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Competition in the Mortgage Industry

Matt Seu
Dec 05, 2013

During the last two years, Bank of America, Citi and Ally have all made business decisions to shutter their correspondent channels. The reasons are varied, but it can be boiled down to two main drivers. First and foremost, everyone is shivering at the thought of repurchase risk and rightfully so. There are lawsuits in process right now that have and could continue to force huge buy-backs, and at a minimum will be a drain from litigation costs. Second is the constant and aggressive regulatory environment. Companies will now need to contend with the Consumer Financial Protection Bureau (CFPB), Dodd-Frank Act, and Basel III in addition to the Office of the Comptroller of the Currency (OCC) and others that have existed for years. At the end of the day, I think that most of the companies got out of their correspondent channels because it was just too hard, too risky and too unclear. Add it all up and it is nearly impossible to understand the types of returns that would result in the future. Combine the risk/return uncertainty with the default crisis and it isn’t hard to understand that companies just don’t have enough talent and leadership to go around. Focusing on retail and improving operational efficiency and controls makes sense for the big names. Wells Fargo is still running a successful correspondent channel, but frankly they have run their business smartly for a long time and took far fewer blows to the bow as compared to their competitors. They never even wanted their Troubled Asset Relief Program (TARP) money, and were not forced into any shotgun weddings. But there are companies who are moving in to take the market share from the large aggregators also. Companies are starting mortgage conduits and taking the correspondent business that the aggregators abandoned. And guess what? They are making money, and doing so with far fewer costs on a per unit basis. I liken the situation to what occurred in the U.S. automotive industry in the 1970s. Honda, Toyota and Nissan (then Datsun) entered the market with small, inexpensive cars and trucks that the big players like General Motors, Ford and Chrysler disregarded. The theory was that the big guys would dominate the high end market and would continue to maintain brand loyalty. Everyone knew that … or so they thought. Fast-forward 40 years later to the present day and the Asian car makers compete toe to toe and GM and Ford and Chrysler are afterthoughts. American’s own a lot of Lexus and Acura vehicles, fare more than own Cadillacs. The Asian companies did it with low cost production, process efficiencies and focus on the customer. I think they were on to something. I’m certainly not predicting that someone will overtake Bank of America right now, but the little guys are going to make their money. So how are they doing it, and how can they come to market so quickly? So what are the keys to success? Well, it really isn’t that hard if you have some key ingredients. You need some smart people who understand the market. There are a lot of them out there. Everyone who was geared up in the asset-backed securities heyday is still around, but maybe not doing the same job as before. We have watched groups that worked together in the past assemble the same cast of characters and go to market quickly. They understand how to run a conduit and are capable of doing a lot of work manually when it starts up. The second thing you need is a solid set of correspondents. Well they’re not hard to find either. In fact, most of them had to scale back due to the limited outlet for their product. Suffice it to say that this part is pretty easy. The final part of the puzzle is capital. Someone needs to fund the initial investment. Again, this isn’t that difficult either. Companies primarily in the servicing business have been looking to diversify and many have started up conduits. Others are simply starting from the ground up and either self funding or getting outside money from investors or warehouse lenders who scaled back during the housing crisis and are primed to expand. The ingredients aren’t that hard to come by and in the short run companies can do a lot of volume, but many run into barriers that constrain their ability to grow. The challenges that we see on a regular basis are with regard to taking these conduits from start up mode to full production volume while not having the technology, processes and controls in place. You can get by with smart folks, good supply of loans, and some investment money for a while, but sooner or later it catches up. The ones that ultimately make it and break through to larger volumes spend time and effort on the infrastructure. Again, this isn’t that difficult, but you need to pay attention to it. The real long run success keys are based in having good technology, solid processes, and controls in place. The business processes are fairly simple. You push price to the channel, watch for rate locks, hedge the pipeline, determine best execution, dispose of the assets, book the accounting, and take care of the unexpected or strategic pair offs. The controls are simply part of the process with some additional QA on top. Once you have your processes and controls in place, you should easily be able to figure out the technology, and again, it isn’t that difficult, but this is where folks make the most mistakes. What we often see follows a basic pattern. Companies with very smart and experienced folks forget to plan ahead. If companies would spend as much time on planning their processes and technology as they do running the financials, they will find that they won’t have barriers to growth show up later. Many companies buy software and then wonder why it: (a) doesn’t work as advertised, (b) doesn’t integrate with other tools, and (c) cost more than advertised. Every company should have a roadmap that goes out at least a year that illustrates what technologies are required, what processes and controls are necessary, and who will implement these portions. Once the roadmap is identified a robust vendor selection process should be leveraged. If companies document their business and technical requirements up front and write clear and transparent RFP (request for proposal) documents with specific granular requirements included, they will find that the sales folks will have to compete on a level playing field. Demanding that each vendor demo contains the requirements in the RFP keeps them honest. They won’t be able to sell promises. What you see is what you get. The company can then select based on functionality and price. Companies should also leverage either a centralized change management or program office or outsource it to a third party. It’s very difficult to implement the processes and technologies and still do the day to day work, and the skill sets and expertise are different. It’s not often that a brilliant secondary marketing officer is an expert in technology and project management. Going forward, the smaller companies will be able to compete even more effectively as the industry becomes more standard. The Federal Housing Finance Agency (FHFA) is pushing the Uniform Mortgage Data Program (UMDP) and has rolled out standards related to collateral and loan delivery. These standards will branch out to include servicing as well. Combine the data standards with consolidated policies and it becomes much easier to participate with the GSEs and the Capital Markets. The jury is still out on the new Securitization Platform outlined in the 2012 FHFA white paper, but if it comes to pass in a form similar to what was published, the smaller players will be able to play on the same field as the big guys. Proprietary standards, processes, and data will be replaced by a consistent infrastructure from rate lock to security containing standard work flow and data exchanges. I wish that I could truly predict the future, but that’s not possible. What I can say categorically is that if the smaller conduits focus on their processes, controls and technology, they will be nimble and will be able to grow. The smart people that run the conduits will look smarter and their returns will be higher. The huge aggregators will still dominate, but you never know. Maybe one day a little guy will take down a Goliath just like the Asian car manufacturers. Matt Seu serves as principal with Actualize Consulting, focusing on fixed-income and securitization operations. Seu and is responsible for managing the firm’s accounts with a focus on the GSEs, large national mortgage companies, Wall Street broker dealers and software companies supporting the fixed-income and mortgage conduit arena. He may be reached by e-mail at [email protected]
Dec 05, 2013