Plight of the Small Independent Lender

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Rob Chrisman's Perspectives
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I know many owners and CEOs of residential lenders and would never bet against their success. They represent a very savvy, entrepreneurial, and street-smart group of individuals. Yet every estimate of residential lending volume tells us that 2018’s volume will be down from 2017’s. And while purchase volume — the mainstay mortgage market for independent lenders — is forecast by the MBA to grow very modestly over the 2018 to 2020 time-frame, the overall slow growth in the market — especially when measured in units —-is expected to foster intense price competition. This  is never good for smaller lenders, many of whom will likely face thin profit margins or losses and, where losses are involved, risks to their warehouse lines. How many smaller lenders will have staying power?

The general consensus is that there are several risks that smaller independent lenders in particular have to contend with. First off, is flat growth. One would think that low interest rates would result in a robust home sales and mortgage market. But despite attractive interest rates, the inventory of homes for sale has been weak. Of course, some of this is seasonal, but the lack of homes in inventory is a function of deeper issues. For example, the problems builders are having finding good land near city centers, finding adequate labor and materials and having local city governments approve development plans all conspire to constrain inventory and are well documented.

And let’s face it, when confronted with a low or no-growth market, the first thing that most lenders do — especially smaller lenders — is to price more aggressively so as to retain their sales force and continue feeding loans to their back-office operations. Unfortunately, price cuts typically result in commensurate drops in margins.

Volume volatility is also not friendly to back office costs and therefore puts a further squeeze on margins. Relatively large volume swings are characteristic of a predominantly seasonal purchase market — which we are in — but are far less pronounced in a refi-market. Further, in a refi-market, the lender has control over when loans will close, which allows them to “level the workload” and thereby better manage back office capacity and costs. Workload leveling is much more difficult in a purchase market.

Poaching of top originators by competitors seeking to sustain or grow volume is another risk that falls more heavily on smaller independent lenders. Top originators are more willing to move to a better capitalized competitor when they perceive that their existing employer may face warehouse problems that threaten their survival. And larger lenders typically see a tough market as an opportune time to pick-off individual originators or even whole branches at relatively low cost from smaller competitors.

So, the current residential lending landscape is tough, but not an impossible challenge for the smaller independent mortgage banker. They are a resilient bunch who have been through business cycles before. But surviving in the current landscape is unlikely with a “business-as-usual” approach.

Can an independent lender lower its sales expenses — with average LO commissions often exceeding 100 bps — to compete with banks that pay their LOs 50-80 basis points? Historically, faced with a down market, lenders would lower their pricing to sustain volume without asking their originators to share in the cost by accepting lower commission rates.

No one wants to be “the first penguin in the water” when it comes to making LO compensation changes. But done the right way, these changes can have a very positive impact on an independent’s bottom line and chances of survival.  In return for accepting lower commissions, independent mortgage bankers should deliver a great “tool kit” to their LOs. Sure, originators will often favor a better comp plan than not in deciding where to work, but management can do their utmost to create an environment where LO decision-making isn’t purely based on commission levels. LOs want better leads, for example, good back-office efficiency, and better-than-average pricing. The result? LOs who make less per loan but close more loans.

Every manager will tell you that the key to sales is focusing on the high producers, a perspective that is backed-up by STRATMOR’s Originator Census Survey that shows that over 80% of the volume is being done by 40% of the originators. So, an increase of 20-25% in productivity for these high producers results in more volume than is being done by the lower 60% of originators.

Focusing on the high producers involves providing them with better leads, a more efficient back office and better pricing. But it also involves a willingness to aggressively prune originators in the lower 60%. Especially in hard times, with survival at stake, letting low producers go is a necessity. Pruning dead-wood originators virtually assures that high producers get better service from the back office. Hard times call for hard decisions!

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