Costs are up. Volumes aren’t. Five strategies lenders are using to trim and tone their operations
The seasonally weak first quarter is here, adding to the extraordinary number of cost challenges facing mortgage lenders following a year of lower volumes and higher rates. Lenders produced $1.7 trillion in home loans in 2017, following a year when volume was over $2 trillion, according to the Mortgage Bankers Association. Purchase loans accounted for more than 60% of volume throughout 2017, following several years when refinancing dominated. And that pickup in purchase mortgages, which cost more to originate, poses unique challenges for lenders trying to reduce overhead.
For the first time since 2014, the average interest on a 30-year fixedrate mortgage hovered above 4% more often than it was below that mark, according to Freddie Mac.
Meanwhile, housing inventory constraints are making it difficult for home buyers to close deals on affordable properties. Yet lenders continue to see their headcounts rise, particularly among the ranks of nondepository mortgage bankers.
Just a few years ago, it cost lenders about $5,000 to produce a single mortgage. Now, personnel costs alone account for nearly $5,300 of the more than $8,000 in lenders’ per-loan production expenses, according to Mortgage Bankers Association data for the third quarter of 2017. Others, like industry accounting firm Richey May, put per-loan compensation expenses for the past year even higher.
Lenders are concerned that costs are spiraling out of control, and many are pursuing aggressive strategies to better manage the situation. But that’s easier said than done. Amid fierce competition for both volume and talent, mortgage companies can’t afford to not to invest in the strongest loan officers and back office capabilities available. That means lenders can’t just make cuts across the board. Instead, lenders are reducing expenses, as well as making investments in tools and processes that improve efficiency across every facet of their organization.
Underlying each of these strategies are new approaches to analyzing a variety of performance metrics and using that data to improve efficiency, often by introducing new technology or finding new uses for existing systems.
The most important area of focus is compensation, which represents the lion’s share of expenditures. But lenders are also scouring other line items on the budget, including marketing; facilities and equipment; cost of funds; and yes, even compliance, to streamline operations and stay competitive.
Fierce competition for sales talent makes compensation tough to cut. Compensation makes up almost 80% of the $8,354 that mortgage bankers spend on average to produce a loan, split about evenly between front office and back office personnel, according to Richey May.
“It just seems to take more hands to get loans funded and closed,” said Tyler House, manager of advisory services at Richey May.
Unfortunately, there aren’t a lot of ways to make cuts without hurting sales.
“Most of the cost frankly is in the early stages of the loan, which is what happens up to and including getting the application originated. So it’s going to be very difficult to wring a lot of costs out without focusing on sales and marketing,” said Garth Graham, a senior partner at Stratmor Group.
The industry consulting firm’s data shows the top 40% of mortgage sales staffs are responsible for the majority of production volume, suggesting lenders could cut as much as 60% of their loan officers without hurting volume. But doing so puts lenders at risk of being understaffed in times of increased demand or when a top performer is poached by a rival lender.
Alternatives include straining the capacity of existing resources, but that reaches a point where it has diminishing productivity returns. It also can drive top producers to competitors if the working conditions are better. New trainees help, but require time and money.
What lenders really want is a strategy that allows them to downsize operations without hurting sales.
Movement Mortgage inadvertently found one.
The idea originated with Geoff Brown, a loan officer who made an off-hand remark at a holiday party a couple years ago about how he no longer knew the members of the operations center support staff he worked with as well as he used to because there were so many.
Executive Vice President Toby Harris took note, and charged Chief Operations Officer John Third with reorganizing the few hundred people in each of the company’s three large operations centers into smaller teams to offer dedicated sales support in different regions.
While the move wasn’t originally designed to reduce staff, the reorganization made it easier to track performance, offer supplemental training to underperformers and make cuts if the training failed.
And after analyzing the outcome over time, the company recently found that it did result in a reduction in its headcount. The first full year the company had the strategy in place, it was able to originate $1 billion more with a support staff that was 10% smaller, primarily due to attrition.
“It really had an immediate impact on improving the relationships between ops and sales, and a side effect it had was to improve productivity, therefore reducing some of the costs per loan,” said Third.
The cost-control strategy that gets the most buzz today involves pairing automation aimed at improving the online customer experience with lower-paid call center originations, but there’s a trick to it.
Call center staff get paid less, but also don’t usually generate leads to loans the way traditional loan officers do, particularly when it comes to purchase mortgages leading the market.
That means lenders need to add leads or other marketing expenses to the cost of operating a consumer-direct call center before calculating any savings from it.
