Through strategic planning, commercial banks can use their full-scale mortgage lending department as a profitable means to cross-sell products and help meet community reinvestment obligations.
Most commercial banks have a mortgage loan department. They see it as a part of their business and offer at least some mortgage financing for their customers. But this department should not be taken lightly.
The mortgage loan department can be a critical element to the success of a bank. It can draw in new customers, make profits and support community needs. Mortgage financing programs can go a long way toward fulfilling community service obligations now mandated by the Community Reinvestment Act. Cross-selling of mortgage loan products can greatly enhance a bank's strategic marketing plan as well. For commercial bankers who have considered setting up a full-scale mortgage banking operation, this article gives some hints on operating this department to take advantage of these opportunities.
When new customers move into town, they usually need to establish a new banking relationship. In addition, they are often looking to purchase a new home. The lender that can provide mortgage financing for them has an inside shot at their other banking business such as deposit accounts, credit cards, installment loans, commercial loans and so on. The lender that is not competitive with mortgage loan products not only loses that mortgage loan, but the customer as well.
Unquestionably, mortgage lending has become more complex over the last five years, as many articles in industry publications have attested. This complexity causes the lender to incur more up-front costs to originate a mortgage loan.
Mortgages are a relatively homogeneous product. As a result, margins are slim for these types of loans. If a bank's overall net interest margin is around 4 percent, the margin on mortgages for in-portfolio loans can be expected to be around 2 percent (if pricing is competitive). Those loans sold on the secondary market net the lender only an origination fee and a service release premium (if the servicing is sold) or a servicing fee ranging from 1/4 to 1/2 percent if the bank continues to service the loan. This compares poorly to normal net interest margin spreads.
In addition, new accounting rules have reduced the impact of origination fees collected on mortgage loans. The majority of origination fees and other points collected for loans retained in portfolio must be amortized over the life of the loan. This reduces immediate accounting profits on mortgage loans originated.
Many mortgage loan industry experts argue that it takes at least 1 1/4 to 1 1/2 points in origination fees to cover the cost to originate a mortgage loan. Given the competitive pricing in the market today, it may be difficult to obtain this level of fees up front and remain competitive.
However, the profitability picture for mortgage loans may be much rosier than some in the industry say. Mortgages do have a narrower profit margin; however, the risk for a mortgage portfolio does not compare at all to the risk with higher margin portfolios, such as commercial lending. At Marine Bank, Springfield, Illinois, our net charge-offs have averaged less than 100th of 1 percent of the portfolio. Compare this with an average year for commercial loan write-offs.
Mortgage loans that are sold with servicing retained typically yield only servicing fees of 1/4 to 1/2 percent. The lender in most cases, however, has eliminated all credit risk, capital requirements and interest rate risk on this portfolio. Clearly, eliminating these risks has some value.
Similarly, because accounting rules concerning the amortization of origination fees and other points collected have changed, the economics have not. Origination fee and point cash flows continue to be a good, steady source of cash flow, if not accounting profits.
Finally, as to the argument concerning the cost to originate a mortgage loan, I am sure that if you were to establish a completely separate origination office for mortgage loans that was required to pay its own way for loan servicing, the sale and funding of loans, mail services, telephone systems, utilities and rent, a 1 1/4 to 1 1/2 percent origination cost would be reasonable. For most commercial lenders, however, a mortgage loan department already exists, or space is available for mortgage loan operations. The incremental costs to originate an additional mortgage loan is much less than 1 1/2 percent.
Community Reinvestment Act
Recent changes in the Community Reinvestment Act require lenders to take steps to solicit input from the community and find ways to support community needs. CRA examiners will look to see whether...