Changing Distribution Scenario of the US Mortgage Market
August 2013
Changing Distribution Scenario of the US Mortgage Market Overview The US mortgage industry went under a phase of severe uncertainty over the past decade – especially since the 2008 economic recession has struck the global economy very hard. Inefficient origination process ‒ including limping appraisals, mechanical checks, inefficient controls and impractical valuations, have all constituted to the existing state of affairs that resulted in the collapse of the retail mortgage market, and decreased consumer confidence. This has bought a new challenge to reduce inefficiencies and revive the industry for mortgage originators over the period. The housing market is considered to be a key indicator of the vibrancy of the US economy. While the regulators and government attempt to re-build the economy, banks also need to add their efforts towards the revival of housing market by improving operational efficiency of mortgage lending processes. To attain such efficiency, it becomes essential to understand the changing trends and evolution of key distribution channels – retail, broker and correspondent. The housing market collapse is also been seen as a real game-changer for several lenders within the mortgage market. Various new regulations have changed the roles of the market participants in the US. Lenders including banks have benefited from these changes, as they face a much positive market scenario and are poised for growth. However, in case of brokers, they may lose some ground as it has created a struggle for survival, with several new licensing norms being put in place. Today, brokers have become a more costly channel, with customers opting for new direct origination methods using new technologies including – smartphone (in the form of a request for a mortgage loan) or online and telephone-initiated origination directly from the banks’ end. Use of such new technologies has not only provided portability (multi-channel access) to application process but has also helped to quicken the transaction and approval process.
Understanding the Basics Mortgage channels (originators) can be termed as an institution or individual that works with a borrower to complete a mortgage transaction. Mortgage channel, which is a part of the primary mortgage market, can be either a mortgage broker or a mortgage banker, and is the original mortgage lender. Although, there are a variety of distribution channels in the mortgage industry today, but the US mortgage industry majorly originates from two different channels – retail & wholesale (broker and correspondent). • •
Retail – Loans that originate through a direct relationship with the borrower Wholesale – Comprised of the following channels;
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Broker – Loans that originate through a mortgage broker, where the Company underwrites the loan directly with the borrower – Correspondent – Loans originated and funded by a third party, where the Company purchases the closed loans after the correspondent has funded the loan. Correspondent includes loans acquired in large bulk purchases from other mortgage originators primarily during 2006–07. Such bulk purchases were discontinued in 2007
Mortgage Origination Market Size The current state of the US mortgages business is a continuing reminder of the financial crisis. The total mortgage origination volume in the US has decreased from USD3.1 Tn in 2005 to USD 1.91 Tn in 2012, thus registering an overall decline of 39% over a period of seven years. Most of the decline was hosted in 2008 when the first wave of global financial crisis struck the US economy. In 2008, the total mortgage volume of the nation declined 38.3% year-on-year (y-o-y) to reach USD1.50 Tn. Though, the market revived in 2009, after posting a 22.7% y-o-y increase to reach USD1.84 Tn, the mortgage origination market once again went into the streams of second recession in 2010 and 2011. The market declined 11.4% and 9.8% to reach USD1.63 Tn and USD1.47 Tn in 2010 and 2011, respectively. But in 2012, the signs of recovery was again been noticed when the mortgage origination volume increased 29.6% to reach USD1.9 Tn. (Refer Figure 1) Figure 1: US Mortgage Origination Volume (USD Bn) 4,000 3,120 3,000 920
2,980 980
2,430 696
2,000 976
880
1,840 1,500
686
1,000
683 479 295
1,224
1,120
1,047
2006
2007
276
1,905 1,630 543 196
1,470
555
475 143
207
726
881
891
852
2008
2009
2010
2011
1,143
0 2005
Retail
Broker
2012
500 140 50 310 Q1'13
Correspondent
Source: Inside Mortgage Finance
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Although, the overall market size of the mortgage origination has decreased considerably (38.9%) over the period of 2005-12, mortgage origination through retail channel has increased its share from 39% in 2005 to excess of 60% in Q1 2013. On the other hand, mortgage origination through brokers (wholesale) decreased considerably from 31% in 2005 to 10% in Q1 2013 due to increase in cost. Origination through correspondent remained somewhat stable during the period. (Refer Figure 2) Figure 2: Channel Contribution Towards Mortgage Origination 2005
39%
2006
38%
2007
31% 30%
43% 48%
2009
48%
2011 2012
33%
28%
2008
2010
30%
29%
20%
32%
15%
55%
12%
58%

33%
10%
60%
Q1'13
37%
32%
11%
62%
29%
10% Retail
Broker
28% Correspondent
Source: Inside Mortgage Finance
