Mortgage Lending Outsourcing: No Longer a “Do It Yourself” Business
By Donna Mack Crowell, CMB, Director of Resource Mortgage Solutions
If you want something done right, then do it yourself!
“Do it yourself” may be a growing trend in America, but why do I cringe every time my husband begins a new home improvement project? The new screen door still does not have a latch on it. The new ceiling fan was returned to the store because it was “defective” only to find that the replacement fan was defective too. (It was the installation procedure that proved defective.) And the new garbage disposal resulted in calling a plumber for repairs to the pipes under the kitchen sink. Like my experience with household “improvements,” Community and Regional banks are finding that “Do it yourself” may not be the most attractive alternative to establishing or maintaining a mortgage program.
Financial Performance Evaluation
If your bank has an existing mortgage program, deciding whether to outsource begins with a thorough and objective evaluation of your in-house mortgage program. Start with your program’s production and financial performance. Is production at acceptable levels? A mortgage loan officer in a healthy real estate market may be expected to originate $1 million in loan production per month. Ability to optimize revenue and minimize expenses against production is the hallmark of an excellent mortgage program. Mortgage bankers talk in terms of basis points (bps) of production. On average, in 2003, a bank’s mortgage department with loan production of $100-$300 million expected to generate 210 basis points of revenue and 104 basis points of expense, resulting in 106 basis points of net income. Therefore, a bank could expect net income of $1.1 million on $100 million in production and up to $3.2 million on $300 million of production.
The greatest monkey wrench in the mortgage industry occurs as interest rate fluctuations drive spikes and lulls in mortgage demand. Inefficiencies are created when mortgage lenders can not re-tool their expenses to the revenue opportunities. When a bank’s demand for mortgage loans increases, initially existing staff are required to work overtime to meet their customers’ needs. Temporary employees may be engaged. If the higher demand continues, as it did in 2003, then permanent employees may be hired. When the reverse occurs, and demand suddenly decreases, a bank must eliminate excess expense quickly to maintain the net income margin. For example, at a monthly volume of $20 million, using the basis point assumptions above, revenues generated are $420,000 and expenses are $208,000, for a monthly net income of $212,000. But if production drops by 50% to $10 million (this happens in the mortgage business), and the bank is only able to scale back its expenses by 10% (say by eliminating overtime) within the same time frame, then profit margins quickly erode. In this example, revenues would decline to $210,000 but expenses remain relatively high at $187,200, resulting in net income for the month of $22,800. If in the following month, mortgage production falls another 20% to $8 million, and expenses are reduced by 20% from prior month, net income is $18,200. Chart 1 indicates that net income for this quarter totals $288,800. Many community and regional banks are hesitant to make staffing and other expense cuts when revenues decline. They fear their communities may look unfavorably at the layoffs.
As you consider the financial results of your in-house mortgage program, do not forget to factor in the indirect expenses. Legal, Compliance, Accounting, Finance, Human Resources and Marketing associates are contributing their time to your mortgage program. Would outsourcing your mortgage program free these resources to accomplish other goals? How well does your mortgage program perform against production, revenue and expense benchmarks?
Non-Financial Performance Evaluation
Mortgage Candidate Pool: Does your market provide an adequate pool of mortgage professionals to fill specialized positions? The vast number of products and compliance requirements force many mortgage lenders to seek experienced mortgage personnel. Array of Mortgage Loan Programs: If you are a portfolio lender and not currently selling loans in the secondary market, you may find that your customers are asking for products that you are unable to offer. Interest Only, Hybrid ARMs, Option ARMs, 100% financing are loan programs available in the secondary market that have not traditionally been held in the portfolio of the community bank. And the 30-year fixed rate mortgage popular with consumers, especially at today’s low rates, is not a desirable balance sheet asset matched against a bank’s short term liabilities.
Geographic Coverage: Is your mortgage loan program limited geographically? If your customer wants a vacation home in Florida, is your mortgage loan origination system compliant with the laws and regulations of other states? Do your processors and underwriters understand the myriad of predatory lending and other laws that vary by state and municipality?
Mortgage Technology: Is your technology current? The technology for mortgage lending is highly specialized. Front-end software, loan origination systems, best execution models and servicing platforms can run in the millions of dollars to become and remain state-of-the-art. Are you facing investments in the near future to keep up with recent technological advances?
