In 1998, the top 10 mortgage lenders held around 40 percent of the market. By 2010, their share increased to nearly 80 percent; since then, it’s dropped down to around 60 percent.
Why the decrease? Well, only five of the top 20 single-family mortgage originators in 2006 remain active today. But what’s continuing to drive the big guys out—market cycles or market restructuring? And will the current trend of favoring smaller lenders and servicers last forever?
Factors Favoring Large Lenders:
To start with, Flood and Fischetti assert large lenders are able to spread fixed costs (e.g., technology expenses) across a high volume of mortgage transactions, reducing average costs relative to smaller competitors. Recently released data from the Mortgage Bankers Association shows loan costs from Q2 2012-Q2 2013 were 13 percent higher per loan for servicers of less than 2,500 loans than for servicers of more than 50,000 loans.
Larger banks generally have a lower cost of debt and broader access to funding in the bond markets than small lenders. The researchers cite numbers from Goldman Sachs, which show that since 1999, large banks have an average of 31 basis point costs of debt advantage compared to smaller banks.
In addition, tighter credit standards, plus legislative and regulatory responses to the market crisis have led to a more standardized and commoditized mortgage market.
This reduces product differentiation and operating costs, favoring large lenders.
Large lenders also employ more experts in complex disciplines such as regulatory compliance and financial modeling. This puts access to critical trending information at their fingertips, for a distinct advantage.
Factors Favoring Less Consolidation:
On the other hand, Flood and Fischetti say a sustained shift to retail origination would signal the momentum going to smaller lenders, because larger lenders have greater capacity for wholesale origination. However, the sustainability of the shift to retail is uncertain.
Smaller institutions are more able to react quickly to market changes—but rising mortgage rates and a shift from refinancing to home purchasing could test the nimbleness of many small lenders.
Smaller banks have a clear advantage with their in-depth knowledge of their local market. According to Fannie Mae’s analysts, in regards to single-family credit losses, small banks consistently outperformed larger competitors since 1992—though they admit the factors underlying this outperformance aren’t completely certain.
As far as legacy issues are involved, following the financial crisis, both large and small lenders received loan repurchase requests from the GSEs and other secondary market participants. A significant volume of legacy repurchase issues have been resolved recently through settlements with many lenders, suggesting that these repurchase requests will recede as a business issue for mortgage lenders, the researchers say.
While large and small lenders each enjoy market advantages over each other, Flood and Fischetti say large firms are poised to benefit more from sustainable advantages.
“Consequently, our assessment indicates that the recent decline in large lender share of the primary market is temporary, and principally a result of cyclical factors that caused larger lenders to pull back from the market,” the two concluded. “Absent a meaningful restructuring of the mortgage market … we believe there is a significant probability that in the long-term large lender share of the primary market will increase compared to current levels.”