Mortgage Banking
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Industry Overview
The US mortgage banking industry includes about 7,000 companies with combined annual revenue that varies between $50 and $75 billion. Major companies include units of Wells Fargo, JPMorgan Chase, Citigroup, and Bank of America. The industry is concentrated: the largest 50 companies generate about 70 percent of revenue.
Competitive Landscape
Demand for mortgage services is driven by home sales and the refinancing that occurs when mortgage rates are low. The profitability of individual companies depends on volume, interest rate spreads, and efficient operations. Large companies have big economies of scale in operations. Small companies compete successfully by funneling mortgages to the large companies. The industry is also capital-intensive and highly automated: annual revenue per employee is close to $300,000.
The global financial crisis of 2008-2009 redrew the mortgage banking landscape. Several prominent mortgage lenders became insolvent and were acquired after subprime mortgages failed. A handful of brand-name banks emerged as industry leaders. JPMorgan Chase took over Washington Mutual after its mortgage unit's losses led to the largest bank failure in history. Bank of America bought Countrywide Financial, once the nation's largest mortgage lender. IndyMac, California's largest mortgage lender, went bankrupt and some of its assets were bought by private equity firms.
Products, Operations & Technology
Mortgage banks lend money to homeowners through a mortgage, with the home as collateral. The traditional mortgage has a fixed interest rate and level monthly payments that pay off the loan over 30 years, but loans with adjustable interest rates (ARMs) and variable payment schedules have also become common. Low interest rates and easy credit led mortgage banks to offer ARMs at subprime rates to buyers who did not qualify for traditional mortgages. When home prices dropped and buyers defaulted on their loans, ARMs lost favor in the late 2000s.
While mortgage loans are usually made to buy a home (a "purchase" mortgage), they're also made to refinance an existing mortgage (typically at a lower interest rate), or to provide cash to the homeowner (a home equity loan).
The main functions of mortgage bankers are loan production, underwriting, and servicing. Large mortgage bankers may also create and trade mortgage-backed securities. The subprime mortgage crisis of the late 2000s involved the devaluation of these mortgage-backed securities. Large numbers of subprime loans were made to borrowers who lacked the financial resources to make monthly payments over the long term. Lenders sold these mortgages on the secondary market, where they were pooled together and sold again as securities to investors. As the number of borrowers who could not meet their mortgage obligations rose, the securities, which received their value from these faulty mortgages, became almost worthless.
Loan production is sales. Mortgage bankers advertise heavily and may have a network of retail offices and Internet sites where consumers can apply for a mortgage. Mortgage bankers charge fees for processing mortgage applications and for loan origination - when an approved loan actually "closes."
Loan underwriting consists of determining the risk of a particular loan. Underwriters typically consider the market value of the home, the loan-to-value ratio of the loan, and the borrower's creditworthiness. Mortgage bankers may use their own credit scoring system to determine the borrower's creditworthiness, or one provided by a number of analytical companies such as Fair Isaac (the FICO score). The risk of default on a mortgage determines whether the mortgage bank approves the loan and at what interest rate. Borrowers with low creditworthiness may still be approved for high-risk, high-interest subprime loans if the interest rate is high enough to compensate for the extra risk. Subprime loans aim to provide homeownership to people who would not otherwise qualify for financing under traditional schemes. Without careful underwriting standards, losses from subprime mortgages can amount to millions of dollars. Subprime loans accounted for almost 14 percent of all loans originated between 2000 and 2005.
Loan servicing includes sending bills, receiving payments, accounting, efforts to collect if the borrower misses payments ("delinquency"), and the operations involved in foreclosure proceedings if the lender must take title to the property. Many mortgage bankers service mortgages owned by other investors, charging an annual fee of 0.25 to 0.50 percent (25 to 50 "basis points") of the unpaid loan amount. The riskier the loan, the greater the servicing fee, with subprime loans at the higher end of the fee spectrum.
Both mortgages and the "mortgage servicing rights" (MSR) attached to them are bought and sold in the secondary mortgage market. A mortgage banker may keep a new mortgage in its own loan portfolio, sell it, or include it with other mortgages in a "pool" that serves as collateral for a mortgage-backed security (MBS). By "securitizing" mortgages, mortgage bankers create an investment instrument that's easily bought and sold by other investors.
Fannie Mae (Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corporation) are large buyers of home mortgages in the secondary market. Unlike other securitizers of mortgages, they issue securities that aren't backed by specific mortgage pools, but the securities they issue are considered safe investments because they are backed by the government. Freddie Mac and Fannie Mae also were caught in the subprime meltdown. Their assets plummeted when their once highly rated mortgage-backed securities were devalued for containing subprime mortgages. Both companies, now under conservatorship of the US government, have received billions of dollars in federal government aid since 2008 to prevent their failure. Since the takeover, Freddie Mac and Fannie Mae have continued to purchase and securitize mortgages but with stricter oversight.
The operations of mortgage bankers, whether they mainly originate mortgages, service mortgages, or manage a portfolio of mortgage loans and securities, depend heavily on sophisticated computer systems. Consolidation in the mortgage banking industry has created large economies of scale.