Lead costs are notoriously variable and tough to control, ranging from $800 to $1,200 per loan, according to Richey May. The cost savings of a consumer-direct channel over a distributed retail channel can be “almost negated fully by the marketing costs that the call center has to go through,” said House.
“That lead cost will eat you alive,” added Graham.
A consumer-direct strategy can produce cost savings in the purchase market, but the margins may be thinner because the product type requires dedicated loan officers to be effective, Graham said.
Pairing consumer-direct strategies with a servicing portfolio or other internal marketing can help lenders keep marketing costs under control, said Dan Cutaia, an industry veteran who is selling an experimental online lending platform called BeLoanReady.
“The call center is more cost effective clearly if you have a servicing portfolio and are not paying these third party lead aggregators or advertisers,” said Cutaia.
Traditional marketing costs for a lender are more manageable when a company doesn’t need to purchase online leads that average $349.
Other ways companies are looking to control marketing costs and ensure loan officers use marketing tools is to have them pitch in financially.
Churchill Mortgage, which is looking to cut loan costs 15% in the coming year, offers some customer relationship management tools to its staff without obligation. But the lender will ask loan officers to pay for a real estate information system that helps them market to homeowners if they’re not using it.
The company analyzes per-loan marketing costs carefully and has found Google’s pay-per-click advertising is among the most effective sources of leads. However, this type of marketing requires a keen understanding of how search engines work.
Additionally, Churchill works to make sure marketing is cost effective by maximizing the use of any lead as a source of future business not just from the borrower but the real estate agent or other referral source the borrower works with.
“You ought to parlay every lead into broader referrals with all the parties involved,” said Matt Clarke, Churchill’s chief financial officer and chief operations officer.
FACILITIES AND EQUIPMENT
Lenders do not only use their strategic knowledge of government programs, real estate and finance to sell home loans; they also use it to get the most out of facilities and equipment costs.
Movement Mortgage, for example, got a $660,000 grant from Virginia’s Economic Development Partnership to support its effort to lease and renovate space in a former J.C. Penney storefront for its operations. And Embrace Home Loans got a $330,000 state grant in Rhode Island to partially pay for the $1 million installation of rooftop solar panels that will provide energy cost savings over time.
Embrace also has experimented with the use of remote underwriters using what President Kurt Noyce calls “the virtual office concept,” which can reduce the need for facilities and associated costs.
“I know plenty of lenders who will hire remote underwriters all day long,” said Graham. “Not every lender is comfortable with that, but it does change how much is spent on fixtures, furniture and equipment.”
With a growing amount of common off-the-shelf lender technologies like loan origination systems and customer relationship management platforms delivered via software-as-aservice, many lenders are already operating in smaller spaces as well as allowing some remote work to be done.
The typical lender spends hundreds of dollars per loan on technology, facilities and equipment, compared to the thousands per loan spent on compensation. Tech budgets might only be more sizable among very large lenders, particularly if they develop and maintain proprietary systems.
“We’re not spending a lot on technology, even with all the digital solutions coming,” said Graham. Roughly 30% of lenders have some form of digital point of sale technology in production and another 30% have some form of it in production, but the remaining 40% of the industry doesn’t, he added.
Part of the problem is that technology savings can be so meager, given the upfront investment.
Embrace’s solar panels won’t produce true savings for several years, and Third cautions not to overestimate the immediate efficiencies from a new digital point of sale system, noting that the reorganization of its support staff had a more immediate impact.
Movement utilizes a self-service point of sale system from technology developer Blend Labs alongside its LOS from PCLender, a vendor that was recently acquired by Fiserv.
The Blend technology offered savings because it helped Movement collect more data, avoid paper and verify information faster. So far, the technology has helped cut about half a day from loan processing times.
“But we’ve only been using it for a year,” Third said. “I think you still have customers out there who are wary about how they provide their data. We’re expecting to see additional gains as the consumer becomes more comfortable with how they provide data for a mortgage application.”
There may be additional savings from the government-sponsored enterprises’ representation and warranty relief efforts for loan information that can be validated with automated services available from Fannie Mae, Freddie Mac and their approved vendors. But Movement isn’t far enough along in implementation to see any efficiency gains yet, Third said.
While digital platforms are a long-term need, the first priority for lenders is to ensure they have automation that examines their own finances on a continuous, real-time basis and couple it with peer group metrics offered by trade groups and industry cooperatives.
