With interest rates still at record low levels, there is still many opportunities for banks to grow their mortgage book of business. Niket Patankar, senior vice president of financial services for Sutherland Global Services, discusses ways banks can increase market share now and in the future.
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.
The Consumer Financial Protection Bureau (CFPB) is trying to crack down on some of the biggest contributors to the financial crisis: mortgage loans with balloon payments, high-interest loans, no-doc loans and loans that exceed 43 percent of a borrower’s income.
The agency’s newly finalized rule that goes into effect in January 2014 creates a qualified mortgage standard and ability-to-repay rule that forbids those kinds of loans, that is, unless the lender wants to get sued for making them.
The trouble for small community banks and rural lenders is they often make some of those loans and they’re not trying to fleece customers.
Community banks sometimes make balloon payment loans of about five or seven years to hedge against interest rate risk. It sounds like a bad deal for the consumers, but these loans are kept in the bank’s portfolio and then simply refinanced without fees when the term is up–so no balloon payment is ever made and the borrower isn’t socked with a hefty reappraisal fee and other fees normally associated with a refinance.
People who don’t qualify for a loan under Fannie Mae and Freddie Mac underwriting standards–they work for themselves and don’t have a steady paycheck, or they own property that doesn’t qualify for a Fannie or Freddie loan for example—might be interested in getting such a loan from a community bank.
The banks don’t sell these loans in the secondary market or to a governmental authority. The bank keeps these loans, and their inherent risk, on their books. The logic is the bankers know their customers (in fact, their families have probably known each other for upward of 50 years).
One such banker is Jeff Boudreaux, the president and CEO of The Bank, in Jennings, Louisiana, a community of about 12,000 people about 36 miles from Lake Charles.
“We can’t make 20- to 30-year fixed-rate loans because we don’t know what will happen with CD rates,’’ he says. “We cannot box ourselves in and have that interest rate risk.”
The CFPB recognized that some small banks and lenders serve rural areas and other parts of the country that don’t have good access to credit. The agency said it wants to mitigate the risk that the new qualified mortgage rules would cut access to credit for people in those areas. The agency is carving out some exceptions for rural and small lenders. Yet, some community banks may still fall through the cracks.
For instance, rural lenders can make qualified mortgages with a balloon payment as long as they stay on the bank’s portfolio and the lender makes more than 50 percent of their mortgages in a designated rural or underserved area. The definition of rural will come from the U.S. Office of Management and Budget, but lenders such as The Bank won’t qualify. Despite its rural nature, Jennings falls in the metro area of Lake Charles. Only about 9 percent of the U.S. population lives in a designated rural area, says Matt Lambert, senior manager and policy counsel for the Conference of State Bank Supervisors (CSBS).
In a separate proposed rule available on the CFPB’s web site, the agency proposes creating a fourth category of qualified mortgages for borrowers who don’t meet the required 43 percent debt to income ratio or will be getting an interest rate that exceeds 150 basis points of the prime lending rate. The only entities that qualify to make such loans would be certain non-profit or designated housing organizations, or small lenders with less than $2 billion in assets that made fewer than 500 first-lien covered loans the previous year. Those lenders will be able to charge as much as 350 basis points above the prime rate. They must keep those loans in their portfolios, however.
But those lenders still can’t do interest only, negative amortization or balloon payment loans, or charge more than 3 percent in total fees and points (a higher fee is allowed for loans below $75,000), otherwise the mortgage is no longer a qualified mortgage. The rule has not been finalized.
Michael Stevens, senior executive vice president at the CSBS, points out that non-qualified mortgages are still allowed. They just don’t carry the newly created legal protection for lenders against lawsuits.
The question is whether a lot or very little lending will take place outside the definition of a qualified mortgage. Stevens thinks that if a lot of good borrowers are left out of the mix, the market will find a way to serve those people.
Richard Cordray, the director of the CFPB, this week encouraged the audience at a Credit Union National Association meeting to make loans outside the qualified mortgage rule.
