As we approach 2022, some concerning headwinds confront the mortgage origination industry. For companies to survive and thrive, mortgage executives must focus on three primary factors: risk, strategy and efficiency.
In terms of managing financial risk, considerations include interest rate, market and reputation. Risk is becoming more pronounced as the Federal Reserve announced its plan to start tapering mortgage-backed security purchases by $5 billion, which will inevitably cause market volatility. In addition, the Mortgage Bankers Association forecasted that refinancing volume will decrease by nearly $1 trillion in 2022. Such a massive drop would create high-level risk for the financials of many originators. There are many mortgage firms that have prospered in 2020 and 2021 due to ultra-low rates.
Managing balance sheet risk
To effectively confront these challenges, managing balance-sheet risk will be key. This includes focusing on capital/equity to ensure the foundation is strong, covenants are met and operational flexibility is maintained. Additionally, it will require development of financial forecasts using realistic assumptions and producing profit-and-loss forecasts to understand and effectively manage profitability levers.
Balance-sheet risk also entails developing cash flow forecasts to ensure velocity is maintained and sufficient to propel the business forward. Against the current macroeconomic backdrop, now is the time to revisit the balance sheet, envision potential scenarios and think strategically about how you can navigate 2022.
Operational risk should also be a consideration. Ensure that a strong control framework is in place to reduce leakage due to inefficiencies, as well as lapses in controls due to risk incidences. Promoting well-developed internal controls to understand the root causes of any operational issues and developing a feedback loop will ensure that loan quality is maintained, and loan-origination operations are efficient and effective.
It’s incumbent upon mortgage executives to be keenly attuned to their business metrics. As volume compression results in greater competition and tighter margins, originators will need to run their businesses more efficiently to protect balance sheets and avoid capital erosion. Companies with broader product offerings, such as non-qualified mortgage (non-QM) loans, are better positioned to handle this adverse environment, while those with limited products will face greater operational constraints.
Strategy for navigating headwinds
The key to navigating headwinds is having a strong set of metrics and analysis to guide decision making. This requires considering changes to product sets and potentially adding revenue generators, such as non-QM loans. Leverage data and financial analytics to drive business transformation and broaden strategy. Additionally, conduct financial evaluations of strategic decisions to ensure they increase enterprise value.
The heightened volatility and volume decline we can expect in 2022 are likely to present opportunities for consolidation. As many originators face significant operational difficulties, they may become more open to being acquired. Accordingly, companies able to better weather the storm might find attractive acquisition or collaboration opportunities that enable them to gain greater market share.
Unique acceleration opportunities will be available for businesses offering non-QM loans that are unaffected by the volume decline in agency origination. Mortgage operators with direct access to agencies and the expertise to create mortgage-backed securities will likely increase margins as they attract business from smaller originators.
Establish key performance indicators
As it is vital to closely follow performance metrics for early detection of risks and other negative issues, establish key performance indicators to monitor critical elements like labor utilization, cost to produce and production per FTE. Mortgage executives need to understand how efficiently their businesses employ labor and find technological solutions to reduce operational bottlenecks. It often takes three months before a new hire becomes efficient, and full-time workers can be difficult to remove from the payroll once they have been onboarded.
This may be an opportune time to use temporary or offshore resources to lower break-even volume and keep costs less correlated with revenue. Ensuring optimal productivity from your workforce could also entail investing in technology that drives additional layers of efficiency, or implementing process improvements. How does your company change or improve processes as you identify inefficient aspects? How long does it take to go from identifying a problem to implementing a solution?
Overhead efficiency, which can include leasing costs, is another key consideration when facing mortgage origination headwinds. Perhaps it would be a more prudent play to use coworking spaces before signing a long-term lease, as you assess whether a new branch or sales office is likely to be profitable. If the workforce is remote or hybrid, is there an opportunity to reconsider the use of office space? Make sure any overhead structure you add is both efficient and sustainable. On average, a $100,000 reduction in overhead results in lowering break-even volume by 3% to 4%.
Other areas to evaluate for efficiency include revenue margins, hedge effectiveness, operational and cash-flow velocity. I also recommend developing integrity validation for system-generated data to ensure accuracy and reliability.
Following a golden era of great profitability for the mortgage origination industry, a critical confluence of issues portends that next year will likely be more challenging. I believe enterprises with capital and long-term vision should stand ready to act on the opportunities created, driving internal decisions with an even greater focus on growth and further strengthening their businesses and growing the firm’s offerings.
2022 will be the year of nimble and efficient organizations, as companies with laborious mortgage origination processes find it significantly more difficult to maneuver. Businesses emphasizing efficiency and effectiveness can overcome the industry obstacles on the horizon and take advantage as others are impeded by them.