“Disruption” is the code word of the moment, an instant expression telling us that because of the Internet things will never be the same with cabs, want ads, payroll services and many other businesses.
Unlike a lot of businesses and professions, there doesn’t seem to be much disruption in the mortgage industry. According to the Mortgage Daily, four of the five largest mortgage originators are traditional banks — Wells Fargo (15 percent market share), Chase (7 percent), Bank of America (5 percent) and U.S. Bank (4 percent).
Such marketplace dominance may suggest that all is well with lending traditionalists but there’s more to the story: “Nonbank lending institutions have increased their market share of agency purchase mortgage originations from 27 percent in mid-2012 to 48 percent in late 2014,” according to a study from Harvard’s Kennedy School by Marshall Lux and Robert Greene.
Nonbanks, as the term suggests, are not banks. Instead of funds raised in large measure from a deposit base, nonbanks get their capital from investors, loans from commercial banks and the sale of debt. Quicken, as one example of a nonbank, raised $1.25 billion in May by selling bonds — and Quicken, by the way, is also among the top five mortgage originators with a 6 percent market share, reports Crain’s Cleveland Business.
While traditional lenders are doing very well — in the first quarter commercial banks and savings institutions insured by the Federal Deposit Insurance Corporation (FDIC) had profits of $39.8 billion — we live in a fast-changing world. If nonbanks have been able to scoop up large portions of the mortgage marketplace so quickly is there any reason why their activities cannot grow still further? Is disruption coming to real estate financing?
In looking at the battle between banks and nonbanks in the mortgage arena it’s clear that traditional banks have many advantages — size, profits, servicing activities which often lead to new loans and refinancing plus long-standing relationships with potential borrowers. In addition, commercial banks are often a source of nonbank capital, the money which in many cases makes nonbanks possible.
Is Disruption A Myth?
No less important, it may be that disruption is largely a fable, one which overstates the importance of new businesses.
“Actual disruption isn’t as great as advertised,” says Alan Murray, the editor of Fortune Magazine. “Sure, 57 percent of the companies on the 1995 Fortune 500 list aren’t there today. But that record isn’t dramatically different from the first two decades, when 45 percent of the companies on the 1955 list were gone by 1975.”
The Washington Post adds that “these massive companies are more vital to the U.S. economy than ever. In 2014, the Fortune 500 companies together had revenue that equaled 71.9 percent of U.S. gross domestic product, up from 58.5 percent in the 1990s and 35 percent in 1955.”
At first it may seem that the big advantage of nonbanks is that they’re Internet based, they don’t have branches or tellers and largely do not have local offices. However, there’s no reason why a traditional bank cannot offer online mortgage services which are just as robust as the systems available through anyone else. If “disruption” means trading an online presence for branches and tellers then traditional banks have a demonstrated capacity to introduce such services.
But if the nonbank advantage is not technology, capital, or size then what is it?
The real advantage of nonbanks is that they represent a fresh start. Nonbanks are new so they don’t need to support armies of tellers or a brick-and-mortar branch system. They don’t have massive pension obligations built up during the past few decades. None is so large that they have been defined as “Systemically Important Financial Institutions,” the SIFIs which face greater federal regulation and capital requirements, burdens which hold down profitability. Nonbanks have not absorbed banks and S&Ls with toxic loan portfolios.
It’s not clear that major banks especially want a large footprint in the mortgage field. Big banks are set up to handle large numbers of loans so it follows that when mortgage volume declines big bank systems are less efficient — and less profitable. Back in 2005 mortgage originations totaled $2.9 trillion compared with $1.25 trillion in 2014.
Equally important, big banks have gotten burned in the mortgage business.
“The real question to me (is) should we be in the FHA business at all and we’re still struggling with that,” said JPMorgan Chase Chairman and CEO Jamie Dimon last year. “We want to help the consumers there but we can’t do it at great risk to JPMorgan. So until they come up with some kind of Safe Harbors or something we’re going to be very, very cautious in that line of business.”
Dimon pointed out that his firm has been especially burdened with high costs from the FHA program.
“Just to give you three numbers,” he said, “we collected $600 million of (FHA) insurance, they disputed $200 million, the government called that a fraud. We reimbursed $600 million to get out of the lawsuit because it was a threatening lawsuit, even like in my opinion it was a commercial dispute between FHA and ourselves about that and the whole time FHA collected another $1.8 billion in premium(s).” (parenthesis mine)
If big banks such as Chase are leery of the FHA sector than maybe there’s room generally for new and smaller mortgage competitors — including nonbanks.
Nonbank activities in the mortgage field are plainly growing and this may be good news for traditional banks. To large traditional lenders nonbanks are simply commercial clients, folks who need financing. Unlike mortgage lending, commercial loans are a line of business for established banks which raise few public concerns. In the end it may be that the best way for traditional banks to make money in the mortgage field is to act as commercial lenders and let nonbanks handle the headaches, one-on-one dealings and sometimes-tough PR associated with consumer mortgages.