Banking vs. The Mortgage Industry: two industries, two different outcomes and how these market differences impact technology by Rick Roque

by 23 Sep 2011
[caption id="attachment_4927" align="alignleft" width="268" caption="bank, HARP 2, HARP, technology, mortgage tech, mortgage, banking, 2 big 2 fail, too big too fail"]bank, HARP 2, HARP, technology, mortgage tech, mortgage, banking, 2 big 2 fail, too big too fail [/caption] This is a tale of two markets.  If you work in the mortgage business, you’ve been living in a parallel universe where on one side – let’s call that the Broker/Mortgage Lender universe, your world has quickly come to an end or at a minimum has been reshaped dramatically.  While if you’ve been operating on the Commercial/Depository Banking side of the universe, a new and very profitable market has opened up to you.  As many expected, mortgage lending has dropped significantly from its height in 2006 at nearly $3.0T (all mortgages, from all channels – retail, wholesale, depository & non depository) to pre 1999 levels of around $1T (or less – the year isn’t over…).  But this reshaping of the market has not been all that bad for all mortgage operations.  There have been some clear winners and losers.  The market share of mortgages for depository banks in the United States has gone from under fifteen percent in 2005 of total origination volume to nearly eighty five percent across the United States.  This is a gift that was handed to them when Federal legislatures decided to place the blame on the market squarely on the mortgage broker and mortgage lender.  This alignment of blame was entirely political as the ABA was all too eager to assume the volume to offset the losses incurred by the collapse in the market. [caption id="" align="alignnone" width="300" caption="bank, HARP 2, HARP, technology, mortgage tech, mortgage, banking, 2 big 2 fail, too big too fail"]bank, HARP 2, HARP, technology, mortgage tech, mortgage, banking, 2 big 2 fail, too big too fail [/caption] To many in banking, the opportunity in mortgage lending has just begun.  Dodd Frank and the very powerful ABA have been skillful in steering the mortgage industry in its direction.  And who can blame them?  The Mortgage Industry is an extremely profitable business, but it is also highly specialized.  As many banks have recently understood, you can’t put a teller in front of a computer and expect them to advise a customer on their mortgage options - that is, unless you reduce the available products in the market and only give the teller, now mortgage advisor, two products to sell.  Even today, the complexity of the mortgage business far exceeds anything in the typical retail banking operation.  There are too many variables and too many interested parties required in the process to efficiently and effectively serve clients.  For an industry segment, i.e. Housing, residential fixed investments and housing services, that at its peak in 2005 was roughly twenty percent of the United State’s GDP, to sustain this, a market needs to sustain scalability and growth.  This part of the market is too important for our national growth as whole.  Over forty percent of our total GDP as a country is made up from five states – California, New York, Texas, Illinois and Florida and therefore getting the housing markets corrected, with market adjusted mortgage products to meet local needs is a national priority.  Looking at the five states, I guess getting one out of five states right isn’t bad - Texas consequently was one of the few states in the country where cash-out refinancing restrictions were severely restricted.  Nick Timiraos from the Wall Street Journal wrote a great article that was widely reprinted across the United States on how the “Housing Bubble didn’t mess with Texas” (WSJ, April 2009); A stable economy has resulted from common sense, ’down to home’ set of policies, and if you can believe this:  that was before Dodd Frankwhat in the world did the financial world do before all of this Federal Regulation?  It was simple:  We did what was in the best interest of the borrower by advising them on the products in the market that would provide them with the lowest rate and monthly payment possible.  Quite honestly, who can blame Texas with their succession undertones?       Housing a National Priority?   – How the Big Banks Crushed Brokers & Mortgage Banks and cut $2T off from an industry. For our economy to grow once again and for an industry such as our own, to expand and scale, you need efficiencies in the process; you need competitive pricing, you need quick turn times and lastly, you need trained professionals who are skilled enough to advise borrowers of the best options available to them in the market.  The mortgage agents of our industry need to be able to handle volume without negatively impacting the preceding factors:  efficiency, pricing, professional competence and turn times - effectively called service levels. The traditional banks can’t do any of these things comparatively well and they have struggled, quite frankly, at each of these levels in order to sustain our industry.  