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What does a Mortgage Banker do?
The mortgage banker is the lender; the one making the loan directly. A mortgage banker will present you with only that lender's program of mortgages, so you need to speak with several lenders to do comparative shopping. You can look at the real estate section of your local newspaper to get an overview of lenders in your area and their rates. The background of mortgage banking are: Depository institutions have traditionally originated residential mortgage loans to hold in their loan portfolios, and mortgage banking is a natural extension of this traditional origination process. Although it can include loan origination, mortgage banking goes beyond this basic activity. A bank that only originates and holds mortgage loans in its loan portfolio has not engaged in mortgage banking as defined here. Those activities are discussed elsewhere in the Comptroller’s Handbook.
Mortgage banking generally involves loan originations, purchases, and sales through the secondary mortgage market. A mortgage bank can retain or sell loans it originates and retain or sell the servicing on those loans. Through mortgage banking, national banks can and do participate in any or a combination of these activities. Banks can also participate in mortgage banking activities by purchasing rather than originating loans.
The mortgage banking industry is highly competitive and involves many firms and intense competition. Firms engaged in mortgage banking vary in size from very small, local firms to exceptionally large, nationwide operations. Commercial banks and their subsidiaries and affiliates make up a large and growing proportion of the mortgage banking industry.
Mortgage banking activities generate fee income and provide cross-selling opportunities that enhance a bank’s retail banking franchise. The general shift from traditional lending to mortgage banking activities has taken place in the context of a more recent general shift by commercial banks from interest income activities to non-interest, fee generating activities.
Fundamentals of Mortgage Banking: When a bank originates a mortgage loan, it is creating two commodities, a loan and the right to service the loan. The secondary market values and trades each of these commodities daily. Mortgage bankers create economic value by producing these assets at a cost that is less than their market value.
Given the cyclical nature of mortgage banking and the trend to greater industry consolidation, banks must maximize efficiencies and economies of scale to compete effectively. Mortgage banking operations can realize efficiencies by using systems and technology that enhance loan processing or servicing activities. The largest mortgage servicing operations invest heavily in technology to manage and process large volumes of individual mortgages with differing payments, taxes, insurance, disbursements, etc. They also operate complex telephone systems to handle customer service, collections, and foreclosures. This highly developed infrastructure enables mortgage banks to effectively handle large and rapidly growing portfolios.
Mortgage banking operations also need effective information systems to identify the value created and cost incurred to produce different mortgage products. This is especially critical for banks that retain servicing rights. To optimize earnings on servicing assets, mortgage banks must have cost-efficient servicing operations and effective, integrated information systems.
Risks Associated with Mortgage Banking: The applicable risks associated with mortgage banking are: credit risk, interest rate risk, price risk, transaction risk, liquidity risk, compliance risk, strategic risk, and reputation risk.
These are discussed more fully in the following paragraphs.
Credit Risk: In mortgage banking, credit risk arises in a number of ways. For example, if the quality of loans produced or serviced deteriorates, the bank will not be able to sell the loans at prevailing market prices. Purchasers of these assets will discount their bid prices or avoid acquisition if credit problems exist. Poor credit quality can also result in the loss of favorable terms or the possible cancellation of contracts with secondary market agencies.
For banks that service loans for others, credit risk directly affects the market value and profitability of a bank’s mortgage servicing portfolio. Most servicing agreements require services to remit principal and interest payments to investors and keep property taxes and hazard insurance premiums current even when they have not received payments from past due borrowers. These agreements also require the bank to undertake costly collection efforts on behalf of investors.
A mortgage bank can be exposed to counter party credit risk if a counter party fails to meet its obligation, for example because of financial difficulties. Counter parties associated with mortgage banking activities include broker/dealers, correspondent lenders, private mortgage insurers, vendors, subservicers, and loan closing agents. If a counter party becomes financially unstable or experiences operational difficulties, the bank may be unable to collect receivables owed to it or may be forced to seek services elsewhere. Because of its exposure to the financial performance of Counter parties, a bank should monitor Counter parties’ actions on a regular basis and should perform appropriate analysis of their financial stability.
Interest Rate Risk: Changes in interest rates pose significant risks to mortgage banking activities in several ways. Accordingly, effective risk management practices and oversight by the Asset/Liability Committee, or a similar committee, are essential elements of a well-managed mortgage banking operation.
Transaction Risk: To be successful, a mortgage banking operation must be able to originate, sell, and service large volumes of loans efficiently. Transaction risks that are not controlled can cause the company substantial losses. To manage transaction risk, a mortgage banking operation should employ competent management and staff, maintain effective internal controls, and use comprehensive management information systems.
Liquidity Risk: In mortgage banking, credit and transaction risk weaknesses can cause liquidity problems if the bank fails to underwrite or service loans in a manner that meets investors’ requirements.
Compliance Risk: Mortgage banking managers must be aware of fair lending requirements and implement effective procedures and controls to help them identify practices that could result in discriminatory treatment of any class of borrowers.
Strategic Risk: In mortgage banking activities, strategic risk can expose the bank to financial losses caused by changes in the quantity or quality of products, services, operating controls, management supervision, hedging decisions, acquisitions, competition, and technology. To limit strategic risk, management should understand the economic dynamics and market conditions of the industry, including the cost structure and profitability of each major segment of mortgage banking operations, to ensure initiatives are based upon sound information.
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