Accounting automation is providing more detailed, real-time analysis of compensation, which represents a huge chunk of loan costs, but is becoming more complex as lenders compete through the use of different override and commission structures, said Advantage Systems President Brian Lynch.
“You are able to do importation of what would be very voluminous journal entries, so that helps to keep costs down,” said Bill Napier, chief financial officer at Homespire Mortgage. “The overall critical control feature is for management and the finance department to just be able keep a constant eye on the budget, knowing they should have the ability to forecast and have readily available plans to implement in the event of whatever scenario is playing out.”
COST OF FUNDS
Warehouse line of credit expenses average $515 per loan. And with short-term rates rising, it’s a cost not likely to abate any time soon.
Even with short-term rates remaining relatively stable in previous years, warehouse line costs have risen since the end of 2013, when they averaged $495 per loan. Costs got as low as $442 per loan at the end of 2014, but started rising again, to $473 in 2015 and $506 in 2016.
The potential for savings now is not huge, but “there are nickels and dimes to be earned if you are more effectively managing your warehouse lines,” said House. “We tell people just be sure you’re using your most cost-effective warehouse lines first, filling those up to capacity before you use your others.”
Another potential area for savings is electronic notes, said Joe Lathrop, a senior vice president at who works in Flagstar Bank’s warehouse lending unit.
A warehouse line can turn faster if a mortgage lender is willing to use e-notes, and that could help lenders control capital costs as volumes shrink.
The more a lender keeps outstanding on a warehouse line, the more capital the line calls for. So if a lender can reduce the amount outstanding by paying off a line more quickly with e-notes, less capital is required.
“If you don’t need as large of a line, you don’t need as much capital in the company to make sure you meet the minimum requirements necessary,” said Lathrop.
Lenders do have to invest in e-note technology, so “each company has to look at their own cost structure to determine the kind of savings that they are going to receive,” Lathrop said.
“They would have to contact a vendor and do their due diligence on the vendor to make sure that they can handle e-notes successfully and make sure that they have the platform necessary,” he said.
How many warehouse lenders will be accepting e-notes also remains to be seen. Flagstar’s warehouse unit recently started to accept e-notes and is still unsure how many lenders will respond to the offer.
“We want to make sure our customers have it available so that when they decide to use e-notes, they will see we are a warehouse lender they can turn to,” Lathrop said.
There are many costs associated with regulatory compliance and related liabilities in the mortgage business, and while there are signs this could change, how and when remains uncertain.
Until it is clear how or whether the GSEs’ rep and warrant relief affects insurance needs, or how any proposed changes to federal tax rules or attempts to rollback Consumer Financial Protection Bureau regulation will play out, lenders will have to make plans based on existing compliance costs.
Licensing, taxes, insurance and legal, along with other professional services fees associated with compliance, currently cost the average lender $591 per loan, up from $533 in 2013, according to Richey May.
One way to save money on compliance services is to seek out discounts for bulk purchases of training and continuing education.
“There are companies that will provide consistent online training and include both the sales and technical-oriented part. The more you do, the more you ought to be able to get the cost down,” said Graham.
Lenders like Envoy Mortgage, for example, shop for bulk rates for continuing education that loan officers must take to stay licensed.
Smaller mortgage lenders or loan brokers also can access bulk rate discounts through cooperatives or other larger business partners.
United Wholesale Mortgage offers a continuing education discount that 2,000 of its mortgage brokers use, according to Brad Pettiford, a spokesman for the company. The discount saves brokers more than $100 per month.
“It’s a huge cost savings,” said Lynda Danna, president of mortgage broker 1st Residential Funding Inc.
Another strategy for lenders are automated change management systems that help companies stay updated on shifts in industry rules by identifying and analyzing new regulations while filtering out information that doesn’t apply to a lender’s products.
Waterstone Mortgage, which recently switched from spreadsheet-based technology to Continuity’s change management system, hasn’t had it long enough to see what the return on investment will be like.
But the company already finds tracking relevant state and federal rules less “labor intensive” than its previous spreadsheet-based system, said Chris Hatton, Waterstone’s compliance manager.
The Continuity system on average takes about 90 to 120 days to provide a return on investment and within a year usually saves each company the equivalent of one parttime employee’s salary, according to Pam Perdue, executive vice president and chief regulatory officer.
Compliance will no longer be lenders’ primary cost concern in 2018, but it will remain a key consideration as they broaden their search for efficiency to encompass the full scope of their operations.
Lenders must broaden their cost-benefit analyses to the full scope of their operations to fully right-size their companies and adjust to new market needs.