Even if you do not have an existing mortgage lending program, but are considering entering the mortgage business, you will benefit from an assessment of your projected in-house process. You can then perform a comparison of your in-house plans to an outsourcing solution.
Define and Prioritize Your Objectives
There are many reasons to consider outsourcing your mortgage origination functions. Below are some common reasons for outsourcing expressed by banks:
Avoid Staffing Volatility: Did you have difficulty hiring qualified staff during the refinance boom of 2003? Are you now facing unpleasant layoffs as interest rates rise and mortgage production volumes decline? The Mortgage Industry originated $3.8 trillion dollars nationwide in 2003 and $2.7 trillion in 2004. The Mortgage Bankers’ Association predicts industry production will be only $2.1 trillion in 2005. One of the greatest challenges for a small mortgage shop is to make staffing adjustments quickly. Not enough staff and customer service suffers. Too much staff and profits quickly erode. Mortgage outsourcers have “surge protection” methods to better handle sudden changes in staffing requirements.
Become More Cost Effective: The mortgage business is one in which economies of scale are paramount. Leveraging the scale of large mortgage lenders may be the only choice you have to attain the cost efficiencies to compete effectively in the mortgage market.
Exchange Fixed Expenses for Variable Expenses: An in-house mortgage department requires significant fixed expenses, primarily salaries and benefits. Along with the expenses of a full-time staff come additional fixed expenses, such as FF&E, communications, office supplies and other related costs. An outsource program allows you to eliminate these fixed costs and to use what you need when you need it from your outsource provider.
Reduce Secondary Marketing Risk: Value in the mortgage industry can be derived from origination fees, net interest margin on warehouse lines, secondary market gains and servicing values. Large mortgage lenders are able to offset potential losses in the secondary market though overall management of hedges and balancing the other value components of the company. However, a community or regional bank may be less willing or able to withstand a significant loss in the secondary market.
Improve Secondary Market Execution: Are you selling directly to the agencies at the cash window? Are you limited in the number of investors to whom you deliver loans? More investors provide more options and may lead to better pricing, but they also add to the complexity of loan delivery and increase staffing requirements. A mortgage lending partner will allow you to benefit from its best execution models.
Expand Mortgage Loan Programs: The secondary market continues to develop an array of loan programs designed to meet every borrower’s needs. There are loans for first time home-buyers, self-employed borrowers, those who want to minimize their payment, and those who want to expedite building equity value in their homes. Outsourcing your mortgage program gives you access to a full array of mortgage lending programs.
Expand Geographic Coverage: By leveraging a national outsourcing partner, you will be able to lend in out-of-state areas with confidence knowing you will be in compliance with state and local laws. If you have a state charter and are not licensed in other states, there are programs available that allow you to make mortgage loans available to your customer without sending them to your competitors.
Avoid Investments in Technology: The technology for mortgage lending is highly specialized and expensive. By outsourcing your mortgage program, you gain access to advanced technology through your mortgage lending partner.
Retain Your Customer: Bankers benefit from their customers’ reliance on them as trusted advisors. For most households, purchasing a home is the largest financial decision of their lives. If you cannot meet the mortgage needs of your customers, you run the risk of losing them by referring them to mortgage brokers or other financial institutions to meet their needs. Mortgage servicing operations routinely offer borrowers a variety of financial services including insurance, credit cards, home equity lines of credit and other offers, all targeted at wooing your customers away from your institution.
Once you have defined your outsourcing objectives, it is critical to prioritize them. Many objectives listed above place conflicting pressures on a mortgage program. If you are clear in establishing which objectives take priority, and are able to communicate these priorities, you will be more satisfied with the outsourcing results.
Evaluate Prospective Mortgage Partners
After identifying mortgage lenders who provide outsourced mortgage services, the next step is to compare prospective partners to your specific needs. The best way to gather the information for this evaluation is to create a Request for Proposal (RFP) and provide it to each of the mortgage lenders you are considering. By using a standardized data collection methodology, you will be better able to compare the prospective partners. Share Your Information: As an introduction to the RFP, provide a description of your current mortgage program. Include production volumes, product mix and pull through ratios (closed loans/applications). Include information about unique loan programs such as state or local down payment assistance programs in which you do or plan to participate. The data you share allows the prospective partner to determine the staffing levels it will need to accommodate your mortgage business.
And as mentioned earlier, share your reasons for outsourcing and communicate your priorities. The objectives and performance metrics are important to the prospective partner to evaluate and determine if it can meet your needs. A mortgage lender that values partnerships would rather decline your business if it cannot satisfy your needs than enter into an agreement that leads to your dissatisfaction.
