Written by Dan Cooper, Mortgage Banking Solutions’ newest Senior Consultant

Thirty years ago the financial services industry was very different than it is today. There were no debit cards, the financial elite were the only individuals that held credit cards, mortgage lending was controlled by the savings and loans, mortgage brokers did not exist and mortgage banking meant selling FHA loans to FNMA and New York based savings banks. In addition mortgage loans and their payments were tracked manually via ledger cards and loans were originated by a salaried loan officer employed by his hometown savings and loan and approved by a loan committee made up of the senior management of the institution. If a loan went delinquent, the loan officer drove over to the customer’s house to find out what was going on. Oh yes, the loan was a fixed rate loan funded by the passbook savings accounts.

Through the years, driven by the industries booms and bust periods, the business evolved to something very different. Fast forward to 2005 and we find a business controlled by Wall Street and their mathematically derived Mortgage Backed Securities, dependent on the “economy of scale” model for servicing profitability, loans being originated over the internet with little or even no customer contact, and the overriding belief that real estate values will keep going up.

The Role of Technology in the evolution of the business

A major driver of these changes has been technology. While technology has provided many positive changes, it has caused to some extent the de-personification of the mortgage business. In the world of VRU’s, decisions driven by loans serviced per person and cost per loan, and e-mortgages, technology has accomplished what the developers intended but not without a cost.

The business has been driven by the technology that has allowed thousands of transactions and thousands of computer generated phone calls to be made quickly and cheaply. The up front cost of this technology was not necessarily cheap but it allowed the mega servicer to pay a hefty premium for mortgage loans and to source those loans from a variety of origination channels. This was at the expense of the small to medium size community banker who could not compete with the rates offered by these mega servicers and originators. In addition, the top producing salaried loan officers could open their own company and pay himself a percentage of the loan amount and simply refer the loan to the mega servicer/originator for closing and servicing. Again, this was at the expense of the personal relationship the mortgage customer enjoyed with his or her ultimate counterparty.

What went wrong?

Not to oversimplify mortgage industries collective problems, but in reality, it is very simple. Mortgage loans were priced, new products were developed and mortgage backed securities were rated and leveraged with the assumption that real estate would continue to increase in value. Of coarse all the models had the ability to run value shocks but, based on past history, a severe decline in real estate values was assigned a very low probability. So, in late 2006 when values started to fall in certain key states, everything began to unravel and will continue to unravel until real estate values stabilize.

Why so many very smart people did not see this debacle coming is much more complex and will need to be analyzed and understood in the coming years. Two of the many reasons are discussed here, customer service and the consolidation of the business.

The Demise of Real Customer Service

Customer Service is defined as assistance or advice given to customers during and after the sale of goods and services. Technology has allowed companies to give assistance to a large number of customers in a very efficient manner. If I want to find out the balance of my loan, I simply log in to the servicers website and in a matter of minutes I can find out the balance, when my next payment is due and how much that payment is. If I need help though with a tax or insurance problem, or I am having financial difficulty and I am serviced by a mega servicer, I will most likely run into problems. Trying to track down the person that has both the knowledge and authority to solve a problem is an arduous task that takes time and patience and routinely ends in frustration and no resolution to the issue at hand.

The same is true in the origination process. Technology has allowed an individual to transact a loan online with little or no human intervention. One may ask at this point, what does this have to do with the current issues at hand. The answer is not as direct as the falling real estate values but is equally as dramatic. Essentially by removing the human interaction we have de-personified the mortgage process. This has contributed to more individuals making poor decisions and effectively over levering their personal balance sheets.

The case for the breakup of the mortgage lending process

The mortgage business is constantly evolving. The business has gone from a community lender controlled industry to one controlled by government and quasi government agencies to one controlled by Wall Street Investment Banks, to an industry in transition. So what will we look like going forward? Here are a few theories to think about.

- One size fits all. Premiums will no longer be paid for quantity.

- Technology will level the playing field. Systems that, in the past, have been cost prohibitive are now affordable by the small to medium sized originator and servicer.

- The art of the cross-sell is easier in a smaller company that has a personal relationship with its customer.

- Outsourcing allows for economies of scale on items that do not require direct customer interaction.

- Mortgage rates will be priced based on a non-levered return. Anything that is not agency eligible will be limited to investments held by community banks, national banks and investment funds. Portfolio sizes will be limited and pricing will reflect that limited demand.

- A unit of gold, wheat or oil is essentially the same. These are what are known as a commodity. A pool of loans is made up of with a very diverse group of individuals that have very different profiles in regard to their ability and desire to repay a loan and collateralized by a unique unit of real estate. This hardly fits the definition of a “commodity”. The past 20 years has been an evolution of trying to make a mortgage walk and talk like a barrel of oil. The process failed because each unit was different and the mathematical models that valued the loans and securities did not effectively factor in that basic premise.

Conclusions

The recent crises has forced to us to face up to a few simple truths. These are things that we intuitively knew but may have forgotten in the last few years. They are as follows:

- Mortgage lending is reliant on the three C’s: Credit, Collateral and Character. Any weakness in one of these affects the quality of the underlying loans. The last few years saw an evolution away from credit and character and towards collateral dependent loans. When the collateral value fell—-well, we are living that story now.

- Technology has evolved to the point where the economies of scale previously enjoyed by the Mega-servicers has been reduced or eliminated.

- Good customer service is very difficult to achieve in large servicing operations.

- Cross selling is more effective when the customer interfaces with an actual person as opposed to direct mail or VRU’s.

- Mortgage lending will now be a government-controlled process. By nature all companies are treated the same and quality, not quantity will be rewarded.

As we have been watching some of the top ten mortgage lenders be consolidated or simply leave the business, the top salespeople and senior management are scattering and opening their own operation. The first step of the theoretical de-consolidation is in place and, based on the flow of funds into independent companies and new startups, will gain momentum as we move through this current recession.

Daniel Cooper, CMB, brings more than 25 years of extensive Secondary Marketing experience to the MBS team. Mr. Cooper is a veteran of many cycles in the business and has managed locked pipelines from $50 million to over $1 billion that are in production operations that exceeded $6 billion per year. Mr. Cooper has employed a variety of philosophies and systems in the process and understands the advantages and disadvantages of each in relation to a company’s risk/return profile. Additional experience includes purchasing, selling and hedging large Mortgage Servicing Rights portfolios, purchasing, selling and managing large mortgage loan and security portfolios, created and managed a profitable de nova mortgage company, and implemented and managed FAS 133 hedge accounting systems and procedures for a $36 billion mortgage servicing portfolio and a $4 billion a year wholesale mortgage company. Mr. Cooper received his BSBA degree in Finance from the University of Florida and his MBA from Florida Atlantic University. Mr. Cooper resides in Houston, Texas where he enjoys time with his wife Kimberly and 3 children. 

Mr. Cooper can be reached at (713) 893-5219