Mortgage banking used to be a business of healthy margins. Much has happened to alter the business landscape. Today mortgage bankers have to change their battle plans in the pursuit of long-term profitability.
"How is business?" ask that question at any gathering of mortgage bankers and the answer is likely to be, "Profitless." The economy is growing, home loans are affordable and mortgage volume is up, yet mortgage bankers are mired in a profitless prosperity. Why have margins eroded and left no money for the owners of the business? And can this sad state of affairs be changed?
The quest for profitability is the primary issue on the agenda of industry leaders as they make plans for the next five years - and it should be. A good place to begin is to step back and assess where we are. Why have golden years for mortgage banking suddenly changed to disappointing ones?
The mortgage banking business is a fascinating one. Its most successful operatives during the past decade have been those who are closely attuned to market forces in the demand for home loans and in the money and capital markets. Short-term strategies helped rather than hurt. As business managers, mortgage bankers know how to adjust quickly to changes in markets, technology, government regulation and costs.
Between 1980 and 1992, while the tortuously complex deregulation of thrifts and banks was under way, mortgage bankers easily outcompeted portfolio lenders and grew vigorously at their expense. Their market share rose from 21 percent to 55 percent of loan originations, and profits matched volume. Now, deregulation has been effectively completed, and we are entering a new business era best described as continuous competition. Managing a commodity business in competitive rather than cartel markets requires new and different strategies. What will work? Read on.
The essentials of mortgage banking
Historically, the value added to the housing finance process by mortgage bankers as classic middlemen was twofold:
* They offered superior market information regarding funding sources and regarding potential homebuyers and their credit capacity. They brought new supplies of money at attractive rates and terms to local markets.
* Superior salesmanship was another crucial mark of the profession. Mortgage bankers did not sit behind desks and wait for borrowers. They solicited loans actively in the field.
When banks and thrifts operated in cartel markets prior to 1980 and in deregulating markets during the 1990s, these hallmark values of mortgage banking were rewarded well. But now that financial services have crossed through the valley of deregulation and now operate in freely competitive markets, those value-adding features have been co-opted and imitated by the competition (banks and thrifts), as well in their mortgage banking style operating divisions/subsidiaries, thus creating chronic overcapacity.
The primary funding sources for home loans are identical: the government-sponsored enterprises (Fannie Mae, Freddie Mac and GNMA). Technology has homogenized credit information on borrowers, and loan underwriting standards vary little from one firm to the next. Few local housing markets are insulated from national lenders. And, as far as salesmanship is concerned, welcome to the world of 5,000 mortgage brokers. In a state of unlimited competition, prices are driven down to a level that will barely sustain the existence of those who provide the product.
King of the Hill revisited
The effect of these changes is to make the conforming home lending business a commodity business. A profitless prosperity emerges. Several years ago, I noted that competing in the mortgage banking business was akin to the childhood playground game, King of the Hill (see Mortgage Banking, October 1993).
Through the second quarter of 1996, it appears that the game has continued. Figure 1 compares the top 10 originators in the first half of 1996 with those of the last few years. …