After decimating every non depository mortgage originating entity, there wasn’t anyone left to do a mortgage.  So the banks got what they wanted – and that was a highly profitable market segment that up until now, had provided a better service at a lower cost than what they could provide to their depository customers.  But in order to do this, we had to lose a decade of housing industry growth.  The decision was easy but the question was how could this be done swiftly?  Allow me to provide a narrow summary of these events and I’ll explain exactly how this impacted mortgage technology.  To accomplish this, Investors like Bank of America, JP Morgan Chase, Wells Fargo, and Citigroup all increased their buyback reserves significantly in 2009 and 2010 in order to accommodate future claims by investors.  In addition to the regulatory squeeze on the Federal and State levels, each of the institutions established a methodical plan to push back as many loans as they could in order to reclaim and recover from existing losses related to the broader housing crisis as a whole.  Despite having enjoyed enormous profits from the mortgages generated by brokers/lenders in the years leading up to the crash and in the last year of Q2 2010 to Q2 2011, they were attempting to unload these mortgage loans back onto the front end brokers or lenders even before they had been required to repurchase the loans from investors.  In a very unclear market, the goal was to recapture as much as possible amidst the confusion and contraction within the industry itself.  Since many of the 55,000 brokers and a vast majority of the 5,000+ mortgage banks were small lenders who had little capacity to respond let alone provide an adequate defense.  Despite in 2006 doing over seventy percent of the origination of all mortgages in the United States, these front end originating operations were thinly capitalized and their ability to sustain the origination volume they were processing was contingent upon the warehouse lines of credit or the wholesale agreements that were in place.  The significance of a buyback, given their low net worth threatened the existence of mortgage lenders across the country.   This is at the heart of the rapid contraction, attrition and closure of mortgage operations across the country.  With fewer than 10,000 mortgage brokers and less than 3,500 mortgage lenders in the United States, it is understandable that these two segments, which dominated mortgage origination this past decade now accounts for less than fifteen percent of all originations. Question - Who does greater than eighty percent?  You guessed right –the regulatory changes and the financial constraints driven upon the market by the larger banks has manipulated the flow mortgage volume to a channel that was woefully unprepared for it.  The irony is the programs and guidelines designed and brought to market were done so by the largest banks in order to sustain and manage the manufactured consumer appetite for mortgages; it’s Machiavellian at its best. Now, I am not saying there weren’t changes that needed to be made, because there were.  Rather than self regulating, the industry was too busy making money and satisfying a federally generated consumer appetite for mortgages.  A citizen not to be afforded (pun intended) the opportunity for home ownership, was the socio-economic cold war threat of the 21st Century. The root of all social ills – crime, poor education, economic growth were tied to whether or not John and Sally in Kansas City, or John and Steve in San Francisco could buy a home.  I remember attending a lecture in 1999 by HUD Secretary Andrew Cuomo, a Democrat sworn in by President Bill Clinton.  I was excited with the administration’s priority to ‘put every family in a home- rich or poor, white or black’ and so the rhetoric went on.  I was genuinely excited with this.  It was inspirational and it seemed entirely American; what could be wrong with this?  Well, nothing unless of course, you can’t afford to own and sustain a home.  But looking at owning a home as an entitlement is different than as a life goal that is personally achieved.  The thought of what would happen after someone was in a home was not the topic of conversation; it was home ownership.  Therefore, the industry and its foundations for the 21st century were constructed to put people into homes.  It is worth noting that the first National Task Force on Predatory Lending was established in March of…..2007?  No - March of 2000 by Hud Secretary Cuomo himself.  Speaking of home ownership as an entitlement, It is fascinating to see who was on the task force – knowing this and you’ll see exactly why this panel did nothing on the topic of subprime mortgages - you can look at the HUD archives, under HUD No. 00-64;  amazing what you can find at 2:00am while doing research for an article. In order to effectively serve consumers, mortgage options need to be presented, explained and the borrower needs guidance as to which product is the best one for them.  Most banks are utterly incapable of providing this level of service.  Explaining a five year pay out on a car loan is slightly different than a 30 year investment by a borrower.  