24th January 2008
Top (10) Mortgage Industry Beliefs for 2008
The following lists what we discern to be the top ten (10) beliefs governing mortgage businesses today, and are likely to be the cornerstone of many business plans for 2008 within the Industry.
|Top Ten Beliefs in the Mortgage Industry
||The More Volume the Better
||Economies of Scale are a Key to Profits
||Cross Selling is a Key to Profits
||Synergism Works in Financial Services
||Centralisation Beats Decentralisation
||Wholesale Funds Providers are brokers' Friends
||Credit Risk is not a Concern: Pass it on
||Housing is a Major Market, . . . the Capital Markets and Government support will Always be There
||Technology will Favour Large Players and Consolidate the Industry
||In the Mortgage Business, The SHORT RUN is all that Matters
Beliefs 1 & 2 - 'Bigger is Better' - Size and Economies of Scale fix everything
Mortgage industry participants worship size and volume, and believe firmly in the magical powers of economies of scale; a genuine
fallacy of the more volume the better. Research on financial institutions shows economies of scale are neither automatic nor
continuous with size. In fact, except in narrow operational fields, the most efficient financial institutions in a field are not
the biggest companies. The largest banks, non-banks and broking firms are not the low cost producers. Furthermore, where scale
economies are gained through re-engineered operations, in large organisations they are often lost to higher bureaucratic costs
and in poor communications and response times up and down the chain of command. Boutique operations on the other hand with a
specialised approach and high customer focus are often small, but highly profitable as they command a specialist price for their
This "Bigger is Better" fixation, is no more evident than in mergers and take overs which the industry has coined
"consolidation". In almost every instance of a take over activity seen to date, promises are made about the cost savings to be
achieved through size, and new and improved service levels for consumers. Regrettably in practice the real economic synergies in
the deal are the potential for staff redundancies rather than eliminating duplicated IT or improving other systems and processes.
But consolidations do eliminate competitors. The bad news is that in every instance the remaining competition got bigger and more
Beliefs 3 & 4 - Cross-Selling and Synergism
As a collorary to the "bigger is better" belief, the financial shores are littered with dreams of well intended bank and non-bank
organisations who believed consumers wanted a one stop shop for financial services. The casual observer may not recognise the
truth of that statement because of the many major companies who bought that thesis - many have entered and left the field. They
entered with great fanfare and strong publicity; but when the strategy did not work, they put the concept to bed as quietly as
Consumers, no longer babes in the woods, are increasingly taking the lead in selecting their home loan provider. Some players are
now consumed with creating computerised on-line loan origination systems, joint ventures
or strategic partnerships, and large corporations like American Express, QANTAS, and BMW are offering mortgages to their
members as a value added perk.
Examples of cross selling failures, however, abound; how about Sears with its socks and stocks and real estate and banking theme (late
1980's), Wingspan an IBM-Bank Boston joint venture of 1998 and others. Operating efficiently a multi-channel, multi-product,
multi-discipline business is capital and labour intensive, and consumers in fact may not wish to place "all" their business with
one provider. This is the equivalent of a "one size fits all" or attempting to "be all things to all people" approach which has
always proven not to be a sustainable business proposition.
Valuable lessons can be learned from studying other commodity type consumer businesses - the grocery business, department stores,
beverage companies and fast food companies. All use price and specials as a competitive weapon. They also use loss leaders,
vigorous cost control, but significantly they focus on niche marketing and brand management. They seek to recoup their costs
on the commodity business, while making their profits on the niche products, exclusive brands and special services.
Mortgage brokers might be well advised to seek out proprietary niche values as specialists in vacation home loans,
immigrant loans, affinity group loans, renovation loans, impaired credit/sub prime (loans with previous repayment delinquencies),
home computer shoppers, small town residents, refinance mortgages, bridge loans, farm or rural loans or low rate high fee loans.
Any one of these could produce 5 percent of volume but 15 percent of profits. McDonald's is said to make more money on french
fries and drinks than on hamburgers. Many movie theatres make more money on popcorn than films.
