MortgageReal Estate

Squeezed: How independent mortgage banks are dealing with low volumes and overcapacity

While demand is evolving, it is also contracting thanks to an economic bottleneck

Consumers want flexibility and capability along with boutique treatment. This is the ethos of modern demand in just about any market imaginable.

It is no different in the mortgage space. According to J.D. Power’s 2018 Retail Banking Advice Study, 78% of responders in the survey said they wanted to interact with their banks and receive financial advice from them. At the same time, 58% of responders said they wanted to receive the advice they seek through a mobile or web-based banking application.

Demand demands more than simple digitization. It demands digitization with a personal touch.

At the same time demand is evolving, it is also contracting thanks to an economic bottleneck.

Mortgage Bankers Association Chief Economist Mike Fratantoni points to a strong economy pushing interest rates up as one of the primary reasons for this bottlenecking in mortgage originations.

“We went from a market which was a $2 trillion market in 2016 [to] we estimate it’s going to be $1.6 trillion in 2018 with more than a 60% decline in refinance volume,” Fratantoni told HousingWire.

According to recent data from Ellie Mae, purchase applications now make up 75% of all mortgages while refinances hover around historic lows, meaning that, so far, Fratantoni and the MBA’s prediction is dead-on.

Even though a strong economy is drumming up demand for homes, low supply and abysmal affordability conditions have prevented that demand from coming to fruition or filling the gap refis left behind in their fall from grace.

“The strength of the job market and demand for housing has meant that purchase volume has increased over that time period, but not enough to offset that decline in [refinance] volume,” Fratantoni said.

On top of the economic factors, the liberal application of regulation has ballooned the cost of origination such that margins are wasting away right along with volume.

According to MBA data, the cost of origination has roughly doubled in the last decade, such that it now costs more than $8,000 to originate a loan.

“With that, it’s become more difficult for lenders to be profitable because, with the decline in volume, you have a lot of lenders chasing each loan. So, revenues are not increasing, and costs are high,” Fratantoni said.

“Our profitability numbers have shown a steady decline and in the first quarter of this year we even saw that independent mortgage bankers were on average showing a loss. Only about 60% of them are profitable even with their servicers cut,” he added.

During 2018’s MBA Secondary Market Conference, Mike Weinbach, CEO at Chase Home Lending, called the market “brutally competitive,” and said that a “shakeout” is in order.

The sooner, the better, he says.

On the same panel at MBA Secondary, Stearns Lending CEO David Schneider agreed saying that, “Capacity needs to come out of the system. There has been a lot of growth in independent banks, but they built their business with margins much higher than we see today.”

So, what is an independent mortgage bank to do? Many have turned to each other or to larger banks and started furiously shaking hands in search of increased capabilities and greater liquidity.

A recent example of this was when Peakstone’s Mortgage Banking Group announced it was working with “a well-capitalized firm looking to acquire mortgage banks with strong origination.”

Big names like Amazon and Zillow are also reflecting this trend. These companies are on the prowl for smaller lending operations they can roll into their revenue streams.

Another way IMBs are responding to adverse market conditions, sometimes in conjunction with a merger, is a redesign of their model, one that accounts for the absence of the refi market and puts a premium on customer centricity.

“We are seeing some of the smaller banks that are consolidating especially if they popped up to fill the void,” Digital Risk Vice President of Business Development Cassandra Alvis told HousingWire.

“But what we’re also seeing is that they are embracing the digital space that’s allowing them to look at their model, if you will, in order to determine if they can utilize the digitization like [customer] journey mapping, design thinking, technology, etcetera, to do things better, faster and obviously cheaper,” she added.

Alvis says a front-to-back evaluation and revamp of an independent mortgage bank’s processes can position it not only to weather this storm, but also to be able to remain competitive in the long game.

“We all were in our fuzzy slippers with the refinance market, but obviously now, that’s gone away. So, we’re kind of riding back to where we were in the early 2000s with regard to it turning into a purchase market, Alvis said.

“So, a lot of lenders are having to flip their models along with digitization,” she added.

The good news is that, by nature, IMBs are a little nimbler than the traditional banks. This has served them well, and will continue to, as they scramble to reposition themselves above the tide.

According to Alvis, these conditions are going to persist. There are cogs in motion in the government-sponsored enterprise realm that may get the mortgage market out of its gridlock, but they will take a while to jar the market out of its low volume rut. That is why Alvis says it is critical that lenders be flexible and creative.

“It may be a while before we’re able to come out of that [affordability crisis], but that’s why it is so important for lenders, and IMBs [and] the major banks or whatever to be able to offer different products to help with affordability,” Alvis said.

If a lender is to survive this dry spell, it needs to be able to find customers where others don’t and keep borrowers when others can’t.

Until the good times come back, it remains to be seen how far the consolidation in the market will go. Fratantoni says it all depends on the relationship between demand and excess capacity.

“How far do we need to go? Looking at the first quarter of this year, the profitability metrics that we track, the net production levels, for IMBs went negative 8 basis points. On average, that’s been about 60 basis points over the last decade or so. I think that could be the indicator of when we’re to the appropriate capacity,” Fratantoni said.

“Historically, we’ve had these periods of 18- to 24-month consolidation periods, and I think we’re about halfway through that,” he added.

Recently, the industry has been showing some signs of life. MBA data reveals that while the first quarter showed that negative 8 bps in profitability, the second quarter surged back 29 bps such that the market is now at 21 bps in pre-tax production profit. This is a far cry from the 60 bps Fratantoni says the market needs to get back to normal, but it is an encouraging sign that the market is correcting itself at a healthy clip.

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