Changing Trends in US Mortgage Distribution Channels Banks Exiting Wholesale Mortgage Lending - Broker Channel Declining In the current scenario of things within the US mortgage industry; there has been a new trend that has evolved post crisis, where one by one, the major US banks have started announcing their exit from the wholesale mortgage banking business. The exit process was initiated during the economic crisis period by Chase in February 2009, which further continued with Bank of America/Countrywide in 2010, and ended up this year with Citigroup in February, EverBank and US largest mortgage lender, Wells Fargo in July 2013. During the pre crisis era, the broker channel originated 29.7% of mortgage loans in the US, which fell down considerably to 15.6% during the financial crisis. Decline in broker channel sales resulted in increase of retail (50.3%) and correspondents (34.1%) shares. But the trends did not stagnate here. Broker channel further declined to 10.2% in the post crisis era, thus making it considerably small as compared to retail (60%) and correspondents (29.8%) channels. (Refer Figure 3)
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Figure 3: Average Market Share of Mortgage Originations During Crisis (2008-10)
Pre Crisis (2005-07)
30.3%
Post Crisis (2011-13*)
29.8%
34.1%
40.0%
50.3% 10.2% 15.6%
29.7%
60.0%
Retail
Broker
Correspondent
Source: Inside Mortgage Finance
*2013 data only reflects the first quarter numbers
Banks have cited regulatory pressures as the key reason for them to exit the wholesale mortgage lending business. Increase in licensing and regulatory requirements, such as restrictive closing costs on loans, had led to a higher cost of production for brokers. As a result, major lenders (banks) have started to close down their broker channels, which reduced the share of brokers in total originations to 10% in 2012 from 30% in 2005. Also, the new regulations have favored the retail/correspondent channels. "…In recent years – particularly in the wake of the financial crisis – the broker lending business has been in a state of transition. Given the recent rise in interest rates and the resulting dampening effect on refinance activity – coupled with the evolving regulatory burdens specific to the broker business – we’ve decided that it is in EverBank’s longterm best interest to exit wholesale broker lending…" –
Michael Cosgrov, EverBank
The Wells Fargo Story In July 2013, Wells Fargo & Co., announced the exit from all of its joint-venture (JV) mortgage brokerages due to the new federal and state regulations that are part of the Dodd-Frank financial-overhaul law. Under DoddFrank, the businesses could be subjected to state regulation, in addition to existing federal regulation, bringing new licensing requirements and additional complexity which could further add to costs. The exit move comes as the lucrative US home-loan business starts to decline amid a waning refinancing boom and rising long-term interest rates that have tempered demand. Like most US banks, Wells Fargo has also noticed its home loan business go down in the most recent quarter. According to bank’s financials, the second quarter (Q2 2013) income from mortgages decreased 3% year-on-year to USD2.8 Bn. In 2011, Wells Fargo had more than 80 JV, which they had over the past year closed all except eight. These eight accounted for the vast majority of the JV’s loan volume. The JVs had accounted for 3% of Wells Fargo's mortgage business in the third quarter. The decision to wrap up the remaining JV’s has already started and will be completed by mid of 2014.
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Small lenders gaining prominence Several small lenders – including well-capitalized community banks and focused players such as Stearns Lending, etc. – have gained prominence over the years. These small lenders are boon for consumers as they offer loans at cheaper interest rates, lower costs and with quicker processing times. Such initiatives help small lenders to offer aggressive pricing over large banks and thus acquiring business from big players including Citigroup and Bank of America, who have retrenched after the financial crisis. According to Inside Mortgage Finance, in 2012, the five biggest US mortgage lenders market shares declined to just 53.2%, down from nearly two-third in 2010. A recent FBR Capital Markets report forecasts that, by 2014, the five biggest US mortgage lenders market shares could shrink to up to 40% of the USD1.8 Tr mortgage market. "…When the big guys get backed up, they have a tendency to raise their price, to slow down volume. And that gives other lenders an opportunity, because the consumer thinks, ‘Why would I pay an extra $100 a month…'" –
Brian Hale, Chief Executive, Stearns Lending Inc
Moreover, some of the small lenders who are backed by private equity and hedge fund money are also aggressively taking advantage of federal guarantees to make home loans geared toward low-income borrowers - more so than the big banks. Such loans, which are insured by the Federal Housing Authority (FHA), require a down payment of as low as 3.5% of the purchase price, as compared to the usual 20%. Online channel – including players such as Guaranteed Rate, Quicken Loans, etc. – have also become popular with borrowers. Currently more than 10% of the total originations happen through online lending compared to 7% in 2010.