In tomorrow's world one could see two competing mortgage brokers with the same origination volume and the same
cost structure, yet one is highly profitable and the other operates at a loss. Why? Because one believes all home loans are
created equal as far as profitability is concerned. The other knows better and markets for profits.
Belief 5 - Centralisation Beats Decentralisation
Neither centralisation nor decentralisation is the winner in business organisation for financial services. Both
have advantages and disadvantages. Central control can get too tight and stultify an organisation's responsiveness to consumers,
and then too loose and drain profits. Decentralisation can lead to lack of harmonised standards operating throughout the company,
as different staff interpret company policy and procedures differently. This has some significant implications for bankers, broker
intermediaries, and other players in the industry in how best to serve the customer via their chosen distribution channels and
networks and/or respective business structures (e.g.: retail direct, wholesale path, broker only, franchise, . . . etc.).
Beliefs 6 & 7 - Wholesale Funders are the Broker's friend, and Credit Risk is not our Concern - Pass it on
The Banks are the mortgage purchasing giants in Australia and their predominance will continue. That means they are the principal
direct and also indirect (through capital market securitisation programs) suppliers of funds to housing and industry players.
This has been good for housing and home ownership but now has a downside risk for brokers. The bankers currently encourage loan
broking as a source of replacement distribution resulting from branch closures, and have significant trail commission exposures to
brokers' groups. Should any significant losses arise from this distribution channel then the bankers will either close it down or
perhaps be forced to adopt the "full recourse" model of the US which makes the broker responsible to buy back bad loans.
In competitive markets, credit risk will stick to banks and the investors of securitisation issues and can materially affect
profits. In commodity markets with razor thin operating margins, mortgage players are well advised to be sensitive to any
increase in delinquencies or defaults. Remember the business cycle is not dead, and when an international credit crisis
hits, it can turn already thin profits into gnawing and life threatening losses quickly; bankers however are very adept at recouping their
Housing finance will be commodity business for years to come, and the entry price for any operator's viability will be operational
efficiency, low costs and controlled growth.
Belief 8 - Politics of Housing - Government support will always be there
The commonly held political belief of mortgage operators is that housing will always get the equivalent of most favored nation
status from government. The words may continue to be there, but the economic arguments are beginning to wear thin. The current
thrust of governments around the globe has always been to regulate and once the regulators perceive a need to protect consumers
from bad practices the only question is when will regulation be implemented?
Moreover the advent of the modern multi-channel broker offering a wide range of home loans from multiple bank and non bank
suppliers, has resulted in the ability to offer convenience to many customers - who have a limited time to visit banks themselves and work
their way through various products, (a panel of 20 lenders is average in the broker industry), which in itself builds a "know your
product, know your client" principle, where the broker recommends a suitable product for the client from a range of choices. This
is clearly a regulatory matter for future licensing.
Belief 9 - Technology Favours the Big
Technology investment should be selective. Experience in Australia and overseas repeatedly shows with technology you are either:
- Pioneer [the "bleeding edge"];
- Fast Follower; or
- Road Kill.
Current model computers we have now are 2000-3000 times faster than the first personal computers in 1984. Within the next three
to five years they will be 2000-3000 times faster again. This obsolescence can be punishing to any business continuously reinvesting
to stay on top.
Whilst it is interesting to see automated loan underwriting and loan credit scoring, the difficulty with
technology is that it does not apply to all demographics (that is the online community have vastly different expectations to the
off-line community as to service speeds) and; users must be educated and educated to it. Issues are not technical, they are human
behavioural and legislative (privacy and security).
Also technology generally will work against margins, that is reduce them over time. As an example, it is our view that in markets
such as the refinance market, plain vanilla loans will eventually go
to the competitor which can produce the fastest outcome.
Belief 10 - Short Run Vs Long Run ("Brand") Strategy
A short-term strategic focus has served mortgage operators well in the past. It kept them at the cutting
edge of financial, credit and housing markets. It invited confidence that perhaps 'King of the Hill' (Biggest is the Best
Strategy) could be played after all. Yet evidence from other competitive industries puts a lie to this premise. The winners in
the grocery, department store, fast food and beverage fields, and even among securities firms, are those with a long-range plan.