Strategic partnerships could be a smart strategy for community banks struggling to make mortgage lending profitable, as two Chicago lenders recently showed.
Mortgage volume is way down this year, due to a decline in refinancing activity, but the compliance burden tied to home loans keeps rising. These factors made West Suburban Bank in Lombard, Ill., consider shutting down its mortgage shop, but it didn’t want to risk losing customers.
So the $2.1 billion-asset bank agreed to hand over the job of making home loans to Federal Savings Bank, a Chicago thrift with a national mortgage program. Under an agreement announced Tuesday, Federal Savings will offer a full range of mortgage products at West Suburban's 37 branches.
"We weren't doing enough mortgages to afford the compliance risk, and this allowed us to outsource the business," said Keith Acker, West Suburban’s president. "It gives our customers access to the wider range of mortgages that they offer, it reduces the compliance problem and it saves us in personnel cost."
Outsourcing mortgage operations has become more common in the past year. It has become difficult for community banks with small home-lending operations to support the fixed costs of regulation and compliance, and a slack market makes ramping up a mortgage department to where it can cover such costs an uncertain proposition.
"There’s more regulations and requirements, so you have to have a larger business," at least $750 million in annual originations, to break even, said Michael Iannaccone, managing partner of MDI Investments. "If you don't have that, you need to a partner with somebody who already has a mortgage platform."
Some national and regional lenders offer partnerships with community banks where the bigger institution handles the smaller lender’s mortgage business. Nonbanks like PHH Mortgage, Embrace Home Loans and FirstLand Mortgage Servicing offer similar services.
Federal Savings typically partners with banks where mortgages are "not a primary area of focus, but it is a service they want to offer," said Steve Calk, the $197 million-asset thrift's chairman and chief executive. "The truth is, it's hard to compete unless you’ve got at least $5 billion in assets and are willing to start with a $3 million investment for startup, staffing and compliance."
That wasn’t in the cards for West Suburban. The bank, which serves four counties outside Chicago, had seen its mortgage business wither since the financial crisis. Management determined it would need to originate 60 to 80 mortgages a month — roughly what it was doing before 2008 — to make a mortgage program profitable.
The bank now closes about five to 10 a month, Acker said. "We ran a cost analysis and determined [mortgage lending] wasn’t worth the risk and compliance cost," he said.
A mutual acquaintance recommended Federal Savings. Calk won't say how many banks Federal Savings partners with, just that the number is "under 100." The thrift originates $3.5 billion in home loans a year.
West Suburban will refer customers who want mortgages to Federal Savings bankers, who will either be stationed in West Suburban’s branches or will be available by phone. To reduce West Suburban's compliance burden, Federal Savings will originate the loans completely independently, though West Suburban will be allowed to buy back loans of its choice to comply with the Community Reinvestment Act.
The keys to the deal involve compensation between the banks and ensuring that they operate independently. When banks pay one another fees for each mortgage, which often happens in partnerships with mortgage brokers, or jointly originate loans, regulators view them as sharing responsibility if anything goes wrong.
Instead of paying one another fees or a portion of the profit from each loan, West Suburban and Federal Savings will, effectively, exchange customer leads. Federal Savings agreed to refer potential customers in West Suburban’s geographic area to the bank, and will let the bank make presentations on certain national sales calls. Calk said Federal Savings typically become its partners’ main source of new leads within 90 days of beginning the partnership.
The deal works because Federal Savings is only a mortgage bank; it won't compete with the business West Suburban specializes in.
"We've got 700 bankers running around the streets, and they get lots of inquiries about products we don’t offer. Since we're not in competitive or conflicting business, we naturally hand those over," Calk said. Referral agreements with the banks he partners with are all based on geographic area and the specialty of the partner bank.
Knowing that Federal Savings wouldn’t compete on any of West Suburban's lines of business was a big plus for Acker. Wells Fargo also approached him about a mortgage partnership, but Acker was worried that the San Francisco banking giant would compete on other products.
Basing compensation on leads rather than fees will hopefully let West Suburban keep its hands clean while getting some new business, Acker said.
"This keeps the compliance issues completely out of the mix for us and them. We’re working together somewhat as partners but it's an arm's-length transaction," Acker said. "It's a good relationship, and we feel it's going to be profitable for both us and them."