Fall 2006 issue of Horizons

With origination levels continuing to decrease over the past several years, it would be expected that “struggling” mort- gage lenders would find it increasingly difficult to survive in the post-refinance landscape and eventually fall by the way- side. While this trend has certainly occurred to a number of lenders over the past two years, the “shakeout” appears to be at a slower pace than in previous cycles. Perhaps lenders are more highly capitalized due to the three record refinance years of 2001 through 2003. In addition, most mortgage lenders quickly adapted their overhead expenditures in late 2003 to reflect the much lower refinance volume. Technological advances also allow most lenders to operate with fewer employees as compared to previous cycles. In any event, there is no question that there is still a tremen- dous amount of overcapacity in 2006 within the industry. The overcapacity should gradually improve as we go deeper into the post-refinance cycle. In the short term, however, there are still too many mortgage lenders chasing too few mort- gage loans. As a result, profit margins (i.e., gain on sale percentages) have taken a significant hit over the past several years. Competition for the purchase customer should remain intense throughout 2006, and RubinBrown's indications are that profit margins will decline by approximately five basis points in 2006. This projected decrease is on top of a five- basis-point decline in 2005. From a cost perspective, the challenge of managing over- head expenditures remains in an industry that is very cycli- cal in nature. The key is managing overhead expenditures in the context of projected origination activity. As noted previ- ously, most lenders in late 2003 quickly adjusted their over- head expenditures to adapt to the post-refinance environ- ment. They were assisted by technological advances and other efficiency measures that allowed them to operate with fewer employees as compared to the past. Since 2003, most lenders have been very deliberate in adding overhead costs. We continue to recommend that any additional overhead costs be scrutinized very carefully in today's environment. This short-term perspective, however, must be balanced against a longer-term “investment” in certain core employee

and infrastructure costs. These costs are key to mortgage companies prospering when market conditions become more favorable. During 2006, RubinBrown's early indications are that the average origination cost per loan will increase slightly over 2005 cost levels. Although the outlook for 2006 can be discouraging, there are reasons for mortgage lenders to be optimistic. The key to this optimism focuses on the lender's ability to attract more purchase business (i.e., top line revenue growth). There were several St. Louis mortgage lenders that experienced double-digit growth in purchase originations for 2005. These “success stories” are continuing for some lenders even under the more challenging environment of 2006. A common characteristic of these lenders is an unwavering commitment of resources and energy to developing purchase relationships, even during the peak refinance years of 2001 through 2003. Although the cost side of the equation is certainly important, the key to success in our opinion is a lender's ability to attract and capture the purchase customer. There is still a tremen- dous amount of overcapacity within the industry and compe- tition for the purchase customer remains intense. As a result, differentiation is very important. It is critical for mortgage lenders to differentiate themselves in some manner from their competitors. A number of St. Louis lenders have done an excellent job of developing specialized niches within the marketplace. In addition, innovative marketing, business development and other service-oriented activities remain critical in attracting new purchase business into the door. With FannieMae and MBA economists continuing to project 2006 as the second highest year ever for purchase fundings, there should be ample opportunities for St. Louis mortgage lenders to attract and capture the purchase customer. Questions? Contact Frank Hogg, CPA Partner-in-Charge, Mortgage Banking Services Group 314-290-3413 frank.hogg@rubinbrown.com

48 • summer 2006 issue

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