From time to time, fundamental shifts occur in all markets, upending the traditional roles of industry players and besetting them with new opportunities and risks. These shifts may be the consequence of technology, government regulation, economic exuberance or deflation or a combination of factors. Whatever the cause, however, old ways of doing business are threatened and new industry leaders emerge. Now is one of those times in the mortgage banking and brokerage industries. Success as the playing field changes is not guaranteed. Strategic missteps can lead to loss, even liquidation. The rewards, however, may be great for those who see the future, move forcefully to implement a winning strategy, and consolidate their gains as they proceed.
The right time and opportunity
Following the 2008 implosion of the mortgage-backed security market and the subsequent international recession, housing prices dropped by almost a third, and the stock market as measured by the Dow Jones Industrial Average (DJIA) fell to 6,469 on March 6, 2009, less than half its previous value of 14,164 on Oct. 9, 2007. As a consequence, a number of investment and commercial banks failed (Lehman Brothers and Washington Mutual), some were forced into involuntary mergers (Bear Stearns and Merrill Lynch), and some were bailed out by the federal government (Goldman Sachs). Fannie Mae and Freddie Mac were placed into receivership while Congress initiated the Emergency Economic Stabilization Act of 2008 followed by the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010 to aggressively regulate mortgage and commercial bank activities.
Almost five years later, the mortgage industry remains in turmoil. Many of the major commercial banks—the biggest players in the industry—were fined by the government due to their activities leading to the crisis. JP Morgan Chase most recently agreed to pay $13 billion in the largest-ever settlement with the U.S. government. Bank of America, Wells Fargo and Citigroup have similar exposures to suits. Paradoxically, the economic crisis and associated falling interest rates spurred a significant growth in refinancing activity, allowing the big players to maintain significant employees and infrastructure to serve that market, in addition to the smaller purchase market. With rates beginning to rise, refinancing has dropped precipitously and banks have responded by closing offices and terminating employees. According to the Mortgage Bankers Association (MBA)
, the trend is likely to continue through 2015 with the average 30-year fixed-rate mortgage
climbing 30 percent from current levels to 5.2 percent, while refinancing volume declines by half—even though purchasing activity is projected to increase 20 percent.
The retrenchment and remaking of the major players in the industry to conform to new economic conditions and regulations, and the subsequent ripple through originators and brokers, is similar to events that affected the domestic automobile market in the 1970s. The price of oil quadrupled from $3 per barrel to $12 in 1974 while “The Big Three" American automobile manufacturers continued to focus on large gas-guzzling vehicles. Their inability to respond quickly to new market conditions led to the rise of Japanese automakers like Toyota, Honda and Nissan into American automobile markets. The opportunity to expand regionally, offer new products, and add upstream capabilities is greatest when traditional market dynamics are in turmoil and the future is uncertain.
Risks to avoid
As with most activities which promise great reward to those who succeed, there are considerable risks that are inherent in the pursuit of rapid growth. The consequence of faulty assumptions, employing the wrong strategy, having insufficient resources or effort, as well as poor timing or failing to anticipate the dominant players' reactions to loss of market share, can slow, even halt your progress—and may result in the total failure of your organization.
A predator at the top of the food chain is most dangerous when injured. Aggression must be tempered with wisdom, haste with caution, and fantasy with reality. Realistically appraising your resources and capabilities and developing a flexible strategy to reach your goals is essential.
Sun Tzu, a Chinese military general living around 500 BC and author of The Art of War, counseled, "If you know the enemy and know yourself, you need not fear the result of a hundred battles." He also said, "Victorious warriors win first and then go to war while defeated warriors go to war first then seek to win." Before seeking a larger market geographically or expanding into services which you have not previously offered, you should dominate your existing market with industry-leading quality and efficiency. Smaller organizations can rarely fight two battles at once due to limited resources and time. Before opening a new office or acquiring a competitor, be sure that you understand exactly what is required to make the move a success and what you plan to do if you hit an obstacle. Keep capital in reserve in the form of cash or pre-approved credit arrangements. Hire the best available people with the needed skills, clearly communicate your goals and expectations, and lead them to victory. When one phase of your plan is complete and able to operate autonomously, move on to the next acquisition, expansion, or service. In other words, don't out-run your supply lines.
Haste makes waste
Examples in which premature action resulted in unanticipated consequences, many of which were bad, are abundant throughout history. General Custer could have used more information about the size of his enemy forces, Congress about the effects of prohibition, and President Obama about the difficulty of building a complex information system when proposing a new health insurance program. Humans, including CEOs and company boards, are prone to act before thinking and to arrive at solutions before they understand the nuances of a problem. Bank of America's ill-advised purchase of Countrywide Financial has cost much more than the $2.5 billion price tag as the latter's activities in the mortgage securities debacle have become public knowledge. Quaker Oats acquired Snapple for $1.7 billion in 1994, only to sell the acquisition for $300 million 27 months later when the synergies didn't prove out.
Your strategy is only as good as the quantity and quality of information available, the objectivity and capabilities of your analyses, and the implementation of the decisions you make. Short-cuts rarely work out—the greater the potential benefit of the omission, the more likely a disappointing and expensive outcome is. Do not rush to judgment. Let the pot stew until its components are stable. Challenge your assumptions, including "expert" opinions, and when in doubt, repeat the process until you are confident you're making the optimum decision relative to the risks. Warren Buffett's famous rules of stock investing apply to corporate activities as well, whether it's opening a new office or buying another company:
►Rule number one: Don't lose money
►Rule number two: Don't forget rule number one.
Complacency is the enemy
Ignoring the trends in your marketplace or assuming that your operation is going to be unaffected is a sure formula for failure whether you are an originator, broker or banker. Your competitors are sitting in board rooms and executive offices looking at the same numbers that you see, figuring out the best strategies for their companies to survive and exploit opportunities. Some are going to do nothing, unable to interpret the trends, anticipate their impact, or decide on an appropriate course of action. Others may take action because of fear or ambition, wresting market share from their more timid adversaries. You need to decide how you are going to be affected and how you're going to respond or you are likely to be run over in your tracks.
Offense is not the only strategy, and may in fact not be the best strategy in these times. Many mortgage companies are going to aggressively retrench by closing offices, terminating employees, and slicing unprofitable products and services with the intent of husbanding their resources and rebuilding when the blood bath is over. Some may expand in selected regions while de-emphasizing operations in others. A small group may aggressively expand, seeking to absorb or destroy as many competitors as possible while they are weak, then ferociously defend their new territories when stability finally comes. Any or all of these strategic postures can be appropriate if they are well-directed.
The past five years have been particularly difficult on the pre-eminent mortgage firms and are likely to be followed by another three to five years of uncertain interest rates, fluctuating regulatory practices, and fickle homeowners and homebuyers uncertain whether to refinance or buy. Deciphering and interpreting trends is likely to be difficult, even confusing, as one measure contradicts another. That said, it is also the kind of market in which fortunes are made and great companies appear from the mist of chaos. It is your time and your place … are you ready?
How do you intend to seize opportunity and avoid missteps in the current market?
Mike Lewis is a retired business executive and personal finance columnist.