At the time of purchasing a home at age thirty and an average life expectancy of age seventy eight, by the time the loan is paid off, this is an end of life type objective.  Unfortunately, since non depository lenders and other mortgage origination channels have been demonized to such an effective degree, the consumer will listen to whatever their local community bank, credit union or commercial bank will tell them about their mortgage.  Even if they are paying higher rates, higher fees and having to deal with much longer turn times; in the “new normal” this is what consumers have been lulled into thinking this is best for them.  And who could blame them?  The mortgage process is extremely complicated.  In the eyes to the consumer, it is a black box of sorts.  When an application gets submitted, somewhere and somehow a mortgage gets through the system. The Challenge for Technology Vendors & the Demand for Mortgages The complexity of the mortgage business is where mortgage technology gets its niche.  This is where most traditional banking technology companies fail at providing efficient and effective mortgage solutions, but likewise, this is where mortgage tech firms have equally failed at going “up-stream” to provide traditional banking technologies; they are two different worlds.  Traditional banking is a single sourced service – you know the products your bank offers because you have been taught everything about the bank since you started working there as a teller for $9/hour.  Mortgage Lending, when performed in the best interests of the consumer is an outward science.  Tailoring the products and programs that are available in the marketplace to the specific needs of the borrower is at the essence of personal banking, something that large institutional banks have forgotten.   It isn’t about simply what you can provide as a depository bank but what products are available in the marketplace.  This focused skill set, product knowledge and the proficiency in mortgages is simply required to handle the volume.  When you don’t have this kind of knowledge and the infrastructure around you to handle the volume what do you get?....45-60 day turn times; expensive closing costs, rising rates, and a myriad of overlays. This is why we are on track for approximately $1T in mortgages in 2011 rather than $1.5 or $1.7T.  The income and employment levels reflect a higher demand for mortgages but since the commercial banks took over the business they are squeezing out the competition, narrowing the product field and rendering the qualification process next to impossible for even the best of borrowers to qualify.  Welcome to Mortgage Lending 2.0, the way Retail Bankers have defined it. They wanted to control the mortgage process and they manipulated the volume in their direction, and now in order to handle the volume they brought the industry to a halt all under the guise of “mitigating risk” and “underwriting standards.”  The honest answer to this is:  we don’t have the technology and infrastructure to handle the demand for mortgages - this demand is a direct result from the collapse of low cost origination channels that previously handled this for us; therefore, we need to reduce the demand by making it harder for borrowers to qualify.  Thus the world of lender overlays and sixty day turn times on loan applications.  The challenge for mortgage technology vendors have been to survive the market restructuring and secondly, to ‘swim upstream’ by providing solutions that address these problems regarding efficiency, turn times and the total cost to quality in the commercial/retail banking segment they traditionally haven’t sold to.  With the exceptions of some enterprise LOS vendors who serve this space, this has been a significant struggle for the rest of the tech firms whose traditional adoption were Loan Officers, Brokers and the midsized mortgage operation.  A technology company can’t make money on small credit unions or midsized mortgage banks.  Unless the vendor moves ‘up stream’ the revenue generating opportunity by loan volumes (transactions) or by number of users is inherently limited. Traditional banking core systems are extraordinarily expensive both in design and application.  Often these solutions are implemented in tool kits requiring an extensive amount of customization to fit the tailored needs of a particular client.  Since banks aren’t particularly ‘price sensitive’ in this regard, technology vendors can operate at relatively high price points.  This has been one significant barrier to entry for banking Loan Origination Software solutions in their interests in moving “downstream” in the small, mid and large origination segments in non depository mortgage operations.  The same is true for mainstream mortgage technology LOS vendors such as Byte, PC Lender, MortgageBuilder etc their price points are comparatively lower and as a result the perceived value is significantly less.  I remember giving a banking presentation to Savings Bank in Vermont in 2007 where I was representing a mainstream LOS and we were selling against a FISERV solution.  