Mortgage Banking
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Industry Overview
The US mortgage banking industry includes 6,000 firms with total annual revenue that varies between $50 and $100 billion. Large companies include Washington Mutual; and units of Wells Fargo, JPMorgan Chase, Citigroup, and Bank of America.
Competitive Landscape
Demand for mortgage services is driven by home sales and the refinancing that occurs when mortgage rates are low. The profitability of individual companies depends on volume, interest rate spreads, and efficient operations. Large companies have big economies of scale in operations. Small companies compete successfully by funneling mortgages to the large companies. The industry is fragmented at the bottom but highly concentrated at the top: the largest 50 companies hold more than 70 percent of the market.
Products, Operations & Technology
Mortgage bankers lend money to homeowners through a mortgage, with the home as collateral. The traditional mortgage has a fixed interest rate and level monthly payments that pay off the loan over 30 years, but loans with adjustable interest rates (ARMs) and variable payment schedules have become common in recent years.
While mortgage loans are usually made to buy a home (a "purchase" mortgage), they're also made to refinance an existing mortgage (typically at a lower interest rate), or to provide cash to the homeowner (a home equity loan).
The main functions of mortgage bankers are loan production, underwriting, and servicing. Large mortgage bankers may also create and trade mortgage-backed securities.
Loan production is sales. Mortgage bankers advertise heavily and may have a network of retail offices and Internet sites where consumers can apply for a mortgage. Mortgage bankers charge fees for processing mortgage applications and for loan origination - when an approved loan actually "closes."
Loan underwriting consists of determining the risk of a particular loan. Underwriters typically consider the market value of the home, the loan-to-value ratio of the loan, and the borrower's creditworthiness. Mortgage bankers may use their own credit scoring system to determine the borrower's creditworthiness, or one provided by a number of analytical companies such as Fair Isaac (the FICO score). The risk of default on a mortgage determines whether the mortgage bank approves the loan and at what interest rate. Borrowers with low creditworthiness ("subprime") may still be approved for a mortgage if the interest rate is high enough to compensate for the extra risk.
Loan servicing includes sending bills, receiving payments, accounting, efforts to collect if the borrower misses payments ("delinquency"), and the operations involved in foreclosure proceedings if the lender must take title to the property. Many mortgage bankers service mortgages owned by other investors, charging an annual fee of 0.25 to 0.50 percent (25 to 50 "basis points") of the unpaid loan amount.
Both mortgages and the "mortgage servicing rights" (MSR) attached to them are bought and sold in the secondary mortgage market. A mortgage banker may keep a new mortgage in its own loan portfolio, sell it, or include it with other mortgages in a "pool" that serves as collateral for a mortgage-backed security (MBS). By "securitizing" mortgages, mortgage bankers create an investment instrument that's easily bought and sold by other investors.
Fannie Mae (Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corporation) are large buyers of home mortgages in the secondary market. Unlike other securitizers of mortgages, they issue securities that aren't backed by specific mortgage pools, but the securities they issue are considered safe investments because both companies have the implicit support of the US government.
The operations of mortgage bankers, whether they mainly originate mortgages, service mortgages, or manage a portfolio of mortgage loans and securities, depend heavily on sophisticated computer systems, which are the source of the large economies of scale in the industry.