level of profitability becomes difficult to predict or achieve. If the gap between industry change and management actions becomes deep enough, the company enters a period when few tactics match up with expectations. Something of the sort happened in the subprime business over the past three years.

Two years ago, a large number of conventional lenders flocked into the unfamiliar territory of subprime origination. From MORTECH, the data have shown that in normal times 5 percent of lenders focus their business primarily on the subprime sector. Not so in these days of disappearing margins. In the last two years, the proportion of lenders jamming into the subprime and nonconforming sectors has risen from one lender in 20 to one lender in five. It was a remarkable rush fueled by the discovery of what for some at least has turned out to be fool's gold.

Think about the consequences of the headlong rush into subprime. First there is the structural issue. With the sudden onset of so much origination capacity, price competition and skinnier margins were inevitable. So many lenders with so little experience in subprime lending suddenly were running along the winding road of subprime production. With the number of rookies in the subprime business, it was fairly predictable there would be a crisis in credit quality. The only real question was when? The answer now is entirely clear.

Managing in the mortgage banking industry generally is characterized by opportunistic responses to changes in short-term market conditions. By nature these are operational adjustments, and, according to MORTECH, mortgage bankers typically take an operational view of their businesses.

In MORTECH, our research series on the mortgage industry, we have learned that more than 70 percent of lenders interviewed approach their choice and use of technology as being operationally driven. …

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