Riding the Latest Margin Compression Wave

By Mike Vough, Managing Director, Secondary Marketing Technologies

If you’ve been in the mortgage industry for any length of time, you’ve witnessed the market’s ebbs and flows firsthand. One of the biggest variables impacting the market is industry capacity. When demand for mortgages – and especially refinances – is high, the number of loans entering the pipeline can accelerate to a point where a lender struggles to manage operational capacity. Lenders have a finite number of loans they can close in a month, even if they pay their staff overtime wages. With this in mind, a lender’s only means of slowing down lock volume is to increase margins and make the pricing they offer borrowers less competitive.

Inversely, when demand drops, lenders find themselves suddenly competing to get loans in the door by offering consumers more attractive terms and lower interest rates. Margins start to narrow even more as competition for loans intensifies – leading to industry-wide margin compression. 

We observed this most recently in 2020 when lenders experienced high loan origination volumes and a refinance boom due to the Federal Reserve’s push to keep interest rates low during the COVID-19 pandemic. Lenders were riding the wave of peak demand with wider margins and shifted their focus to growing operations to take advantage of all potential originations. At the same time, many lenders put other strategic priorities, such as increasing operational efficiency and reducing costs, on the back burner temporarily due to the increased volume and lack of operational capacity. 

When the mortgage market began to contract starting in February 2021, many lenders found themselves with excess operational capacity. After spending months recruiting and training staff to build operations, simply reducing headcount or compensation was not a viable option. Recruiting skilled workers in today’s job market is not easy. Downsizing also isn’t in line with most lenders’ growth strategies, though some originators have recently made news with staff layoffs. The alternative option was margin compression – offering consumers increasingly better loan terms and interest rates to fill the pipelines and keep staff busy.

Feeding the Margin Compression Beast

Margin compression goes back to industry capacity. It feels a little like feeding the beast because its impact on the industry grows bigger as competition intensifies, and lenders narrow their margins more and more to win business and maintain their production volumes. Lenders begin by offering slightly better terms and rates, but as more of them compete for the limited industry capacity, margins keep shrinking and loans become less profitable for everyone. This can become super charged when competition in the industry is fierce. We have observed that many originators have made investments in technology and people, and they want to see those investments pay off. 

Margin compression further affects revenue generation with every loan refinanced because the new loans entering the lenders’ pipelines are not as profitable as a similar lock this time last year when margins were wider.

How Can You Respond to Margin Compression?

Last year was a good year for expansion, with many lenders taking advantage of high margins and strong demand for mortgages and refinances. Lenders had more business than they could handle, and were doing everything possible to close all the loans in their pipelines. This year is a different story. It’s time to return to basics and shift focus to operational efficiency, best practices and cost reduction. 

During periods of margin compression, reducing operational costs is even more critical to maintain margins. If you have inefficient operational processes and high overhead costs, remaining profitable during periods of margin compression is going to be difficult. Three key areas where you can take immediate action to combat the impact of margin compression on your bottom line are:

1. Operational Best Practices 

2. Technology and Automation

3. Recapture and Retention

Operational Best Practices 

When faced with margin compression, lenders should begin by aligning their operations to industry best practices. Explore the methods of successful lenders and industry leaders to determine where your operations can benefit from adopting these practices. 

As part of this evaluation, review your loan origination processes at a granular level to find ways to improve performance. Look closely at every area of your operations to increase productivity and bring down costs. Explore details such as: How many days does it take to originate a loan? How many manual touchpoints are in the workflow? Where are the bottlenecks? Some savvy lenders even introduce comparative metrics and tools to help identify branches or brokers that are firing on all cylinders, as well as those that need some additional assistance.

Integrating best practices into your loan origination workflow can help you increase productivity, reduce costs, and provide exceptional customer experiences to attract more business. A satisfied customer or real estate agent can recommend your company to help grow your pipeline and ultimately widen your profit margins. 

Technology and Automation

Technology is an important part of the picture when countering the effects of margin compression. Implementing technologies that will automate workflows and increase efficiencies during loan origination can deliver the cost savings required to improve margins. 

There are many different types of automation to consider when evaluating technology solutions for your organization. Lenders can take advantage of automation functionality that uses data to guide the user through each step in the process, helping reduce the burden of labor-intensive tasks. Similarly, advanced technology can enable you to pre-configure systems to handle numerous tasks without the need for human intervention. 

Additionally, workflows that enable lenders to designate exceptions can perform routine functions and push alerts to your staff when a manual review is needed. Likewise, lenders can automate key lending decisions around underwriting and verification by establishing rules to dictate processing, while automating “stare and compare” tasks with the power of artificial intelligence. Innovative technology puts all these features at a lender’s fingertips to help accelerate processes, decrease errors, and reduce costs.

Recapture and Retention

Finally, you should focus on recapturing existing customers in your portfolio who are considering refinancing or purchasing a new home. Retention is even more critical now because, unlike last year when lenders had no problem finding the next loan, this year is a different story. 

Lead analytics platforms can help you identify customers in your portfolio who might be thinking of refinancing or buying a new home based on their loan characteristics, market conditions and other data. Similarly, customer relationship management (CRM) platforms and marketing automation systems can make it easy to remain in contact with customers and nurture relationships to increase retention.

Automating important initiatives like lead capture and customer communications can significantly improve recapture and retention rates.

Looking Ahead

Today’s margin compression isn’t new – we’ve seen it before. Adoption of best practices and technology innovations can make you more prepared to proactively address challenges like margin compression in the future. Enhancing your operational strategies today will position your company to successfully navigate ever-changing, hyper-competitive mortgage markets moving forward.

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Ready to incorporate industry-leading technology into your operations to combat the impacts of margin compression? Black Knight’s end-to-end solutions help lenders maximize industry best practices, automate workflows for greater efficiency, and recapture more customers. Reach out to sales@optimalblue.com for more details today.