Request Specific Information: Create an RFP that addresses every phase of the mortgage process. Examples of information you should request include:
. What portions of the mortgage origination process are outsourced? What tasks does (may) the Bank perform?
. What loan programs (products) does the mortgage lender provide?
. How are rate sheets disseminated? (Request rate sheets for a period of time to evaluate rate competitiveness in your market place.)
. What technology is available for the bank to use: consumer counseling tools; online applications; automated underwriting systems; rate quotes?
. How does the lender ensure disclosures are compliant? Are disclosures private labeled?
. How is loan status communicated and how often?
. How many loan processors will be assigned to you? Are they dedicated solely to your Bank? Where are they located? (What accommodations are made for time zone differences, if any?) What is the lender’s targeted files per processor?
. Can the Bank use its choice of third party services: appraisers; title companies; closing agents?
. What are underwriting turn around times? How does the partner prioritize loans in the underwriting pipeline (i.e., do purchases take priority over refinance transactions)?
. How are closing documents delivered, by mail or electronically?
Does the lender “table fund” or does the Bank provide funds at closing. If the latter, are loans assigned to the lender at closing or purchased at a later date? If purchased, what is the time line for the lender to purchase closed loans?
Can the lender process and close loans for the bank’s portfolio?
. Does the lender buy only whole loans? Does the lender buy loans and allow the Bank to retain the servicing, if desired?
. Does the lender retain the servicing or will servicing be sold?
. Will the lender provide private labeled servicing, “generically” branded servicing or does it use its own brand?
. Does the lender plan to cross-sell additional products to the mortgagors, and if so, which ones? Is a “no solicitation” option available and if so, at what cost?
. Does the partner have the ability to service loans in the bank’s portfolio as a sub-servicer?
. How does the lender measure customer satisfaction?
. Does the lender require an exclusive relationship? If so, what is the contract term?
. Does the lender offer flexibility to add or change services and how quickly can the partner react to your changing business objectives?
. What fees are charged by the lender: to the Bank; to your customer?
. What is the revenue opportunity for the bank?
. Once the lenders have responded to your RFP, you are ready to compare the prospective mortgage partners. Generally, you will choose two or three finalists and ask them to present to your management team. An on-site visit to the prospective partner’s facilities is also recommended.
With the information you have collected, you can now compare your expected results from outsourcing to your in-house evaluation.
Consider the Bank in our example earlier. If it were to outsource its mortgage program by retaining commissioned only mortgage loan officers who earn 50 basis points of their production, the Bank may expect financial performance to be as much as 100 basis points of revenue on production. On $20 million in monthly production, the Bank may generate $200,000 in revenue. With expenses of 50 basis points the outsourced program results in $100,000 net income. Continuing with our example, if mortgage loan production falls to $10 million, the bank’s net income is now $50,000, compared to $22,800 experienced in the same scenario for the in-house mortgage program. And if mortgage production falls to $8 million, net income is $40,000 compared to $18,200. Furthermore, banks have the opportunity to leverage consumer, commercial and private bankers to take mortgage applications which may reduce overall expenses and create an even greater profit potential.
In this comparison, the net income for the quarter of the in-house mortgage program is 33% higher than in the outsourced program. Would this bank choose to outsource? That depends on the bank’s mortgage program objectives, which is why it is crucial to establish your mortgage program priorities. Does the bank seek to optimize the bottom line? Does bank management have the discipline, skills and tools to manage its expenses to the revenue opportunities? If the Bank in this example sets as its priorities mitigating risk, reducing earnings volatility, avoiding market reputation risk due to layoffs and deepening customer relationships with expanded mortgage loan programs and geographic coverage, then outsourcing may be a more attractive alternative. For a bank that does not currently have a mortgage program, outsourcing is a ery attractive way to enter the mortgage business. Imagine the results above on little or no investment.
Whether your bank is in the mortgage business today or considering establishing a new mortgage program, a mortgage partnership provides advantages and expertise that is difficult to replicate in a small mortgage operation. With so much to gain, why “do it yourself?”
Donna Mack Crowell, CMB is Director of Resource Mortgage Solutions, a division
of NetBank. Resource Mortgage Solutions provides mortgage services to companies
who seek to outsource all or a portion of their mortgage lending programs.
For more information, call 1-866-389-7276 or visit us.