How Does Profit Margin Compression Affect the Balance Sheets of Mortgage Industry?
The US mortgage industry has faced numerous challenges over the past decade. While the economy has steadily improved after the last great housing crash thanks to stronger labor markets and reducing interest rates, there are still challenges which worry most mortgage lenders. This combined with a slew of new regulations such as TRID (TILA-RESPA Integrated Disclosure) have further affected compliance costs associated with performing day-to-day mortgage business.
One of the main factors impacting profitability and business operations of mortgage lenders is margin compression. A recent survey conducted by Fannie Mae concluded that despite improvements being made in housing market expansion, lenders are still worried about their profit margin outlook. Since 2015, lender profit margin expectations have steadily fallen over the years. While this issue affects all banks and mortgage lenders equally, shrinking profit margins have put smaller community banks at high-risk. This is because they do not have ancillary sources of income, such as complex investments or fee incomes which can offset their mortgage profit compression. What's worse is that most industry experts believe that the situation will only get direr from here on, before it can improve.
How is Mortgage Industry Affected by Profit Margin Compression?
There are multiple economic factors involved in driving mortgage profit margin compression. With dwindling sales, banks are offering home buyers with attractive offers and low interest rates, which is great for the borrower, but not so good for the mortgage lenders.
This also drives down revenue generation as new loans stop becoming as profitable as old ones. Refinancing such homes further compounds the amount of loss, as borrowers try to trade longer-term and higher-interest loans for lower-interest ones which stand for a shorter time. On top of that, bond yields from ultra-low interest loans undermine the mortgage market's long-term stability.
The term Net Interest Margin is often used in conjunction with mortgage profit compression. Also known as NIM, it has 2 important components - interest income at the expense of liabilities and interest income on the earning of assets. The larger the gap between these two, the better your profits are. Post the housing loan crash, the average housing loan portfolio declined to historic lows, and cost of funds bottomed out. As a result, NIM for banks as well as lenders started compressing heavily, so much so that many small lenders make very less profit and are only just able to stay solvent.
Mortgage Industry Challenges - Factors Which Lead to a Low Profit Margin Outlook
In these testing times, lenders only look forward to enhancing their operational efficiency so that their business doesn't get affected. Companies are regularly finding ways of leveraging technology to cut down costs, while streamlining their processes and maximizing vendor performance to make money. At the same time, the impact of margin compression on mortgage companies cannot be avoided. Two of the major pain points when it comes to reducing profit margins stem from the following -
1. Regulatory Compliance In a recent survey conducted amongst lenders across the USA, a whopping 61% believe that unhelpful regulations are stifling their operational efficiency by reducing their profit margin outlook. The impact of TRID cannot be unseen, as it has led to changes in the workflow of lenders while ensuring that many smaller lenders must look at other revenue generation points to raise their standards.
2. Increasing Competition Today, lenders are becoming increasingly wary of market competition being heralded by startups which operate only out of a website, and large chains which still have surplus money in the coffers to keep taking risks.
With the refinance boom coming to an end, lenders have started fighting it out for the small origination market. There are also fewer opportunities for lenders to exploit as the housing financial plans mature and the buyers get more educated when buying a mortgage.
3. Reducing Purchase Demands Across USA and in many European countries, the purchase mortgage demands have slumped to a standstill. According to a recent Fannie Mae survey, the purchase demand numbers are the lowest in the past 3 years. As a result, the average yield for earning assets are also steadily going down.
4. Primary/Secondary Spreads are Getting Wider While the origination volumes are steadily decreasing along with the refinances, the primary/secondary spread remains wide. This increase in origination costs will further hamper profit margins, even though there is a wide difference in the primary and secondary market mortgage rates
How Can Lenders Lead a Strategic Response Against Margin Compression?
The average mortgage portfolio has declined at an average of 1.8% per quarter for the last 10 quarters steadily. Fighting against the NIM squeeze is not an easy task, but strategies which are deployed now can help mortgage companies regain their concentration and set up their practice to pay big dividends in the coming years. Some of them include -
Rejuvenate Pricing Power
Mortgage lenders should perform a careful analysis of client profitability and compare it against price sensitivity at the product level. This can then be further expanded upon by analyzing the key client relationships which are part of the portfolio, helping deduce what price works best for them
Enable Transparent Costs
Banks and lenders need to achieve cost transparency by setting up an adequate process for funds transfer pricing which can properly allocate central costs to the product level. Without this, banks will be unable to assess both the profitability of the product or their clients. It can also lead to the generation of counterproductive incentives for the bank's business units.
Optimization should be a go-to strategy at all levels. Optimization at a higher level can help lenders balance their different lending products such as mortgages, refinancing, etc. This can lead to better changes in pricing, cost transparency, etc. At a lower level, optimization can help streamline day-to-day processes and help build efficiency while reducing prices
Rework the Hedging Strategy
Your existing hedging strategy should reflect the current mortgage rate environment as well as the expectations of the bank and the risks it is willing to take. In today's uncertain scenario, one should be prepared for a variety of rare outcomes and be prepared for the same.
By retaining the rights to mortgage servicing you never subject yourself to another company's overlays. Your loan officer services the customer for life and helps provide greater cash flow in a market where cash flow is slowly disintegrating. This can also help you prevent random fluctuations in servicing rates. The only thing you should worry about is putting up the capital for retain servicing, but once you do so, you can cut down on costs and retain customers for life!
Enable a Proprietary System
Building your own proprietary loan origination system can truly add value to your proposition. You will never have to subject yourselves to the timelines of a vendor and can automate most of the tasks which take up a chunk of your day. While many companies believe that it may take years to complete and at a huge cost, it is also extremely important that you get started on it right now.
Partner with Flatworld for Mortgage Solutions that Can Help You Breach the Divide
At FWS, we believe that our experience in providing top-notch mortgage services to global clients has allowed us to develop a streamlines servicing model that can help you find suitable answers to your day-to-day mortgage industry challenges. Our services are provided at extremely affordable rates, and with the help of our multiple delivery centers, you never have to worry about a project getting delayed any more.
To learn more about how we leverage the latest technology to provide our clients with the best services while remaining updated with the latest trends in the mortgage industry, contact us now!