Is the mortgage industry poised to repeat the mistakes of the past? The old saying is, if we don't understand and recognize the past we are destined to repeat it.
Are the instructive lessons of the past sufficiently integrated into current industry business models and strategic planning? Specifically are winning strategies for present and future change adequately envisioned and articulated? After all our industry is notorious for boom and bust cycles of originations and profitability.
Will future market conditions and cycles be different? The fact is change is happening now in categories like regulations, technology, competition, risk management, the global economy, geo politics and industry consolidation. In my opinion, the combination of change already taking place, coupled with future change, will produce an even more volatile and chaotic business cycle relative to the past. Regardless of your role and the focus of your company, are you prepared operationally and strategically to execute in a potentially volatile, fast changing environment? Do you have a vision and a plan to match?
I contend most companies and individuals are not well acquainted with past lessons and are therefore are not adequately educated to prosper in the future. The phrase, living in the now, is powerful for individual behavior but could prove lethal for firms in the mortgage space.
Consider how many executives, consultants, advisors, managers and workers remember what happened when the boom cycle of 1988-1993 came to a screeching halt in 1994. My guess is not enough. On Nov. 16, 1994 the Federal Reserve unanimously raised the two key benchmark interest rates (discount rate and fed funds rate) by three-quarters of a percent to 4.75% and 5.5%, respectively. Banks quickly followed by hiking the prime lending rate to 8.5%. This change marked the sixth increase of the year of a quarter percent or more even though Fed chairman, Alan Greenspan, espoused a policy of "gradualism" with respect to Fed interest rate hikes. The Fed's actions were a response to stronger than expected economic growth and two point seven percent annualized inflation. Could this very same scenario play out again? Absolutely. What would be the impact on the mortgage industry and what counter measures should be considered?
Personally I haven't forgotten what happened in 1994. I was the president and COO of a multistate, multibranch independent mortgage company, with 350 employees. The company was closely held and specialized primarily in wholesale originations of FHA/VA loans with a smaller mix of conventional and jumbo products. Each branch also had a retail staff focused on serving the purchase and real estate broker community. Like most mortgage companies during this cycle, rapid expansion was the order of the day. The contraction that followed in 1994 and 1995 was personally and professionally painful as branch closures, layoffs and expense reductions consumed all our firm's time, resources and focus.
Instead of building a business, attention was diverted to finding the least costly exit strategy. To put this in perspective, throughout most of 1993, the mortgage company received about 125 new submissions a day but by early 1994 new submissions were averaging less than 10 a day. In retrospect my management team should have anticipated this cycle and considered various contingency plans to modify our business model and temper our and strategic thinkers. So what are the factors weighing on the market today or in the immediate future that will cause industry contraction and economic pain? How should visionary executives be thinking and planning for the future?
Investors including many large institutional mutual and hedge funds are abandoning equities and blue chip bonds with small albeit safe returns and instead chasing yield by assuming more risk. The competition for higher yield has driven down junk and other bond yields. True, investor’s are in the business of taking risk, but is risk in general being appropriately priced? In many expert’s opinions, probably not. A recent anecdote in The Wall Street Journal quoted a well-known hedge fund manager as saying he had the majority of his funds in highly liquid, cash equivalent, investments so he could exit quickly. That says it all. Obviously Greece and Spain's economic woes, EU issues, slower growth in China, India, Brazil, etc. North Korea and Iran are developing nuclear threats, plus the Arab Spring, wars everywhere, and ongoing global terrorism are all contributing to the uncertainty.
Dodd-Frank has created many new rules and many more are being written along with a complete restructuring of the financial supervisory process and organization. Many of the current and proposed new rules fail to differentiate roles in the mortgage finance chain. Community banks, nondepository mortgage banks and brokers are all facing the same rules as large commercial banks. These changes are expensive, complicated and often confusing. One proposed rule to create one flat origination fee regardless of loan amount could upend the current financial model.
The presidential election dynamics featuring vastly opposing views on the role and size of government, tax rates/codes, the deficit, stimulus, job creation and foreign policy have paralyzed meaningful action. Compromise is unthinkable at least for now. What changes will the November elections bring?
Is the U.S. economy on the precipice of recession or depression again? Factors include persistently high unemployment and under employment, slow or no growth. Higher prices could potentially spell higher inflation? 1994? The price of oil and other natural resources is increasing rapidly while homeownership rates are declining and new construction/permits are anemic. Yet I continue to observe mortgage operations expanding or planning to expand. 1994?
Major change is occurring in communications especially in the exponential growth of social media/networking. Facebook is now accessible by nearly half of the world's Internet users. There is also explosive growth in mobile devices/smartphones, pads, apps and cloud computing. Retail shopping continues to evolve as the Internet versus brick and mortar or in tandem transforms shopping habits. Advertising and marketing delivery channels have major implications for traditional mortgage channels and execution. Outsourcing opportunities for all facets of the mortgage business are being facilitated by technology particularly advances in cloud computing and improving secure data storage and transmission. Can the holy grail of a paperless electronic mortgage process finally be executable end to end?
New tools, more data and increasingly sophisticated quantitative models are being developed and deployed. But are these innovations managing and anticipating risk adequately? Do the models in vogue have appropriate inputs and controls and how often are the models and underlying assumptions updated or changed? The JPMorgan disaster is a wake up call. Maybe we need more human input to go with the quantitative data?
With all of these factors and more converging what will be the impact on the mortgage market? In my opinion the past will be relevant and a significant correction is virtually inevitable. In addition to a contraction in origination volume and increased pressure on revenue and margins including servicing, the product mix, staffing options and delivery channels will need to adapt quickly. In order to execute efficiently in the future you better be evaluating and making detailed plans now. Recent conversations with key executives in the California market support this thesis.
To survive and prosper, senior managers in the mortgage space must plan for compressed margins and even more ruthless competition particularly from deep pocket aggregators. If you are a mortgage banker and are not actively working on new delivery channels and opportunities to deal directly with consumers, the communication/technology revolution could overwhelm your traditional business model/ channels. I argue if the past teaches us nothing else you can't continue to be all things to all people as many mortgage operations do today. Find a niche, whether a product suite, a specialized client or referral base, a limited geographical area, or perhaps a delivery channel that your team can embrace. Create a clear vision and blueprint and pour your efforts and resources into developing a high level of expertise and a reputation for excellent execution in that niche or perhaps niches. Many examples can be found and studied in business. But above all, have a vision you can articulate. I believe titanic change is going to happen even as we celebrate the 100th anniversary of that famous event. Just like 1994 and the Titanic there will be survivors who gain recognition and prosper.