We thought we had the sale effectively closed; we did exactly what they needed as it related to mortgage origination, reporting, compliance etc and better yet, we were (literally) less than 5% of the cost of the FISERV solution.  Do you think we got the sale?  No.  Fiserv got the business – why?  “Rick, we just couldn’t justify to our board such a low price point for the solution – there had to be something wrong or lacking in functionality to justify such a gap so we went with FISERV.”   Regardless of the RFP, the numerous demonstrations, etc… the out of the box solution that required minimal customization lost to a solution that required a significant amount of maintenance, customization and attention.  This reflected exactly the cultural and technical barrier to entry.  The easiest solution wasn’t necessarily the most successful. You Aren’t Bankers”…. Impact on Vendor Technology These dynamics have everything to do with technology and the vendor makeup of these two industries- banking and mortgages respectively.  The tension between the two industries grew as the origination volume grew between 2002-2006. Traditional bankers loathed the idea of people in the mortgage industry being called ‘bankers’.  If there is anything satisfying about the collapse of mortgage lending, it was the ABA snubbing its nose at the MBA for finally making the point: you aren’t bankers.  I had a conversation at an ABA conference with a bank executive from a large national depository in 2007 and he was adamant that mortgage bankers shouldn’t have the privilege of being called “bankers”.  The tradition, commitment to community, the suspenders – whatever his reasons, he just felt that doing mortgages was not ‘banking’ and of course, somehow the market collapse was the fault of mortgage brokers and bankers and this somehow disqualified mortgage professionals who work for ‘lenders’ to being considered ‘bankers’.  I suppose if opening a CD at 0.5% interest or getting a savings or checking account makes you a ‘banker’, then I think a new term needs to be defined because these activities and the management behind them are trivial as compared to the complexity of mortgage lending.  If a market crash is what exempts you from being a ‘banker’ I suppose the preceding S&L crisis, and of course the Great Depression don’t count, nor the more than 400 banks that have closed by the FDIC since the crisis took root.  Anyhow, the tensions between the two banking segments have grown in large part there are two distinct cultures of professionals.  This is one reason of many that technology vendors who are successful in penetrating the mortgage lending market segment have had a difficult time also achieving adoption in retail banking – and vice versa.  Banking technology doesn’t happen in a vacuum.  Vendors create products to fit specific market needs.  The goal of any vendor is to speak the language and to mirror the culture in which they are selling, in both the product and presentation.  As a result, there are many examples of technology vendors who have been quite successful in traditional banking and have struggled in mortgage technology  (didn’t Fiserv once own Datatrac?...)  Not to get too far off track, however, what drives technology trends in one industry doesn’t necessarily translate into trends in the other. How are mortgage technology trends different than banking technology trends?  First, banking technology trends are explicitly consumer focused.  Although, similar to mortgage technology, banking technology vendors are very slow to adapt to mainstream consumer trends.  The slow adoption of consumer trends is rooted in the cost of development and implementation.  Additionally, it is worth noting that given considerations of fraud and consumer privacy, as an industry we don’t want to be first adopters until a technology is properly understood and vetted.  It will be a few years before you can ‘bump’ a mortgage payment on your smart phone or before cloud technology has a meaningful adoption in mortgage lending.  Speaking of cloud computing, the reliability and security questions regarding cloud based solutions are deeply concerning especially given the recent and widely publicized security breaches.  I have a difficult time with my contacts on my MobileMe service Apple provides – I am constantly losing contacts or having contacts appear multiple times on my phone; do we really want such snags occurring with our mortgage or client records?  And this is Apple I am speaking about!  If Apple can’t stay on top of this, how can a $3M or $10M per year mortgage technology firm with a hand full of servers in a small data center manage these concerns? The technology isn’t mature and is too risky for widespread adoption.   Mortgage Technology will continue to be shaped by industry and market trends.  These trends are a result of the tectonic collision between banking industry segments creating a vendor vacuum pushing mortgage technology vendors upstream and banking vendors downstream; I believe the winner will dominate the middle.   Rick Roque, non-operating owner of Menlo Company.  If you have any comments on this article, feel free to call Rick at 408.914.5895 or by email:


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