Not all that long ago, people used to go to their bank to get their mortgage. This was a very relationship driven business. The internet came along and changed everything.
Banks used to handle just about all of the mortgage business at one time, and all of it among those whose credit risk fit the appetite of banks.
There is a market for borrowing among all risk categories, from those with excellent credit to those whose credit is atrocious. Everyone gets the opportunity to get served, but banks have always owned the low risk segment of this market, until recently that is.
This is the case with both secured and non-secured lending, and with secured lending, you have the person’s home as collateral, so this makes it even more viable to lend to them even if their credit isn’t that great. Mortgages can also be guaranteed by the government, and this makes lending to people even more appealing.
In the old days, banks had to hang on to the mortgages they loaned out, as well as needing to cover the losses of bad mortgages themselves. We may think that if a bank takes your house, they get their money back, but given that these properties are dumped on the market and sold below market value in a rush to liquidate the assets quickly, there are some real losses that occur with this.
If the problem is on a systemic level, like it was during the housing market crash, this greatly adds to the risk, not only with the greater number of defaults, but with a greater magnitude of losses as amounts that are received back with foreclosures plummet.
The New Regulations Have Put the Hurt on Bank Mortgage Lending
This recent mortgage crisis did see some new regulations put in place, and rightly so, as any regulatory environment that would allow such a debacle to occur certainly needs to be reworked. These new regulations may have been a little overbroad, as the focus here needs to be confined to the areas that are actually troublesome, which in this case was how we securitize mortgages, but the response here was more at the originator level, raising capital requirements for banks and making it more difficult to lend to anyone.
It is necessary to place constraints upon the market at times, but we want to do our best to target this as much as possible. This was really a sub-prime crisis, where a lot of people were given a mortgage when they should not have been, and it was securitization that allowed for lenders to cast off prudence and write countless bad mortgages, which then became sold to rather unsuspecting investors.
Banks are now complaining that these regulations have made it less profitable for them to sell mortgages, and given that some of this applies to banks exclusively, it also is seen to reduce their competitive advantage. Non-banks don’t have to worry about these things since they don’t have capital requirements, they act more like middle men between the borrower and the actual lenders, which are often just everyday investors who own mutual funds that contain this debt.
As part of the reform that was required to address the massive amount of defaults that this crisis caused, regulators sought to address systemic risk, and instead of looking at just the boats that were taking on water when the seas get rough and fixing those, they ended up lowering the level of the ocean and affecting all boats so to speak.
When the effect is banks being more reluctant to lend generally, instead of just being a little more selective, which is indeed the case, then this is a clear sign that we’ve gone a little too far here.
Aside from a greater reluctance for banks to offer mortgages, their non-bank competitors have been gaining more traction as well. Non-bank lenders had worked their way up to a quarter of all mortgages in 2008, and this has now climbed to over half of all mortgages today.
Non-Bank Mortgage Lenders Have Increased Market Efficiency
The increased participation of non-bank lenders, which are defined as lenders who do not have a deposit side to their business and get their financing from what is called wholesale funding, which comes from a variety of non-traditional sources, is actually a good thing in itself, provided that acceptable risk controls are used.
We traditionally have relied on banks to provide all of our banking needs, including mortgage lending, and they would take the money that people place on deposit with them and lend it out. This process isn’t particularly efficient though, and we’ve certainly moved toward a lot more efficiency these days with non-bank lending as well as securitization.
These changes allow for a broadening of both the number of lenders as well as an expansion in behind the scenes financing. Banks have been also slower to adapt to changing conditions, and in a real sense, are stuck in the past to some degree, and much more so than their non-bank competitors, who got to start from scratch and build a more modern model.
This is still all about relationship building to a degree, although the relationships are built differently these days. Quicken Loans, the biggest of the non-bank mortgage lenders, is a good example of this. Quicken’s main business is providing personal financial software, and they were able to leverage their relationship with these customers by buying a mortgage company, Rock Financial, in 1999, and use this platform to promote mortgages to their users.
Quicken has now become a major player in the mortgage business, competing head to head with some very big financial institutions, and is now the number three lender overall in the United States. This side of the business has sure come a long way from the days where all they offered is a way to balance your household budget.
A lot of mortgage shoppers prefer to deal online these days, and banks still rely primarily on in person contact, whether it be at the branch or though their telephone banking operations. To them, the expansion of telephone banking has been a big step over the past few years, but they still lag well behind the newer breed of lenders that rely primarily on the internet to both win people’s business and process their applications.
This surge in non-bank mortgage lending is seeing them grow more and more while the banks hold less and less of the market. This trend appears to be accelerating, with industry leader Wells Fargo now reporting a 23% reduction in mortgage originations year over year.
Wells Fargo still holds about twice as much business as Quicken, but with the two lenders going in the opposite direction, it may just be a matter of time before Quicken passes everyone. Quicken already is number one in the U.S. for new mortgages and appears poised to just keep growing.
On the bank side, executives are complaining that mortgages are no longer profitable for them due to the new regulations, and are actively looking to reduce their exposure. This, combined with the gravitation of the market away from them and toward their newer competitors will likely serve to further drive this trend.
The latest trend is with having the entire process from start to finish occur online, turning the business completely over to computers where borrowers don’t interact with people at all anymore. Given that this is the preference of a lot of people, they are being served in the manner they prefer, as well as providing the opportunity to increase efficiency even more on the lender side.
This is a long way away from going to your bank and sitting down with an advisor, and advisors now come right to your home, but for many, this is still way too old-fashioned. While this may have worked out great in the past, times are changing, and the number of people who want to get a mortgage this way is going down each year as we get more adept with technology and it becomes more integrated into the process.
We may see this being the norm or even the only way at some point in the future, and computers work more cheaply than people do generally, and in particular, don’t need to be paid commissions.
At the very least, there’s been some real expansion here, much like a town with only two stores now having dozens. If banks don’t find mortgages profitable anymore, there are still lenders that do, and with banks moving away from mortgages, someone needs to step in and fill the gap.