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The Increasing Importance of Scale in the Home Mortgage Space

Mike Lewis
Feb 10, 2014
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Since the early 1980s, interest rates on 15-year and 30-year fixed-rate mortgages (FRMs) have trended downward, eventually reaching lows under 3.5 percent in early 2013. This trend generated multiple periods of high refinancing volume, accelerated a historic increase in securitization, and created mega-banks such as Wells Fargo, JP Morgan Chase and Bank of America, which grew to dominate the mortgage securities industry. The subsequent mortgage security crisis in 2008 slashed bank earnings, led to billion dollar lawsuits, and resulted in new legislation that added increased scrutiny and extended potential liabilities for industry participants.
The mega-banks continue to be under pressure with billions in bad loans yet to be worked out, refinancing volumes at their lowest since 2000, huge staffs, and excess capacity built during the years of extraordinary growth and friendly regulation. At the same time, there are new opportunities for companies to capture market share from the retreating behemoths whose size has become a liability in the rapidly changing mortgage market. While it is unlikely that the mega-banks will disappear, there is the real possibility that new, aggressive competitors can nudge them aside and gain a foothold in the national marketplace.
Does size matter?
An old boxing adage claims that a good big man beats a good small man every time, simply because size brings more power. The same can be said of mortgage institutions. Scale does matter and it brings specific advantages to those who have it:
►Fixed costs can be spread over a larger base to increase profit margins. Increased profits means there is more money to reinvest in employee recruitment, training, and compensation. It also allows for investment in new technology and innovative marketing programs, further leveraging strategic advantage in the marketplace.
►Products and services are available to a wider, more diverse market, thereby minimizing the impact of adverse conditions in a single geographical area or product line.
►Competitive barriers are established that must be overcome by new and potential rivals who want to gain a foothold in the marketplace.
However, size has its disadvantages too, which the mega-banks are discovering today. When cataclysmic change hits the markets, as it did in 2008 and 2009, it is difficult to react quickly and take corrective action. What are seen as assets in a stable market become millstones in a chaotic environment:
►Unlike variable costs which move proportionately to sales volume, fixed costs cannot be easily eliminated.
►Pipelines, laboriously and expensively assembled over years of stable refinancing markets, are crumbling as smaller originators adjust to more complex home-purchase, rather than refinancing, mortgages.
►Traditional servicing has become much more complicated and expensive as the mega-banks wrestle with millions of foreclosures, unprecedented government scrutiny and regulation, a potential change in the role of government in the mortgage markets, and new securitization rules yet to be finalized.
The market dynamic has been turned on its head, the big boys are reeling, and there are opportunities for new leadership and companies to emerge. While the size of mega-banks has become a disadvantage in today's market, primarily due to an inability to rapidly adjust to the new environment, scale is nonetheless important for new competitors if they seek a national footprint.
Essential elements of success
Successful mortgage companies share several common traits which combine to accelerate their growth and create competitive advantage. As they grow larger, the advantage of scale, whether in a single market niche or as a fully integrated mortgage firm, adds to their dominance. The common traits of market leaders are as follows:
Purpose: Good results rarely happen by chance. Success is the outcome of a coordinated, thoughtful combination of goals, strategy, and implementation. For example, Wingspan Portfolio Advisors, founded in 2008 in the midst of the mortgage securities debacle, was named number 23 on the 2013 Inc. 500 list of America's fastest-growing companies with a growth rate of 8,768 percent in the last three years. Wingspan, using a combination of strategic hires, advantageous acquisitions and innovative technology, is an example of a small company aggressively moving into market space previously occupied by the biggest mortgage players.
People: Employees matter, as all good companies know, but troubled companies often forget. Guaranteed Rate, a private company based in Chicago, more than doubled its home mortgage business from $7 billion in 2011 to $14.7 billion in 2012, providing loans in all 50 states and becoming the second largest independent home loan company in the country. The company has a Net Promoter score of 77 percent, higher than companies like Apple, Amazon, and Southwest Airlines. Guaranteed Rate employees receive multiple benefits including on-site meals, a private gymnasium and year-round training programs. The company was recognized as one of Chicago's top places to work by the Chicago Tribune in 2012.
Process: Combining a $150 million proprietary servicing system with a superior loan resolution process, Ocwen Financial Corporation has been widely recognized by consumer advocacy groups for its foreclosure prevention. Ocwen acquired Barclays' mortgage servicing business, HomEq, in 2010 and developed a consumer-friendly mortgage modification model widely recognized by consumer groups for its expertise in HARP. The company also acquired Liberty Home Equity Solutions, a reverse mortgage originator, in 2013 to achieve a 149 percent growth rate in revenues in the first half of 2013 versus 2012. The company plans to make more acquisitions in the future.
►Position: Scale is not limited only to those companies which offer a complete range of mortgage services and products. Mark Greco, founder and president of 360 Mortgage Group LLC, completely changed his company's focus in 2010, abandoning the retail market to focus exclusively on third-party origination and serving the mortgage broker community. The company began operations in the southwest and is now licensed in 31 states. Even as mortgage volume has grown, it has captured advantage in scale by maintaining a single centralized operation center in Austin, Texas. Knowing your strengths and focusing on them is essential to occupying a strong competitive position.
Final thoughts
To paraphrase Rudyard Kipling's famous poem, "If," keeping calm, maintaining focus, and overcoming your fears are the keys to success in any business. This is particularly true in the world of mortgages, where interest rates, regulations and changing consumer preferences make for a chaotic industry. The old order is under siege and new players are going to emerge to become the leading mortgage companies of tomorrow. Even though the mega-banks will eventually adapt, the opportunities for new companies to join them on the upper tiers of success have never been greater. The window is open, but it's going to close at some point in the future. Make sure your company seizes the moment. What do you think mortgage companies should do to remain competitive?

Mike Lewis is a retired business executive and personal finance columnist.

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