Residential Lending, Banks, and Market Share
In the not the too distant past, if you wanted a home loan, the first place you’d go was to your bank. And often it was a large bank. A Federal Reserve Bank of Richmond research piece shows that the ten largest banks in 1960 were Bank of America, Chase Manhattan Bank, First National City Bank of New York, Chemical Bank New York Trust Company, Morgan Guaranty Trust Company, Manufacturer’s Hanover Trust Company, Bank of California, Security First National Bank, Banker’s Trust Company, and First National Bank of Chicago. But by the end of 2005, only three of these banks still existed: Bank of America, Citigroup (formerly National City Bank of New York), and JP Morgan Chase (an amalgamation of many of the banks listed above)!
To continue this, in 1960, there were nearly 13,000 independent banks. By 2005, the number had dropped in half, to about 6,500. In 1960, the ten largest banks held 21 percent of the banking industry’s assets. By 2005, this share had grown to almost 60 percent. And by 2017 the number of banks had dropped to 4,900.
What gives? A piece by Tom Finnegan of the STRATMOR Group notes that, “Theoretical scale advantages have not only not materialized, but, based on MBA-STRATMOR Peer Group Roundtable (PGR) data, seems to reflect diseconomies of scale in many instances.” Large Banks are subject to regulatory pressure and oversight to a much greater degree than Independents have experienced historically, and this has contributed to outsized legal and compliance costs. They must deal with complying with the Community Reinvestment Act, which can potentially add costs. Some banks are not comfortable with the potential risks, regulatory, financial, or reputational.
Furthermore, looking at mortgage originations, as “deep pocket” mortgage providers, the large banks have been subject to class action lawsuits and governmental enforcement actions which have resulted in large settlements – significantly reducing or eliminating years of earnings in the business line. They have shifted business channels and changed models. Several years ago JPMorgan Chase and Wells Fargo shut down their wholesale channels: They couldn’t guarantee regulators that they could completely oversee broker clients. Chase has withdrawn from FHA lending due to the potential severe liabilities from the False Claims Act.
But there are other residential lending issues as well, and non-bank lenders are only too happy to step in and inhale the market share loss suffered by the large banks. In the PGR data, STRATMOR treats the origination and sale of mortgages as a distinct component of the overall mortgage business and analyzes origination and sales separately from the servicing of mortgages. And from the investment in mortgages for their loan portfolio. Using this approach, as a group, the large banks lost $4,803 for every mortgage originated in the Retail channel in 2018, an 81 percent increase over the $2,659 per loan loss in 2017.
This loss was driven by large bank total per-loan expenses of $13,628 (375 basis points based on loan size) in 2018, much of it due to the residential mortgage division being allocated a healthy piece of corporate overhead – something non-bank lenders don’t face to such a large degree. Diving into the numbers show that the poor income performance of large banks reflects revenue and marketing problems in addition to expense issues.
Banks are quick to point out, however, that “revenue streams over and above” what is captured in the numbers include the value of protecting an existing banking customer from cannibalization by bank competitors who originate a mortgage for that customer and then move their existing bank accounts. Large banks pay a steep price for these streams: PGR data found that large bank revenues were more than 150 bps lower than the revenues of large independents. In dollars, at an average loan balance of $363 thousand, that’s a revenue differential/price concession of around $5,400 per loan. Some large banks will argue that cross-selling deposit accounts, HELOCs, car loans, direct deposit, wealth management, brokerage fees, etc. generate more than $5,400. And thus the argument can be made that low big bank mortgage revenues are a consequence of other income streams that are not reflected in the mortgage P&L.
Can non-bank lenders continue to take market share? Yes. Some lenders are trying to move into additional phases of the financial life cycle historically owned by banks (first-time home buyer programs, reverse mortgages). Others increase brand awareness through advertising, or ink deals with investors to offer portfolio products. And non-bank lenders are once again taking a look at servicing loans, allowing them stay in touch with their mortgage customers throughout the life of the loan and thereby improve their capture of a new loan when an existing loan pays-off.
Unlike large banks, where residential lending is only a piece of the overall business, for non-bank lenders it is the only piece. One hundred percent of their concentration is on lending related to homes, and there is little or no fall back revenue to be earned from auto loans, wealth management, credit card fee income, and so on. We can expect to see continued strength in residential lending from non-banks who seem better able to originate loans from a P&L perspective and who are also comfortable with the risks present in the business.