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The Quicken Loan Story Quicken Loans is a Detroit-based online mortgage lender founded in 1985 by Dan Gilbert. Quicken is one of the fast growing mortgage lenders in the US, whose origination grew to USD70 Bn in 2012 from USD12 Bn in 2008, with a growth of 483%. The most important factor behind Quicken’s growth was its ability to acquire market share from other lenders, who were badly hit by the 2007-08 sub-prime crisis in the US. Record-low interest rates have helped, spurring a refinancing boom and thus resulted in boosting Quicken’s profits. Moreover, Quicken distanced itself from the worst sort of mortgage practices that punctuated the nation’s housing meltdown. According to the 2012 fourth quarter figures, Quicken Loans, which operates only online with no brick-and-mortar infrastructure, ranks as the nation’s third-largest residential mortgage lender, closing in on No. 2 JP Morgan Chase. Quicken now writes nearly 5% of all residential mortgages in the US, and is still growing in a highly fragmented market. The company employs around 10,000 workers, almost all of them in downtown Detroit. Quicken Loans Growth During 2008-12: 483% USD70 Bn 24.9 20.1 USD30 Bn
USD29 Bn USD12 Bn 6.8 4.2
Q1
Q3
2008
Q4
8.7
7.9
6.2 4.1
2.7 2.1 3.0 Q2
13.9
USD25 Bn
Q1
Q2
Q3
2009
Q4
Q2
8.4 5.3 5.5
5.0 5.1
Q1
10.8 10.9
10.2
Q3
Q4
2010
Q1
Q2
Q3
2011
Q4
Q1
Q2
Q3
Q4
2012
Quicken's Mortgage Volume (USD Bn)
Increasing Cost of Operation The depressed state of the US economy had an adverse effect on the overall mortgage operations of the lenders. Not only it led to increase of origination cost, but has also impacted the profit and productivity of the lenders. According to Mortgage Bankers Association, the net cost of origination per loan increased 10% to USD4,182 in Q1 2013, up from USD3,813 in Q4 2012. Similarly personnel expenses averaged USD3,785 per loan in Q1 2013, up from USD3,570 per loan in Q4 2012. On the other, the average profit made per loan originated by banks declined ~21% to USD1,772 in Q1 2013, down from USD2,256 from Q4 2012. Similarly, productivity was 3.1 loans originated per production employee per month in Q1 2013 as compared to 3.8 in Q4 2012. Changing Distribution Scenario of the US Mortgage Market
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Mortgage Origination Challenges Due to certain challenges that confront mortgage lenders, origination has become a tough job at retail level too. Some of these key challenges that lenders face in revamping their origination operations are listed below; Decline in Retail Mortgage Loan Volumes The revival of US economy relies greatly on new mortgage purchase loan (loans for new purchases) originations and increase in home owners’ confidence. Although the market share of retail channel has increased from 39% in 2005 to 60% in 2012, the overall market numbers have decreased from USD1.22 Tn to USD1.14Tn, during the same period (Refer Figure 1 & 2). This means that new business volumes have been declining thus affecting income levels, because of heightened refinance activity and other requirements relating to loan modification. This is why banks have not been able to handle additional business volumes, and efficiently process refinance requests to bring down their operational overheads, which have adversely affected their profitability. Shifting of Sourcing Model One of the significant fallout of the financial crisis has been in the banks trend to shift away from wholesale (broker) origination channels. Amount of loans originated through broker channel and proportion of such loans to total loans originated has been coming down consistently since 2005-06. Origination of loans disbursed through broker has decreased from USD976 Bn in 2005 to USD207 Bn in 2012. Similarly, the market share (contribution) of broker channel has decreased from 31% to 10%, during the same period (Refer Figure 1 & 2). Tougher Regulatory Environment Banks are already required to comply with a number of regulations during the mortgage loan origination process, but after the implementation of the Dodd Frank legislation, compliance process has become even more complex and time consuming. Due to the rapid frequency of such regulations and their granular impact on origination processes, banks face multiple challenges including – timely response, escalating compliance costs, cascading awareness of compliance requirements down the organization and compliance monitoring.
Conclusion The US financial crisis and the current state of the home mortgage business portfolio continue to put a huge pressure on the operations of banks. This has not only bought the financial viability of several banks under threat, but has also lowered down the confidence of the country’s citizens. This is why, a fair recovery of interest in new mortgages, and revival of home owners' confidence is a much needed catalyst for recovery of the US economy out of stagflation
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pressures. This would also help banks eliminate bad loans and investments from their balance sheets. For such a recovery, banks need to initiate with several systems and processes in place to manage what has become the “new normal� for the industry. They have to necessarily become innovative & enterprising in transforming their mortgage origination business. Technology can be a great enabler to start of the process for overcoming the existing challenges in the origination process. Banks should invest in robust technology solutions for mortgage origination, as the proportion of originations through alternate direct channels including internet banking and mobile banking is still negligible. Also, to overcome the deficiency caused by current economic condition banks need to transform existing mortgage operations by improving operating efficiencies thereby reducing overheads, and putting sophisticated control mechanism in place. Banks should also try to garner a greater share of the refinance market. This can result in achieving growth in the overall mortgage segment and stay ahead even in a falling market.
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References 1. Inside Mortgage Finance 2. Mortgage Bankers Association 3. Mortgage Professional America 4. Detroit Free Press 5. Mortgage Calculator 6. Washington Business Journal 7. B-Complaint 8. Bloomberg 9. Reuters 10. The Wall Street Journal 11. Sutherland Research
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