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BirdsEye View

the mortgage business

Banks that are in the mortgage business have enjoyed the fruits of their labor the past couple of years even more than in the past. 2012 has seen unprecedented spreads in the mortgage market, which doubled over the prior year. Even in the face of low rates, these assets are still far more attractive than alternative securities, and the fee income is a meaningful contributor to better performance. The meaningful reduction in the number of mortgage brokers has also helped banks establish a stronger competitive position, and the relatively low home prices and stricter underwriting criteria help shore up the credit worthiness of the assets.

The introduction of the Qualified Mortgage concept, anchored in the borrower's ability to repay the loan, has thrown a monkey wrench into the business. Volumes are still attractive given the extremely low rate environment, but the complex definition of the QM and the need to be ready to report on it starting next January is creating additional pressure on mortgage originators who are already subjected to intense regulatory risk.

The CFPB's 43 page summary of the QM requirement has been, for once, a relief. The document does summarize all the important rules governing the QM definition. The eight requirements include:

  • Current or reasonably expected asset value (for Loan To Value calculation), verified beyond tax assessment valuation

  • Current, documented employment.

  • Monthly mortgage payments of the fully amortized mortgage

  • Monthly payments of any simultaneous loans of the same property (e.g. if the same residence is held as a collateral on a small business loan as an abundance of caution) (NOTE: This rule and Basel III treatment of real estate collateralized loans, including those where the property is used as an abundance of caution, make unsecured lines to businesses appear more attractive  an unintended and negative consequence to these two shifts)

  • Monthly property maintenance payments such as taxes, home owners association dues (including the possibility of those dues rising in the future)

  • Debt, alimony and child support obligations

  • Monthly debt-to-income calculation on total mortgage and non-mortgage obligation relative to gross income (even though the real driver of ability to repay is net income)

  • Credit history

Another notable aspect of the QM concept is the disqualification of balloon loans. A possible response is shifting the demand for balloons into 5 or 7 year ARMs. Even so, limiting the amount to be lent on balloons is a wise decision, especially given the interest rate risk involved.

Many in our industry believe this new requirement is another game changer that will result in numerous players exiting the mortgage business. One cannot afford not to make non-qualified mortgages, and the capital price of those is heavy.

My view is different. I think this is a time of opportunity for banks with strong mortgage operations and compliance programs. This is especially true when we are all looking for loans while loan demand is still soft in most of the country.

If you are thinking of staying, entering or expanding your presence in the mortgage business, consider the following operational, compliance and cultural aspects:

  • One important lesson we should have learned from the recent crisis is that we must be prepared for when loans go bad. This is why on-going review of the current process for compliance, interest rate risk mitigation, credit worthiness and efficiencies is a worthwhile effort. So is a vigilant examination of the controls put in place to avoid fraud and default risks.

  • The operational side of the mortgage factory can become inefficient due to convoluted past practices and a disconnect between the front and the bank components of the operation. Better alignment of the Loan Officer (LO) and the underwriter/processor not only improves the customer experience but also streamlines the process, yielding operational efficiencies. In some banks the mortgage sales person and the retail banker are one and the same, and they are paired with an underwriter/processor to create a team that can "manufacture" the mortgage as a unit. They have the skills to determine whether the loan will be saleable and what are the necessary elements needed to close within the 30 day time horizon. The group contacts customers weekly to keep in touch and ensure all documentation is in order. The LOs are involved in the information gathering stage.

  • A strong appraisal staff can ensure quick and efficient turnaround of mortgage applications with closings around 30-40 days from application. Ordering these appraisals early is key to success (once income is verified is a good benchmark).

  • Both LO and the branch staff should share the responsibility and obligation in the mortgage process from origination to closing. The point-of-sale person can take the application and then work with the small support unit to produce the mortgage.

  • Improve communications among all process stakeholders. Even a weekly 30 minute meeting can be helpful to working out the kinks in the process. Bring together all involved  the leaders of the small lender/processor units; retail folks; closers; product people  who get together for a short 30 minute session (commit to that amount of time, no more) to review progress, identify defects in the process and ensure repairs and fixes are made in a timely fashion.

  • An important regulatory question is when does a customer query turn into an application (for Reg B purposes). There is no easy answer, but one approach is to define receipt of the 1036 form and origination fee as the start of the application process. Another is to consider the fulfillment or RESPA's six items as the point when the clock starts ticking.

  • The regulatory risk is particularly high when it comes to the foreclosure process. This is especially true in states where foreclosure takes years to accomplish. As is often the case, detailed documentation of the process itself is helpful, even down to the individual job family. Focus on the default area and use a task map tool such as Visio. Don't forget Key Performance Indicators for each position and FTE capacity planning to demonstrate readiness (e.g. how many files does a collector process per day, ergo this is the number of collectors needed). Clearly documenting policies, procedures and staffing requirements in the default area is a regulatory compliance necessity.

  • Another way to enhance efficiencies in the back office is to tie meaningful incentives to productivity quality and timeframes. You will get your team better engaged and improve the customer experience. You might even start experiencing recoveries& Also emphasize modifications, which, again, help the customer and help the bank. Use the benchmarks developed for the KPIs to incentivize your team and to improve your Quality Control process, including remedial actions to show attention is being paid to the information and reports generated.

Mortgages are a core banking product. Offering them carries an increasing regulatory risk, but the rewards in terms of profitability (both net interest margin and fee income) and customer relationship building are also lucrative and impactful.