“Well, it’s happened. Took longer then I thought, but it’s happened.” -Bagheera
(a.k.a. the panther from Disney’s Jungle Book)
It’s a beautiful fall here in Scottsdale, AZ, headquarters of Cornerstone Advisors. The license plates from across the Midwest are pouring into our streets, filled with half-blind snowbirds creaking along at 23 miles per hour.
Ah, but something else has changed. Things have become pretty quiet at the mortgage brokerage office across the hall in our building. For the past two years, it hasn’t been that way. There was more foot traffic, cell phone chatter, 1003s printing and HUD booklets flying than you’ve ever seen. An amazing $3.2 trillion in loan volume will be originated by the mortgage industry in 2003. What a heck of a party!
Alas, this too must pass. The mortgage bankers are now predicting that mortgage volumes will drop a whopping 47 percent during 2004. While there is no clear direction right now in the economy, continued stimulus and stock market up-ticks could drive even higher long-term rates early next year. At some point soon, the talk at neighborhood barbeques will center around families being “prisoners” of their current homes, afraid to build a new house or take that new job because they would forfeit the dreamy 4.75 percent mortgage on the books.
The mortgage refi boom has been a tremendous shot in the arm for bank profitability. Banks will earn close to $14 billion in “gain on sale” revenue during 2003, and CEOs have had the opportunity to brag about strong non-interest income at their institutions. The question is, what do we do now?
Well GonzoBankers, it’s time to think of the mortgage business as a game of musical chairs. Each time the music stops, there will be fewer chairs in the circle. Players in the game will have to run even faster to those open chairs and throw more elbows at unsuspecting neighbors. With lots of capacity built up and fewer deals to chase, one thing is certain:
CRAZY PRICING WILL COME AND MARGINS WILL THIN!
The game of pure hustle and endurance will now become a game of discipline, efficiency, and proactive marketing. Banks hoping to preserve a meaningful portion of their revenue and profit contribution had better buckle in and get ready to implement the Gonzo 10-Step Mortgage Plan for 2004. Here goes:
Step #1: Budget for thinning margins.
Folks who promise their boards 1.6 percent servicing released premiums next year might end up short when things get ugly. Make sure your 2004 budget reflects a cut in margins due to overcapacity.
Step #2: Don’t dream – cut costs fast!
When margins are thinning in a commodity business, there’s only one thing to do – cut costs and become a cost leader. Unfortunately, there will be a tendency for many mortgage shops to hesitate in rightsizing their mortgage operations. (“What if we get busy again? We’ll have to hire all these folks back!”) In recent discussions with clients, I have learned that those shops planning to deliver meaningful profits next year already have their scale-back plans in place. The key here is to benchmark, benchmark, benchmark! Measurements that track loans closed by originator, processor, closer and underwriter should be gospel and reported to the board every month.
Step #3: Use the time to streamline the model.
In the past three to four years, many bank mortgage functions have had little time to take a fresh look at processes and deploy more innovative new technologies. The coming year will be a great time to focus on initiatives such as these:
Step #4: Grovel at the feet of realtors and builders.
Refis will make up 66 percent of mortgage originations during 2003, but only 28 percent during 2004. With this mix change, banks will have to do a better job of relationship selling to Realtors and builders, the traditional marketing pipeline for purchase money mortgages.
Step #5: Grab a slice of portfolio niches.
Cornerstone has recently seen banks find some success with niche portfolio products. Many banks have been originating simple 10-year mortgages with no fees or the paperwork of Fannie and Freddie. Others have looked at balloon jumbo products, construction-to-perm and immigrant/ethnic niches for opportunity.
Step #6: Find a place for the ARMs.
As the interest rate environment shifts from fixed rate to variable, banks could be faced with an interesting dilemma: opportunities may exist to pump a lot of adjustable rate mortgages onto the balance sheet, but there may be more than the bank wants. Many institutions are busy trying to change their balance sheets to reflect fewer mortgages and more commercial and consumer loans. A bundle of ARMs will only exacerbate this issue. It is therefore critical that your bank’s secondary marketing manager be planning for conduits to sell these ARM loans, hopefully at a reasonable profit margin.
Step #7: Manage the ol’ servicing asset.
As long rates begin to bounce around, banks could see marked changes in the valuations of their servicing rights. Most commercial banks have exited the servicing business, but for those who still have this function, there will be two options to consider:
Step #8: Grab some talent during the downturn.
When industries contract, it’s always a good time to pick up talent displaced in the shuffle. Many mortgage banks just won’t make it through the shakeout. This will provide commercial banks the opportunity to recruit some of the gunslingers from these shops who will want a more stable employer. Although it doesn’t make sense to bulk up the mortgage staff at this time, banks still need to look at trading out weak producers for available strong ones.
Step #9: Automate cross-sell at origination.
Cross-selling retail banking products to mortgage borrowers has been one of the greatest “white whales” in the banking industry, full of promise and adventure but a dream never quite realized. Most banks take a half-hearted approach to mortgage cross-sell. However, Cornerstone has found that institutions with automated cross-sell processes have impressive results. For instance, Associated Bank in Green Bay, WI, has successfully cross-sold its unique home equity credit card to a large portion of its mortgage borrowers.
Step #10: Uncover opportunity in the deposit base.
It is truly amazing how little mortgage production actually comes from a bank’s deposit base. If your bank doesn’t track this figure, go check it out – it’s probably low, amigo. Our soon to be released 2003 Cornerstone Report: Benchmarks and Best Practices for Mid-Size Banks reveals that there are more than 20 deposit accounts for every mortgage account at the typical bank. Using some basic assumptions, the average mid-size bank could double its loan production if it captured mortgages from only an additional 12 percent of its deposit base that own homes. If there’s anything that MCIF and CRM and all the marketing stuff should target, it’s increasing mortgage origination through the deposit base – we’ve already got the darn relationship.
A lot of mortgage originators bought nice new cars in the past few years. Let’s hope they also socked some away. Banks are in for a tough mortgage environment, but there are actions they can take now to keep that baby profitable.