"We'll make it up in volume," that's the prevailing conventional wisdom of many lenders in the mortgage industry when faced with adversity. But, does it still ring true? New industry dynamics have emerged--decreased revenue, threats of increased regulations, rising costs, stiffening competition from new entrants (including Internet mortgage companies), and new technologies have changed the rules of the marketplace. Yet, many lenders still adhere to the belief that increasing production is the most prudent strategy. Lenders have shown a reluctance to focus on reducing costs. But, why the reluctance? One reason is that cost control is a much tougher, more complex issue to grapple with than production. Cutting expenses often necessitates some degree of staff reductions‑a difficult, unpleasant task that few relish. Cost control measures may mean changes to time‑honored business practices, operations, and procedure‑not only for lenders, but also brokers and other industry professionals. Old habits die hard. In addition, pumping up the volume is "sexier" than cost containment. Sales and marketing executives‑the catalysts who drive production‑are generally the company stars. Their compensation is typically based largely on volume.
Pressures Forcing Technology Adaptation
According to the Mortgage E‑Commerce Council, in 1993, a $1.1 trillion year, lenders' value added in the wholesale channel (including servicing) was 110 basis points. Looking at 1998, a $1.7 trillion year, a Wholesale Access study determined that the value added by the wholesale channel was 45‑55 basis points. In the heady days of the sub‑prime industry, the cash prices that lenders received for loans were six or seven points, while currently, the price is in the three‑point range. Despite a 50 percent volume increase, lenders today receive only half the revenue they once earned. Clearly, the strategy of "making it up in volume" is a losing strategy. The development and widespread use of technological innovations such as credit scoring, automated underwriting (AU) systems, and risk‑based pricing are contributing to the commoditization of mortgages, thus reducing the value of branding as a competitive factor of differentiation among lenders.
The Mortgage E‑Commerce Council states, "In a commodity marketplace with its accompanying pricing pressure, economic history shows that the only sustainable advantage becomes being a low‑cost, high‑service provider."
Rethinking the Process
Effectively, costs for alternative/non‑conforming lenders need to be reduced by 50 percent. Incredibly, this is the reality staring lenders in the face. The only way to reduce costs this drastically is by throwing out the old models and redesigning the mortgage fulfillment process from scratch. Lenders must get down to the basics and ask fundamental questions about what their customers really want and how to best deliver products and services to fulfill those needs. Technology that seamlessly connects information and services sources to users should then be applied. It is not enough to add technology to existing workflows‑the entire process needs to be re‑engineered.
To date, many lenders use the Internet only for product information with their Web site promotions‑in essence, serving merely as "virtual billboards," rather than functioning as cost‑cutting productivity tools to streamline processes and operations. Companies that don't bother to redesign their back offices will be poor performers in the new economy, while the best‑in‑class online lending companies incorporate a high degree of technology and integrated process/workflow management.
As an example of cost reductions gained through technology, automated underwriting has achieved significant results. According to KPMG MorPro study data, besides adding speed and consistency, total underwriting costs for companies that use an AU system on more than 60 percent of loans were cut by one‑third, and back office productivity rose by 20 percent, for a total productivity increase of 42 percent.
Lenders have a long way to go to leverage the full potential of Web‑based technology. Online access to critical functions such as pre‑qualifying borrowers, receiving loan approvals using automated underwriting systems, and viewing the loans in their pipeline at any time, reduces the number of file "touches" by internal staff necessary to fund loans, resulting in much lower costs per loan.
Cost reductions and service improvements through technology come only over time as the organization "learns" and fine‑tunes the process. Thus, those companies that began the process earlier hold a distinct competitive advantage over those companies that cannot or will not break from the old ways of doing business. Investing in technological development early will provide your company with a lead over many lenders on the learning curve. However, with a competitive industry, your company doesn't have the luxury of standing still. You must continue to work to further reduce costs and increase service levels.
The recent passage of electronic signature legislation is further indication that the mortgage industry is well on its way to paperless mortgage transactions. Those companies that are best capable of leveraging these new opportunities are those that are already Internet‑enabled. Will a five‑day mortgage transaction become the standard?
Paradox: More with Less
The productivity gains achieved by technology allow human capital resources to be re‑deployed to more complex tasks such as handling challenging loans, exception processes, and relationship development. Your company will benefit by utilizing proprietary software to enhance work productivity such as task scheduling, balancing workloads, and allocating work. Also, by reducing the number of people involved in the decision‑making process, you can shorten the loan decision time and improve consistency.
Another advantage provided by technology is scalability. The mortgage industry is especially sensitive to scalability due to massive fluctuations of loan volumes caused by changes in interest rates. To maintain adequate levels of customer service, lenders are hard‑pressed to staff up quickly when rates fall. When interest rates rise, lenders are overstaffed, and must layoff personnel.
According to Kenneth Posner of Morgan Stanley Dean Witter, "Successful lenders must be able to allocate resources internally or quickly hire and train new staff during refinance booms."
Automated underwriting and data delivery systems are the ultimate in lowering both fixed and variable costs‑incremental costs approach zero. Those companies with automated systems are much more capable of handling volume fluctuations without reducing service levels. Adding another Web server to accommodate the ebb and flow of Internet traffic is a timelier and less costly method of managing capacity than hiring or downsizing staff‑a hardware solution rather than a personnel solution.
Service Essential to Success
The Internet is redefining what the term "service" means for many. Convenience and speed are becoming far more important factors than personal transactional relationships (think bank ATM's). Internet users who shop or browse online for personal use also expect the same kind of service in their business transactions. To assist brokers with specific loan issues, you must completely re‑engineer your back office processes for speed and convenience. Traditional underwriting and processing functions should be carried out by teams of credit analysts and loan analysts with broader responsibility and decision‑making authority‑their proximity to the transaction will result in faster responses and decisions. Adopt a more customer‑oriented focus, and redesign your Web site to make navigating and providing additional features easier.
Difficult, But Critical
Reducing costs--a difficult but critical task--is a major challenge that will force lenders to make tough decisions and take bold measures. Over the next few years, in an environment that will be strongly impacted by the Internet, lenders will no longer be able rely on band‑aid solutions such as capital infusions or support from parent companies. Alternative and sub‑prime lending companies must find a way to reduce total costs by half‑down to two points‑while at the same time, maintaining or even improving service levels. Adopting a business model that leverages Internet technology offers the best solution. Lenders, Mortgage Brokers, and borrowers are already reaping dividends from innovations such as loan pre‑qualification, online loan submission, and automated underwriting.
The KPMG Internet Mortgage Report offers this prediction: "Continuing to operate under the traditional business model will leave companies with outdated business processes, unresponsive customer service efforts, and little or no chance of enhancing shareholder returns. The industry leaders of the future will be those companies that capitalize on available technology and are willing to change fundamental business concepts, products, and processes."
Amy Brandt is National Sales Manager of WMC Mortgage Corporation. She may be reached by phone at (818) 592‑2532 or by fax at (818) 712‑2822.