We have seen too many banks and credit unions exit mortgage banking, usually at exactly the wrong time. But the good news is that many banks are alive today because mortgage banking booms in 2009-13 and 2019-2022 offset losses or lackluster performance in CRE and C&I loans.
Mortgage banking can be the perfect countercyclical line of business to their other lines of business.
We worked with two banks losing money in their mortgage banking unit who ignored our advice and exited the business in February 2019, just before the greatest mortgage boom in history! Here are the seven deadly sins we have seen over the years.
Banks can be unaware of their competitive strengths. Banks often don’t take advantage of the strengths they have when compared to independent mortgage banking companies (IMBs). They can offer portfolio products, construction/permanent loans, HELOCs, and piggyback seconds. They have the capital strength and liquidity to weather downturns. They can cross-sell non-mortgage products and services, and they can use their strengths to recruit top-quality IMB loan officers, especially during mortgage industry downturns.
Banks don’t understand that mortgage banking is a manufacturing business. It’s not a spread lending business based on interest income minus interest expense/cost of funds. The business must be treated as a business that produces widgets and must do so efficiently with quality control measurements, standards, and key risk mitigants needed for secondary marketing and counterparty dependencies.
Banks don’t understand the difference between mortgage lending and mortgage banking. Mortgage lending is where a bank originates mortgages for its own portfolio. Mortgage banking is where the lender sells the loans to Fannie Mae, Freddie Mac, or aggregators, where the bank doesn’t keep the mortgage on its balance sheet and just collects origination, gain on sale, and possibly servicing income. Mortgage lending is relatively simple. Mortgage banking is more complicated and takes a bigger commitment. We can suggest good alternatives for banks who want to do mortgage banking but don’t want to develop a large staff to do it or are concerned about staffing for upturns and downturns.
Poor mortgage banking reporting. Banks typically don’t have good accounting for mortgage banking and don’t have a proper income statement or performance metrics. They use their core systems, which are based on spread lending lines of business, but they really need a package that is specifically designed for mortgage banking as a manufacturing business. How can a mortgage division executive be expected to run the business without proper reporting? It would be like managing a baseball team without knowing anyone’s batting averages. And how can senior management and the Board assess and discuss mortgage division performance with mortgage senior management without good metrics?
Banks don’t react well to the volatility in mortgage banking. It’s highly cyclical, but most banks don’t lay off enough people when the business slows. They also don’t dump their low-producing loan officers. Mortgage banking employees understand that layoffs are part of the business when volume is off. But banks could do what one bank with a “no layoff” policy does: Redeploy them elsewhere in the bank.
Banks don’t recognize how much money they make from mortgages. No matter the market conditions, “cash is king.” They don’t understand all the ways they make money in mortgages across the bank. There’s origination income, portfolio mortgage net interest income, servicing revenue, escrow deposits, and income from cross-selling for other departments, such as deposits and wealth management.
Cross-selling. Banks haven’t figured out their opportunities for cross-selling other bank products. The mortgage transaction is the most important one for most bank customers, and the mortgage application gives the bank very useful financial information. The smart banks are methodical about using the information to cross-sell checking accounts, trust accounts, personal loans, credit cards, home equity loans, etc. Many banks fail because the mortgage division is cooperative, but the retail areas don’t show enough commitment. Others fail because the mortgage loan officer treats the applicant as a transaction instead of as a bank customer.
We probably work with more bank and credit union mortgage banking entities than anyone else, and we haven’t found one yet that couldn’t be fixed. So contact us if you need help, and certainly don’t commit the deadliest sin of them all: exiting the mortgage business.
Joe Garrett and Mike McAuley are partners at Garrett, McAuley & Co., a consulting firm that is “Helping lenders increase revenues, reduce costs, and better manage risk.”