“Of course, we understand that some of you–or your boards or lending committees–may be initially inclined to lend only within the qualified mortgage space, maybe out of caution about how the regulators would react,’’ he said in written remarks. “But you should have confidence in your strong underwriting standards, and you should not be holding back.”
Chris Williston, the president and chief executive officer of the Independent Bankers Association of Texas, is not satisfied. He wants a two-tiered system of regulation: one for small banks and one for larger banks that have the resources for complying with a deluge of government regulations.
The new qualified mortgage rule alone has more than 800 pages in it, and a concurrent proposal has more than 180 pages.
“All of our bankers are just weary and frustrated,’’ Williston says. “We have a lot of banks that are ready to throw in the towel.”
New rules coming out of Washington, D.C., will impact the mortgage market and banks big and small. Among them, the Consumer Financial Protection Bureau (CFPB) has proposed rules regarding mortgage disclosures. The agency says it is attempting to simplify and write plain English disclosures for consumers. Comments on the proposals are due Nov 6. In addition, the CFPB will require lenders to make sure a mortgage holder qualifies for a mortgage, or has the ability to repay the loan, creating what’s essentially a series of check boxes for lending departments, as well as restrictions on loan terms.
Because banks both large and small will be required to comply, Bank Director asked attorneys to weigh in on the CFPB’s proposed mortgage regulations.
Should community banks be exempted from the Consumer Financial Protection Bureau’s proposed rules on mortgage disclosure and qualifying mortgages?
Yes. Community banks need to be exempted from the Consumer Financial Protection Bureau’s proposed rules on mortgage disclosure and qualifying mortgages, as community banks have been and are subject to regulatory oversight on mortgage disclosures rules. There is no need for the CFPB to be involved in the supervision of community banks. Why do we need two regulators to oversee this issue and many other banking issues when federal bank regulators were adequately doing their jobs? One major problem that lead to the current crisis revolved around unregulated mortgage originators, not disclosure rules. Let bankers and their prudential regulators continue with regulatory oversight of mortgage disclosure rules and keep the CFPB out of community banks.
—Bob Monroe, Stinson Morrison Hecker
First, the current proposed definitions of qualified mortgages and qualified residential mortgages will continue the current inequity in the mortgage market. Essentially, people like me can refinance their mortgage to 3 percent with zero closing costs, while other people who desperately need to refinance cannot qualify. Thus, there needs to be some overall sanity brought to mortgage regulation. Beyond that, mortgage regulation needs to cover the entire food chain. The CFPB can reduce the burden on smaller financial institutions regarding such matters as assessing a customer’s ability to repay a loan. If the system of regulation mandates a cost structure that only large financial institutions can absorb, then the result will be the unintended (and the CFPB says undesirable) consequence of a market in which only the multi-trillion dollar institutions can participate.
—Peter Weinstock, Hunton & Williams
Small banks are struggling to keep up with the new rules, and already, we’ve seen some small institutions enter into what amounts to mortgage referral relationships with bigger banks that have enough horsepower in their compliance departments to keep up with all of the new rules. The CFPB needs to implement reasonable accommodations for these smaller institutions. Otherwise, they may very well regulate these banks out of a fundamental piece of their business.
—Jonathan Wegner, Baird Holm
Regulatory compliance costs have always fallen more heavily on community banks than on large banking companies because of the smaller volume of transaction over which community banks must distribute compliance costs. These costs make it more difficult for community banks to compete with larger banks on the basis of price. These considerations argue in favor of exempting community banks from proposed rules on mortgage disclosure and qualifying mortgages. On the other hand, when dealing with consumer protection issues, consumer advocates may argue that it is unfair and confusing to consumers to exempt anyone from consumer protection requirements. Despite these arguments, the presence of unregulated providers in a market provides a point of reference and a practical check on the potential for regulatory requirements to lead to a diminution in, or even unavailability, of key services and should ultimately benefit consumers.