Residential lenders, whether they be depository banks, credit unions, independent mortgage banks, or brokers, are often concerned with the time when refinances dry up.
Danger: Lower volumes and margin compression ahead! What are STRATMOR clients doing? In general, lenders are logical, systematic individuals, and, in keeping with that, we felt it important to look at both the revenue and expense items that a lender has and see what can be done when the time comes for “belt tightening.”
Most lenders are still benefiting from a great 2020, and very good first and third quarters of 2021. If they spent all of their income on compensation and benefits for employees or owners, this would have been near-sighted. Certainly lenders “took chips off of the table” but many reinvested profits back into their companies, whether it was in signing or retention bonuses, new technology to help the manufacturing process, increased warehouse lines, or expanded business channels.
Simply put, lenders sell, and compete on product, price, or service. For lenders to be able to create, find investors for, and roll out new products is critical. Even “old” products are worth revisiting. For example, originating VA interest rate reduction refinances (IRRRLs) is fashionable again. But basic VA loans are widely used for home purchases. In the first quarter of 2021, large lenders had sizeable percentages of their VA loans used for home purchases: Quicken (10%), loanDepot (24%), Navy Federal Credit Union (43%), Guild (52%), Guaranteed Rate (69%), Fairway Independent (77%), and Prime Lending (82%).
From a revenue and expense perspective, depository banks borrow money (from depositors) at one low rate of interest, and lend the money out again at another, higher rate of interest. The difference is income for the owners and/or shareholders. Non-depository mortgage banks use their warehouse lines as a source of funding. If there is a positive spread between the cost of the warehouse line and the mortgage rate, the mortgage bank can use this as income. And lenders typically charge an origination fee of 0.5% to 1% of the loan value, which is due with mortgage payments. This fee increases the overall interest rate paid on a mortgage and the total cost of the home. But lenders find negotiating warehouse line expenses, or shifting mortgage rates, problematic and subject to market forces.
Residential lenders can make money in a variety of other ways, including origination fees, yield spread premiums, discount points, closing costs, mortgage-backed securities, and loan servicing. Closing costs that borrowers pay include application, processing, underwriting, loan lock, and other fees. Mortgage-backed securities allow lenders to profit by packaging and selling loans. Lenders may also get money for servicing the loans they package and sell via mortgage backed securities (MBS). Changing fee structures can provide benefits but are also subject to market forces.
Borrowers may pay discount points to the lender, often due at closing to help buy down the mortgage’s interest rate. Lenders know that if a borrower is paying points upfront, the fees typically lower monthly loan payments, which saves homeowners money over the life of the loan. Once again, lenders changing fees is limited by what competitors are offering. In addition to the loan origination fee and possibly the discount points, an application fee, processing fee, underwriting fee, loan lock fee, and other fees charged by lenders are paid during closing.
Another source of income is in the sales execution of the mortgage, or pools of mortgages, aka “Gain on Sale.” After closing on different types of mortgages, lenders will group together loans into mortgage-backed securities (MBS) and sell them for a profit. STRATMOR can assist capital markets staffs in becoming well-versed in best execution models, specified pool sales (“spec pools”), and finding reliable, well-priced jumbo and/or non-QM outlets. Companies should also do their best to limit pricing concessions and free extensions, or at least track them to identify dollar amounts and sources.
Lenders may earn revenue by continuing to service the loans they sell. If the whole loan or MBS purchasers are unable to process mortgage payments and handle administrative tasks involved with loan servicing, the lenders may perform those tasks for a small percentage of the mortgage value or for a predetermined fee. Outsourcing servicing to a reputable subservicer at a lower cost is often done by companies retaining servicing but realizing that it is an expensive proposition.
Moving to the expense side of the income statement, lenders’ largest expense is typically salaries, commissions, and benefits. Direct loan production costs come next, followed by marketing, travel, and entertainment. Costs to service the servicing portfolio are included, if the company is servicing, as are general and administrative expenses.
So, the areas of cutting costs are somewhat limited, especially when producers, whether they are retail loan officers or TPO account executives, are held in high regard. Travel and entertainment budgets are often targeted, although marketing is typically increased in an attempt to gain market share. Companies should try to improve efficiency, or the amount of “friction” between application and funding and servicing. How productive are processors, underwriters, doc drawers, and funders? Certain tasks are assigned to lower cost outsource providers.
Invest wisely in growth-focused digital tools and training. Originators are encouraged to improve their sales, retention, and referral techniques. As an analogy, if you buy a Ferrari, you’re not going to forget what kind of car you own. But the same brand identity doesn’t exist with mortgages. Most people who financed their home don’t know the individual or company they used. Recognition is even worse when they obtained the loan through a mortgage broker, who in turn placed it with a mortgage banker, who then sold it to an aggregator, and who may use a subservicer! How does the borrower remember you? Any loan officer building their brand and marketing to their previous clientele for refinances should keep this in mind.
Loan originators, whether brokers or loan officers, will tell you that a person’s habits do not change simply because a credit card was paid off through a cash-out refinance. In fact, the sight of a $0.00 balance on a credit card may tell a borrower that there is room to spend money using credit again. Top LOs are constantly in front of previous clients, reminding them who they are and of their product offerings.
Lenders earn income in a limited number of ways, and they spend money in a limited number of ways. Running an efficient operation is not rocket science, but it does take knowledge, discipline, and a lack of fear to make and execute wise, yet occasionally difficult, decisions in the face of diminishing margins and production volume. The industry has been through business cycles before, and will go through them again. Growing volume and margins may be difficult but maintaining market share by increasing revenue and decreasing expenses can be done. “Hope is not a strategy!”
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