What A Difference A Year Makes

It takes a strong stomach to be a mortgage banker these days. In a business that's notoriously cyclical, the current downturn is shockingly severe. Interest rates this year have risen further--and faster--than almost anyone expected. As a result, demand for mortgage loans has plunged: the Mortgage Bankers Assn. estimates that the pace of lending today is down 45% from the first quarter.

Mortgage banking's woes, though, go far beyond cyclical downturns. High interest rates, coupled with wider uses of technology, are sparking a far-ranging restructuring and consolidation of the industry. Mortgage banking as a stand-alone business is shrinking as commercial banks gobble up many of the major players and independent mortgage banking companies find it harder to make it on their own. Indeed, mortgage banking will never again be as open to entrepreneurs with more guts than capital. "Everyone's forecast is for continued consolidation," says Gerald L. Baker, chairman and CEO of Fleet Mortgage Group Inc., a unit of Providence-based Fleet Financial Group Inc. "The name of the game has got to be improved efficiency and improved marketing."

Mortgage bankers have their hands full simply dealing with current problems. The Mortgage Bankers Assn. sees mortgage lending falling to $605 billion in 1995, down from $1.01 trillion in 1993 (chart). Mortgage refinancing, which reached a feverish $556 billion in 1993, could plummet to $67 billion next year.

The pain from the drop in activity is just beginning to be felt, though. Employment in the industry, which reached 258,000 in the first quarter of 1994, is down just 9%, to 234,000. David Lereah, the Mortgage Bankers Assn.'s chief economist, expects employment to fall by at least as much again over the next year--and that's not counting the many thousands of part-time and temporary workers losing their jobs.

None of this has deterred commercial banks from expanding further into the industry. Chemical Bank, Chase Manhattan, Bank of America, and Norwest Corp. have all made acquisitions this year, aiming for dominant market share when rates start to fall and demand for mortgages picks up again.

MORE PRESSURE. Some observers feel the banks are a little too eager. "The banks paid very full prices," says Jonathan E. Gray, an analyst at Sanford C. Bernstein & Co. The new owners are working to trim the fat: Chase, for one, expects its purchase of American Residential Mortgage Corp., which it acquired in September, to result in a $20 million loss included in its fourth-quarter results, partly to cover restructuring. Robert D. Hunter, senior executive vice-president, says he does not expect American Residential to turn a profit for Chase before 1996 but adds, "we bought it as a strategic play" to boost Chase's ability to make smaller mortgage loans.

Mortgage banks owned by commercial banks are likely to put more pressure on the independents. Because of their capital resources, they--and thrifts as well--have more flexibility than independents. For instance, with interest rates rising, the captive mortgage banks and the thrifts are able to offer currently popular adjustable-rate mortgages (ARMs) at below-market rates. Because the rates are low, they can charge high fees or points. And they can hold the mortgages on their books until rates decline. Independent mortgage banks are at a disadvantage. Lacking the capital of their big rivals, they have to sell off their loans immediately. But that makes it hard for them to offer cut-rate ARMs, which they would have to sell below face value. If they offer market-rate ARMs, they have to charge fewer points--and make less profit.

The news isn't all bad for mortgage bankers. Because of the dearth of activity, they and other lenders are caught up in a heated market-share battle. To get business, many institutions are stretching on credit quality. "As originations have dried up, people have been trying to expand and have adjusted their underwriting standards [downward]," says Thomas G. Gillis, an analyst at Standard & Poor's. But because mortgage banks don't retain their loans, any pickup in delinquencies when the economy slows again will mainly hurt commercial banks and thrifts.

Many mortgage banks hold on to rights to service the mortgages, though. Those rights are becoming more valuable, since they generate a steady stream of income that gets more reliable as interest rates rise and mortgage refinancings slow down.

A SHAKEOUT? Both mortgage servicing and mortgage lending are becoming more technology-driven, which benefits the big players. Using technology for record-keeping and for processing millions of monthly payments creates substantial economies of scale. "I think we'll see a lot of consolidations on the servicing side," says James G. Jones, BofA's group executive vice-president for consumer lending. Chase's Hunter goes further, predicting that technology will become more of a factor in mortgage-application processing, mortgage servicing, and marketing. "There is one issue: Can you be a scale player?" he says. Richard M. Kovacevich, Norwest's president and CEO, says 38% of the bank's mortgage originations in October were made by laptop computer. A year ago, no laptops were used.

The growing technological requirements of the business will create a major barrier to entry for small, independent mortgage bankers trying to regain a piece of the market when rates turn down again. Some bankers say the consolidation among the top players in mortgage banking will resemble the changes that have taken place in credit cards over the past 10 years. There, the top 10 players have about a 50% market share, up from less than 25%. And if small mortgage bankers are unable to compete on cost, they will find themselves close to mere brokers--simply passing along loans and servicing to the big guys. "The classical definition of a mortgage banker might be changing," says Fleet Mortgage's Baker.

No one expects the mortgage-banking industry to die out. But the days when it could sit around waiting for the cycle to change and put it in clover again are probably gone forever.

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