The Mortgage Industry: Virtual Banking and Virtual Technology
Teixeira, Diogo, American Banker
VIRTUAL BANKING MEANS providing financial services by coordinating inputs from different contributors into final form for the consumer. There is no clearer example than the residential mortgage loan industry. The tasks of origination and funding, processing payments, accounting and servicing, and securitization and secondary marketing are functionally disaggregated to an unusually high degree.
While some financial institutions still perform all of the processing of residential mortgage loans, it is far more likely today that different companies participate in the different sections of the business. Independent mortgage brokers, or mortgage banking subsidiaries of banks or thrifts, may originate the loans. Banks may fund the loans and "warehouse" them until they are sold to secondary-market investors. Their profit comes from origination and servicing fees and from interest rate margins. About 60% to 70% of all new residential loans are "pooled," purchased by government-chartered secondary investors, and securitized into mortgage-backed securities. Servicing rights can also be traded among banks, often several times during the life of the loan.
What does this disaggregated industry structure mean for the information technologies used in the mortgage loan business?
The provision of technology to serve each participant in the process is now becoming highly specialized. Technologies used, and the sources thereof, now differ according to the economies of scale and market dynamics of each segment. There are three major sections of the residential loan business: loan origination, secondary marketing, and servicing. All require very different software:
* Loan origination. Most large banks and their mortgage subsidiaries use their own proprietary software. These applications often run on mainframe or midrange systems, although the trend is now to move origination to client-server platforms, Mortgage origination is highly labor intensive, so expanding the scale of a mortgage origination operation does not greatly reduce unit origination cost. Since the economies of scale in mortgage origination are low, tens of thousands of small, independent mortgage brokers are successful in serving a large segment of the mortgage origination market, and 90% of these use PC-based or client-server-based software supplied by vendors. Dozens of companies market hundreds of these loan origination packages, most focusing on document generation, to serve this fragmented segment of the origination software market.
The PC-based segment of the market has grown rapidly, along with the number of independent mortgage brokers. Origination software, whether marketed as separate modules or as integrated functions in a software package family, must include applications for borrower qualification, application processing, credit checking and scoring, approval and closing, and generation of the volumes of regulatory documentation required at each step.
* Secondary marketing. Most large banks use proprietary query-and-report programs for analysis of in-process and warehoused loans. These systems are used for reporting on the inventory of loans held in portfolio, managing commitments to buy and sell loans, calculating gains and losses on loans bought and sold, managing interest rate risk on loans in the pipeline, and transferring loans to secondary investors. Processing economies of scale in this segment are moderate, so these applications are still largely mainframe-based. Vendor-supplied packages are typically purchased by smaller banks and mortgage companies, and by other financial service organizations that have limited capital and funding for loans and for software used for loan warehousing and portfolio management.
* Loan servicing. Economy of scale factors are very high. Volumes are high and complexities are enormous. Specific feature-functions require loan accounting, payments processing, managing escrow accounts and payments, customer service, collections, and reporting. …