The current mortgage market is in a state of flux. The prolonged low interest rate environment is creating an extended boom for mortgage companies and providing tremendous profitability for banks. Fueled by attractive rates, heavy refinancing activity and a temporary surge in the influx of applications under a recently modified version of the Home Affordable Refinance Program (often referred to as HARP2), yield spreads are high for portfolio investment, and the gain on sale margins is also high.
Banks need to take advantage of this boom in the short term without losing out in the long term. Many financial institutions are successful at this, while other—fearing a repeat of the 2008 mortgage crash—are scratching their heads and wondering what to do. Should they join the party while the mortgage climate is hot, or take the ultra-conservative approach and stay on the sidelines?
To skip the party altogether is like leaving money on the table–and there is, indeed, money to be made in today’s bustling mortgage market. However, banks have to figure out a longer term strategy for building a sustainable business model that prepares them for the future, while allowing them to be profitable today.
To that end, here are three strategies to consider:
As market volumes are likely to decline, banks should right-size and right-shore their models to bring down the overall costs of production by 30 percent to 50 percent.
While 2012 mortgage volumes were healthy at $1.8 trillion, they are likely to decline to $1.5 trillion and $1.3 trillion in 2013 and 2014 respectively. Shrinking volumes will reduce market requirements and create challenges for banks that built up underwriting and production capacity to accommodate the boom. Over the next several months, banks need to create models to manage their production costs and create efficiencies that will help them prepare for a lower-volume environment.
Begin by building a model with a 12- to 18-month window for restructuring, and take steps to lower the overall cost of production by 30 percent to 50 percent. Lowering operating costs is critical, because the overall profitability per loan will shrink as volumes drop. While the net cost to originate is currently trending at about $3,800 per loan, banks will need to reduce their per-loan costs to around $2,800, or even less.
Another critical step is to adjust the headcount down by 20 percent to 30 percent. Right-sizing and right-shoring is a smart tactic whereby banks can split their processes into two different environments: Base the regulated processes and customer facing processes on-shore in the U.S., and shift non-regulated, back-office tasks to a more cost beneficial off-shore location such as India.
Design products that help gain business and make money in the marketplace.
In today’s competitive mortgage market, it is important to design products that are flexible, convenient and accommodate the needs of the core audience. It all circles back to Customer Management 101: Give customers what they want, not what you want to sell them.
This is especially important for community and regional banks because their footprint is local and they know their consumers, often by name. Instead of one-size-fits-all mortgage products, they can tailor to specific demographics and affordability profiles to retain their customers and prevent them from straying to the big national banks.
Examples of flexible products include mortgages that allow customers to choose the duration, such as 15, 20 or 30 years; the payment structure, which can be bi-weekly or monthly; and the interest rate, either variable, fixed or a combination. So long as you cross the threshold of affordability on the basic mortgage criteria, there is latitude for creativity. That said, no need to revert to exotic products: Think back to the era of option-ARM mortgages and negative amortization–both designed to fail, because they were created in a market that was not going to last forever.
Focus on customer experience management to improve margins and retain customers.
The customer experience is in addition to creating products based on your knowledge of the customer’s needs, it is essential to streamline the customer experience. Build a one-touch (maximum, two-touch) process from the initial application to the closing.
Establish a single point of contact—no bouncing customers from one processor to another—and manage the process every step of the way to ensure that it is a seamless, pleasant experience for the customer. Educate applicants upfront by thoroughly explaining the expectations—right down to every piece of documentation and forms they will be expected to provide.
Minimize delays: No long waits for underwriting. Do not take 120 days to close. Nothing is more frustrating to customers than missing a targeted closing date or receiving yet another request for a pay stub or bank statement. An efficient process yields a satisfied customer. And the banks that successfully attract and retain mortgage business amidst the up-and-down momentum of today’s market are the ones most likely to be profitable in the long run.
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