What are the unifying factors that bank lenders should watch?

By: Dan Green for CBInsight

Community bank mortgage lending takes on many shapes. Every community bank has a unique set of processes, products and supporting technology, so what are the unifying factors that all mortgage lenders should watch to determine their performance?

Last month we talked about mortgage customer share and mortgage employees per 1,000 closed loans. Among a dedicated group of bank mortgage lenders we surveyed, the former is down — an indicator of opportunity — and the latter is up. Because mortgage lending is changing in ways we still do not fully understand, it is too soon to know what the increasing number of employees per 1,000 closed loans means. While the original mortgage performance indicators remain valid, their new levels are currently unknowable.

So what do we know? The two most important mortgage performance indicators, productivity and cost-to-close, worsened from 2013 to 2014. The tide has shifted from refinance to purchase, and we all know purchase loans take more effort. TILA-RESPA’s regulatory tidal change plays a part, too, as we mentioned in last month’s article. As a result, productivity decreased while the cost-to-close increased. These two indicators have a very strong inverse relationship; when one goes up, the other goes down.

In fact, the relationship is so strong that when productivity is known, cost-to-close is highly predictable. All that is needed is a large body of data covering several years, as well as some careful, thoughtful analysis. And productivity is easily knowable; it should be almost automatically quotable by every mortgage operations manager. The ratio of closed loans per mortgage employee per month is a powerful metric.

Cost-to-close is also a powerful metric, some would say the single most important piece of information every mortgage lender should have. This is so, the wisdom goes, because it is the only variable in the formula used to calculate the rate presented to the borrower that is in the lender’s control. Every other factor — such as servicing value, hedging cost, and servicing revenue — is established externally. Knowing cost-to-close opens the possibility of controlling both profitability and competitive positioning. Productivity is so important because it represents labor, the largest component of cost-to-close, which takes us right back to employees per thousand loans closed, the focus of last month’s article.

Labor makes up 45% to 65% of the cost of closing a mortgage. Highly productive lenders typically operate on the low end of that scale; lower productivity lenders can count on their labor component being much higher. We are asked all the time about ways to reduce the cost of mortgage manufacturing. The answer that delivers the biggest bang for your buck is to increase productivity. Direct and indirect costs, the other two main cost-to-close components, are much harder levers to pull. At some level, corporate overhead is what it is. Many direct costs are often hard to adjust, at least in the short term. Focus on closing as many loans as possible per mortgage employee and your costs will decrease.

If this sounds like we’re saying ‘cut your head count’, we are not. There are two variables in the productivity equation — mortgage employees and closed loans –which lead us to customer share, the other subject of last month’s article.

We simply do not know, given the evolutionary phase of the mortgage market, exactly what mortgage staffing levels optimally could or should be. Rather, what we are suggesting is focusing on customer share. We know it dropped 25% between 2013 and 2014. We also know community bank membership grew at a pace more rapid in 2014 than at any time since 1995. This spells opportunity. The way to increase productivity is to increase mortgage production.

Right now we have a purchase market overall with many geographies reporting strong, if not over-strong demand. Boomers are right-sizing as well as positioning themselves to age in place. Millennials are forming households with an eye towards first-time homeownership. Both segments need financing assistance, though Millennials represent the single biggest opportunity, in terms of size, that our industry has ever seen. Help a first-time buyer and create a borrower (and a customer) for life.

Productivity did indeed decline while cost-to-close increased. The former dropped 32% to 3.32 closed loans per employee per month while the latter increased almost 60% to $4,398. Substantial changes such as these are common when significant market shifts occur. This may not be ideal, but it is the reality of the situation.

Our take on this is that community bank are built for growth and are now in the perfect position to leverage their decade-long work of building mortgage infrastructure, expertise and the single best reputation for residential mortgage lending service in the industry. The way to increase productivity and decrease cost-to-close is to increase mortgage production and market share.

That leaves us with the unanswered question: what are the optimal levels for employees per thousand loans closed, customer share, productivity and cost-to-close? We will have a much better idea one year from now and, we think, a solid answer this time in 2017. In the meantime, concentrate on the remarkable opportunity this market represents!