It’s a watered-down version of the veiled threat lobbed by parents at rambunctious children tearing through homes across the country every day. If you’re not careful, something’s going to break.
Today it has another application — in the home mortgage industry. Big banks look like they are courting considerable risk by playing a long game that’s squeezing market competition while also forcing warehouse lenders to increase risk tolerance as their markets dry up.
Worst of all, the entire strategy seems to be based on the ability to weather a storm of significant short-term losses for the promise of brighter skies down the line. The result could be catastrophic to both mortgage originators and the economy as a whole.
As any originator who’s had to compete for business with a large lender can tell you, big banks’ appetite for losing money on residential and commercial mortgage originations has increased steadily over the last few years. Bank of America, Wells Fargo, JPMorgan Chase and others have shown an affinity for offering rates that smaller independent mortgage brokers can’t compete with because the deals simply aren’t profitable, with margins barely edging into the black — if at all.
One report from Mortgage Bankers Association and Stratmor Group found that the largest banks lost a “somewhat amazing” $4,803 for every mortgage originated in the retail channel in 2018. That was an 81% increase over the $2,659 per-loan loss in 2017. Let’s assume that this was by design on the big banks’ part and not the result of general ineptness.
Big lenders likely are trying to achieve two things with this money-losing strategy, neither of which are necessarily new: increase their balance sheets in the form of mortgage servicing rights and squeeze the market, forcing smaller originators to either consolidate or close altogether. Less competition means more business. With a financial structure prioritizing servicing rights over origination revenue, these banks are content to play in the shallow end of the loan origination pool. Put another way, they’re losing money on originations to rub out competition, and they are free to do so as long as their bet on interest rates pays off.
If the Fed takes action and raises interest rates to cool a fiery economy, as it signaled it would in December 2018, these large lenders would see their servicing portfolios skyrocket in value, leaving those losing originations in the rearview mirror. Only three months later, Fed officials reversed course amid slower overall economic growth and signaled that interest rates may stay the same for the rest of this year.
Rates have not only remained relatively stagnant in 2019, they’ve actually decreased over the last quarter. The pot of gold at the end of the interest rate rainbow remains elusive. Unfortunately, the money lost on those originations remains very real.
Suddenly, the nation’s largest originators are beginning to implement slow and expensive strategies to stop the bleeding. As reported in Business Insider, America’s biggest banks are offloading parts of their home loan businesses to machine-powered startups as they try and fend off sagging profits.
Take U.S. Bank, for example, which unveiled its digital mortgage experience this past May. Backed by Blend, the digital mortgage software company, the digital mortgage play purports to cut both cost and time from the home loan process. But it will theoretically decrease servicing costs as well.
Culling the herd
Until now, the margin compression that has faced the industry for the past year or so has proven lethal for smaller, regional lenders, but hasn’t phased big lenders. It has, however, forced many independent mortgage banks and brokers to consolidate and, in the worst of cases, shut their doors.
Independent mortgage banks and mortgage subsidiaries of chartered banks saw net losses of $200 on each loan originated in fourth-quarter 2018, according to the Mortgage Bankers Association. “Independent mortgage bankers continued to struggle in this very competitive mortgage market environment, with the average pre-tax net production income per loan reaching its lowest level since the inception of our report in 2008,” said Marina Walsh, MBA’s vice president of industry analysis, at the time. “Among the headwinds for mortgage bankers were lower volume, lower revenues and higher costs.”
In that kind of climate, it’s no wonder that, within a matter of weeks, HomeStreet Bank sold off its mortgage origination business, Live Well Financial shuttered its operations and Bank 34 abandoned the mortgage business as well. More than one of these companies cited some version of “unforeseen market circumstances” as the reason for leaving the business. In February 2019, when Provident Financial Holdings announced its exit from mortgage banking, the company CEO also cited “required investments in expensive technology,” in all likelihood to lower costs. Sound familiar?
Now throw in a particularly sluggish first-quarter 2019, the slowest quarter for mortgage originations since 2014, according to the Fed. If the parallel trends of sinking rates and slowing originations continue, it will only speed the demise of more and more local and regional originators.
Meanwhile, the large depositories are built to weather just this type of market uncertainty. They seem content to scale down on people in the pivot to a more digital mortgage experience, while also subsisting on razor-thin margins and taking a hit on mortgage servicing-rights portfolios during this time when rates are stagnant or slumping.
Federally insured lenders can take that hit in the short term. They watch and wait while the HomeStreets, Live Wells and Providents of the world can’t. The herd is being culled.
End of dream
Some will say the modern and crowded mortgage marketplace dictates the exit of smaller players who don’t have the capital to follow suit in digitizing the loan experience. For borrowers, the short-term effect is an ability to nab great rates on homes and mortgage refinances.
Sounds like a great time to be a borrower, right? In the long run, less competition and less choice will reveal a market deficiency, one that is ultimately unfavorable to the average borrower — and clearly unfavorable to originators across the country.
Furthermore, private equity players have entered the mortgage industry in recent years. They’re not just watching the smaller and regional players disappear around them. These private equity players are actively gobbling them up and are willing to make the same mortgage servicing rights-focused long play as the large depositories.
So, fast forward. If market conditions continue along the same vector, there will be significantly fewer local and regional lenders in the years to come. Less competition is always worse for consumers.
Within the mortgage industry, the players left on the field are going to be highly leveraged digitally. They’ll be increasingly asking borrowers to press a button on their phone to get a mortgage. The play toward digital is the right one. It’s an efficient, client-minded proposition. But it doesn’t have every borrower in mind, and it shouldn’t be the industry end-all, be-all.
The digital proposition works well for the refinance side of the business, and it works well for the borrower with a 750-point credit score, who’s had the same corporate job for the last five years. These mortgage slam dunks fit squarely into the boxes that mortgage origination apps want to fill and package quickly, with industry-leading efficiency.
Who gets left behind in this equation? For one, hundreds of small lenders and originators across the country. More importantly, all those who don’t fit neatly into the mortgage box: some of the hardest working people in this country such as the self-employed, those with less than stellar credit, immigrants, and first-time homebuyers with few assets.
For these borrowers, and for the thousands of other one-off cases, more digitalization, less humanization and far less lender competition is not just a roadblock to the American dream. It could be the end of it altogether.
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The big-bank squeeze on commercial and residential originators is a dangerous game, and the effects are just starting to be seen. If this trajectory continues, there will be more forced consolidations and closures, which will undoubtedly ripple through the industry. In the end, it won’t just be originators paying the price. Borrowers, too, will suffer. If we’re not careful, something’s going to break.