Three Questions With Joe On The Bank Mortgage Business

Mortgage Banking

Yesterday we had a chance to interview Joe Garrett, a former successful community bank CEO, active bank investor, current bank director and partner in Garrett, McAuley & Co., a firm specializing in advising banks on how to improve their mortgage business.  Joe is not only an expert in bank mortgage operations but one of the sharpest wits around with a near-photographic memory when it comes to politics and baseball.  We sat down with Joe and asked him the top three questions that have been on our mind.


Joe, how is the bank mortgage business these days?


The mortgage business is, in a word, biblical. The mortgage business operates in about a seven-year cycle. Consider that the average profit per loan based on the dollar volume of production according to the MBA looks like this:


Mortgage Spread


Before you conclude that the average bank profit is around 60 basis points of profit per loan, you have to keep a historical perspective.  Here are the previous “not so good years:” 


Mortgage Spread


Mortgage banking profits are like the children's rhyme, "When she was good, she was very, very good, and when she was bad, she was horrid."  For 2004 to 2008, the average profit per loan was 15.6 bps. Horrid.  Now, with rising rates and growing labor costs, I worry.



You are big on benchmarks, what are some of the most popular benchmarks and performance standards that our banks should know?


Ok, here are some rapid-fire answers – The cost of servicing a performing mortgage loan is around 4-6 basis points per loan. If it is a non-performing loan, the cost starts at 50 bps and climbs from there.  I also saw your work on the 40% commercial pull-through rate (i.e., what percentage of applications turn into closings) at most banks. Well, in mortgage banking these days, the minimum target rate is about 68%.

Looking at your cost-to-originate a loan is vitally important, and given how much of the business is out of your control, and given how commoditized it has become, cost structure is one of the few areas where you can make a big difference.

I think another thing is to constantly test and know your hedge ratio and the effects of a rate shock. We see too many banks which aren’t really on top of this.


What Are The Three Things Banks Can Do To Improve Mortgage Performance?


1) Audit everything that entails risk, and not just the compliance factors on your loans.  An example is auditing your H.R. department.  Let's say your employee handbook says that all employees will be given an annual review.  If someone doesn't get a review and thinks they've been discriminated against, all it takes is a half-way decent plaintiff's attorney to make your life miserable, maybe even filing a class action against you. Wouldn't you want to know if some of your employees are not getting their annual review? A good internal audit program would have uncovered this way before it became a legal problem.


In similar vein, while banks are thinking through their audit schedule, they also need to think through their regulatory exam effort. To this point, a client of ours just had a CFPB exam that was strictly on their Compliance Management System (CMS).  Not loan officer compensation, not Fair Lending, not servicing, just their CMS.  Banks need to give some thought to how they might do in such a targeted exam. To the extent banks can improve their process and procedures, and actually follow them on a documented basis, things will go a lot smoother in the exam.


2) Now that we are halfway through the year, it is time to start planning 2016. Banks need a production plan that not only is attuned with the changing market, but a risk plan as well. Many banks that portfolio their mortgages have more risk than they know due to the complicated hybrid structures with various levels of period and lifetime caps. And for mortgage bankers who sell their loans, a good plan needs to also model the inevitable increase in rates, drop in volume, and up to 90% decrease in refinance activity.


3) Finally, your bank can’t dabble in the mortgage business. You used to be able to do this, now you need to build an infrastructure that can scale or you should reconsider your options.  The regulations are too complex to run a mortgage business as an ancillary business.  Every bank should be asking themselves if they really want to be in the mortgage business and if not, there are many buyers looking to bulk up. If you do want to be in, then invest in technology and process improvement to have the leanest operation possible.