Mortgage executives have a hard time forgetting 2018. The market was coming off a refi boom, competition was fierce, and the profit margins were slim (if there were any at all). In a bid to gain market share, some of the biggest mortgage originators priced loans aggressively to keep production up and attract loan originators. It led to losses for many originators, who were slow to adjust their pricing. Today, as margins again compress due to a combination of rising interest rates, fewer refis and ballooning workforces, mortgage executives are keeping a close eye on LO comp.
Keeping a staff well-fed and happy while minding the bottom line is a delicate balance, mortgage executives said at a panel from the Mortgage Bankers Association‘s spring conference on Wednesday.
“Trees don’t grow to the moon, and at some point volume comes off from refinances and margin will get tighter,” moderator Michael McAuley, principal at mortgage consultancy Garrett, McAuley & Co., told the panelists.
Lenders need to prepare for margin compression “because it’s likely to be significantly worse,” McAuley said. Except this time, the lenders in 2018 who priced loans aggressively “have a lot more retained earnings and a lot more staying power,” he said. It raises the stakes for lenders who hopefully learned the hard lessons in 2018.
Adjust pricing on the fly
It was a similar story at California-based retail lender Guild Mortgage Company. Lenders were too slow to adjust pricing in 2018, said Terry Schmidt, president of Guild.
“Once we really got those figures and had a heart-to-heart talk with regional managers and said, ‘I need to cut 25 basis points from the whole model, we need help, how are we going to get there?’ They all did it.”
Ultimately, you really can’t dictate the margin overall, said Mike Fontaine, co-president and COO of Plaza Home Mortgage. “You’re going to have to be somewhat in line with what the market is. Last year all of us were able to enjoy larger margins due to the capacity constraints but moving into this cycle we feel that there is a large capacity that’s going to be available, so unfortunately volumes slow and margins slow so you get a double whammy on it with a higher cost structure relative to the number of units you’ve able to produce in a given time.”
Pricing the loans in line with the market is critical, the panelists said. And there are some technological advances that are reducing costs. The hybrid e-close has resulted in fewer errors on the post-closing side and lower costs. Fontaine said he looks to invest in automation so long as it isn’t consumer-facing.
But the elephant in the room remains personnel costs in the industry, especially LO comp. According to mortgage software firm LBA Ware, the average LO commission in the fourth quarter of 2020 was 105 basis points, flat year over year. But the average individual production in the fourth quarter was $2.6 million per month, a 63% increase from $1.6 million in Q4 2019. LO headcount increased 27% year over year.
If the path to achieving an acceptable margin in leaner times is reducing LO comp, how will mortgage execs do that, McAuley asked.
“It’s hard to go to your loan officers and tell them they’ve got to reduce their commissions,” said Gates. “There are some other tools — we implement dollar minimums and maximums with everyone. And we do have conversations and show the math on that — if they’re willing to lower their maximums then they can be more competitive on larger loans.”
Apex came up with an LO comp structure where a worker receives a typical base salary plus a bonus during a busy time. When the market slows, they’ll go back to their typical levels.
It’s all about transparency, according to Schmidt, whose lender’s gain-on-sale margins increased by 122 basis points in 2020 to 500 basis points but are showing signs of shrinkage.
“The more transparent you are as a company, the better,” she said. “You’ve got these margins behind the scenes where it’s just to cover all of your costs. We made a change about a year or two ago where we pretty much showed our teams everything, a fully loaded transaction with fully loaded costs of running the business. We really refined what’s our target as a company, what’s the profitability mark we need to get to? For retail it’s generally pretty similar, it’s how you present it. Sometimes you have loan originators who think they’re getting something special going somewhere else financially, when in reality it’s all the same. It just gets packaged a little differently. So we can be really transparent about that, and I think it’s helped us.”
Will LOs take a haircut?
It’s not just the LOs who would need to worry about reduced compensation when leaner times arrive. Underwriters who commanded salaries north of $120,000 and landed fat signing bonuses will be in a precarious position. To a lesser extent, the same is true of processors, closers and other ops people who made top-of-market money in a very different environment.
“That doesn’t seem sustainable,” said Gates. “I know that anecdotally, some of those companies who I’ve spoken to said that many of those higher cost people who are also their newest hires may be the first to go in a shrinking volume environment with a higher costs. Or maybe they’ll have to go back and renegotiate those compensation packages down to what’s been a more typical level.”
The panelists also took on the subject of pricing concessions as part of LO comp.
“Pricing concessions can be valuable,” said McAuley. “They’re an indicator of price discovery — if you have no pricing concessions or no request for concessions, probably too often your prices are more aggressive than the competition. On the other hand, as my partner Joe Garrett likes to say, concessions kill. I’ve run into companies where maybe 60% or 70% of their loans were getting pricing concessions in 2018. Their argument was, well at least we’re getting a full price fat margin on the other 30%. But then the other 60%, 70% are getting pricing concessions, I think there’s some obvious some problems there.”
Schmidt said Guild has a proprietary system that shows all loan officer details. A branch regional manager can see how many subsidies they’ve asked for and can determine what’s necessary. The system also requires an explanation for any subsidy.
Stronger use of analytics platforms will help guide mortgage executives to determine how many concessions their LOs should be offering, McAuley said. He reviewed some lenders in the Southwest and found the top-producing LO was often not the most profitable for the company.
“It was a pretty consistent pattern that your top LO was not actually the most profitable and good at holding the margin,” he said. “They were the top producer because they were getting a lot of concessions, and it was really the second producer or number three that were the most profitable to the company because they were able to hold the margins while still doing a lot of production. It’s sort of a sweet spot there.”