Margin compression. Arguably, there are more glamorous topics to discuss, but a recent mortgage blog post from Rob Chrisman’s Daily Mortgage News & Commentary surprised me with its passionate statement that no one is talking about margin compression. Actually, with the annual budget-planning process approaching, many of us are already discussing and acting on it.
The cyclicality of the mortgage industry is very familiar to most of us; however, with the sobering growth outlook for the coming two years coupled with new regulatory requirements, lenders and servicers should consider sustainable actions rather than short-term limited efforts.
ECONOMICALLY SPEAKING
The message is clear — the housing market and overall economy is in a slow, steady recovery mode. Barring any extraordinary events, either here or abroad, the economy should continue on this path. Investment money continues to flow to the U.S., unemployment is trending slowly downward and gross domestic product (GDP) is forecasted to improve slightly during the next couple years.
This creates an environment of good yet lethargic growth prospects; or, if considering the glass-half-full version, a recovery built on steady, sustainable activity. Again, not very exciting, but perhaps after the past few years we should opt for the mundane.
PRACTICAL APPROACH
Understanding the industry outlook for the near-term underscores the importance of making decisions based on concrete knowledge. As a practical approach, cost-based accounting is critical in identifying which functions, departments or businesses are least profitable.
Looking at the contributing factors beyond a purely secondary pricing play provides the added depth a firm needs to make informed decisions. In this context, consider the loan that looks great from a pricing perspective, but incurs additional costs later in the process. Whatever spread the lender made on that loan has now diminished by additional rework and human intervention.
Calculating true cost to manufacture, or cost per loan, should include cost through the later stages of originations and onboarding. Applied consistently, this holistic method provides an additional view into areas needing further investigation. It is not unusual to uncover some surprising results, such as a loan officer with excellent conversion and pull-through rates actually costing more due to other issues, including incomplete application information.
Often, an internal support group, such as training, shows low direct cost only because it has off-loaded responsibilities onto other departments. It is particularly costly and risky when a department, especially say, compliance, forgoes responsibilities to meet an arbitrary budget goal.
VARIABLE COST MODEL
More frequently, lenders and servicers are turning toward a variable cost model with targeted outsourcing. They understand that paying a unit price rather than incurring the expense for a full-time employee reduces their costs related to compensation, benefits, training, equipment and facilities. Outsourcing allows the vendor partner to adjust when volume fluctuations occur, rather than the lender incurring those costs.
An average rule-of-thumb training ramp-up time for a new employee is about 90 days until they are 60% to 65% productive. This is assuming the individual has some mortgage experience entering a new company at a processor level. Along with the ramp-up cost, the lost productivity of the trainer — typically a senior processor or team lead — needs to be included. In a volume spike situation this becomes very expensive.
Additionally, a growing number of lenders are using outsourcing providers for advisory services, which can include training, compliance services and vendor management. Again, these lenders are saving due to a variable cost structure based on usage fees — far less than what it may cost to hire and retain such services within their firm. Each company is unique and needs to assess whether this type of structure meets their needs and requirements.
LET’S NOT FORGET TECHNOLOGY
From a technology perspective, now is the time to consider whether the systems and applications being used are truly the best choice. In times of decreased volume, we have more opportunity to answer that question and focus on improving technology before the next market turn.
Lenders who feel their staff does not have adequate technical knowledge to identify the right opportunities will find several new technology consultants in the market who cater specifically to small to medium-size shops. Identifying automation options and implementing them in 2014 could continue to positively affect production costs for several years.
For several companies, these recommendations are evident. However, as the aforementioned blog entry and similar responses illustrate, there is a gap. Perhaps the writers have not managed through such an industry cycle; or it’s just as possible that they may not have previously been involved in the budget-planning process. Regardless, their instincts and concerns are correctly placed. As margins continue to compress and the general economy changes, the financial industry must again focus on back-to-basics as the fundamental core of a successful business model.
