After sifting through three years' worth of retail production data, government lending appears to be far more costly than generally believed, and unprofitable for many lenders. This result suggests a systemic decline in the average quality of government loans, and underscores the need for lenders to measure performance, especially costs, at a much more "granular" level of detail.
DESPITE BEING THE COUNTRY'S largest financial service, the mortgage industry has a limited understanding of its own economics. This is especially true when compared with other financial service sectors.
* For example, while most companies report operating results by origination channel and other functional units, many significant costs are simply allocated by formula based on head counts or loan counts. Precise differences in profitability by loan type are rarely measured and reported.
* As a result, few companies, including most of the very largest lenders, can answer questions like: How profitable are fixed-rate government loans originated through our retail branches? Or: What does it cost us to originate a streamline conventional loan?
* More generally, the limited "granularity" by which the industry measures its results stands as a major impediment to improved management and performance. It's hard to make sound strategic and operating decisions when you don't really know what your revenues, costs and profits are at a detailed level by product, channel, geography and customer segment.
What's worse, senior management in many companies simply does not grasp the significance of more granular information as a powerful weapon in its arsenal for competitive success.
This article presents statistical analyses of retail production performance using data collected under the Mortgage Bankers Association of America (MBA)/STRATMOR Peer Group Program over the 2000-2002 time frame. While the results are both surprising and provocative, our key objective is to underscore the importance of understanding results at a more granular level.
Retail production channel economics
Our analyses apply simple "linear statistical regression models" to analyze how retail production costs and margins are impacted by loan type. These models "fit" observed results to variations in production mix observed across the lenders participating in the Peer Group Program to answer such questions as: What does it cost to originate a government loan versus a conventional loan? Are government loans more or less profitable than conventional loans? How do costs and profitability vary between the superlarge lenders (megalenders) and large lenders?
Retail production costs
Figure 1 presents average retail originations for megalenders (Group M) and large lenders (Group A) over the 2000-2002 time frame. The table clearly illustrates the scale differences between these two Peer Group lender segments.
During 2001 and 2002, megalender retail originations ran at about six times that of the large-lender Peer Group segment. While this ratio was only about 2.5 in 2000, the increase largely reflects the addition of several very large megalenders to the Peer Group during 2001 coupled with the across-the-board surge in production volumes, particularly among Group M.
Figure 2 presents the regression analysis results for direct retail production costs before commissions, and excluding a variety of postclosing costs (e.g., quality control, shipping and delivery and so forth). In Figure 2, "other" loans include such loan types as jumbo, alternative-A, portfolio loans, etc.
Considering megalenders and large lenders as a whole, direct government origination costs ($ 1,838 per loan) are almost $900 greater than for conforming conventional loans ($982 per loan). This cost difference is far greater than what is commonly believed within the industry Most lenders we have spoken with believe that government loans cost perhaps $300 to $500 more to underwrite, process and close than conventional loans. …