FRBSF Economic Letter
2000-23; July 28, 2000
 Economic
Letter Index
B2B E-commerce in Residential Mortgages
Western Banking Quarterly is a review of banking developments in
the Twelfth Federal Reserve District, and includes FRBSF's Regional Banking Tables.
It is normally published in the Economic Letter on the fourth
Friday of January, April, July, and October.
Internet-related technology is part of many industries, including the
residential mortgage business. At first, e-commerce innovations mainly
involved the business-to-consumer (B2C) segment in electronically soliciting
and submitting mortgage applications. More recently, business-to-business
(B2B) mortgage transactions have come into the e-commerce world.
Understanding the structure of the mortgage business is important to
assessing the potential role e-commerce can play. Also, e-commerce innovations
may eventually change the structure of the mortgage market. This Economic
Letter describes the current structure of the residential mortgage
market and reviews key recent B2B e-commerce developments that could elevate
or diminish the future role of current key players.
The residential mortgage business
The residential mortgage business has many components, some of which
are unbundled or aggregated differently as e-commerce spreads, and most
of which involve B2B, not B2C, interactions. Typically, a residential
mortgage goes through four phases: origination, secondary marketing, securitization,
and servicing. Origination begins with a B2C interaction, soliciting and
receiving loan applications from homebuyers. Thereafter, interactions
are primarily B2B. Application processors go to other businesses for additional
information about the borrower, such as credit reports, employment, and
financial account verification. Underwriters use such information to evaluate
the credit quality of the borrower and either deny or accept the application,
quoting prices and additional terms under which to fund the loan. Often,
application processors or escrow agents must get additional items, such
as property appraisals and documents certifying that hazard, mortgage,
and title insurance are in place. B2B interactions also happen if the
mortgages are sold on the secondary market for whole loans or are securitized.
Mortgage servicing--collecting and disbursing principal and interest payments--involves
both B2C and B2B interactions.
In addition to the many third-party providers of services, such as credit
reports, property appraisals, and hazard, mortgage, and title insurance,
three traditional types of firms are in the mortgage origination business.
Retail organizations are subsidiaries of lending institutions that handle
in-house the full range of mortgage origination functions, including consumer
contact, underwriting, and loan funding. At the other end of the product
bundling spectrum, mortgage brokers act as an intermediary between a borrower
and multiple potential lenders; typically they do not themselves determine
underwriting standards or provide actual loan funding, but rather they
get loan funding from the wholesale divisions of large institutional lenders.
Correspondent firms take applications from customers on behalf of a single
sponsoring lender who determines the underwriting standards and provides
funds; correspondents often close loans in their own names but immediately
execute pre-arranged sales to sponsors, making the sponsors the actual
sources of initial loan funding.
Currently, a relatively small number of financial companies capture a
large share of single-family residential mortgage loan "originations,"
defined in terms of whose underwriting standards are applied and who really
provides initial funding of loans. For the top 25 originators, market
share increased to 57% in 1999, up from 26% a decade earlier. The top
ten originators had a market share of 39% at the end of 1999.
Despite the relatively high and increasing degree of concentration in
underwriting and funding of loans, the mortgage business has a more diffuse
structure in terms of customer contact. Data for the final quarter of
1999 show that only 43% of conventional loans were originated through
retail channels, and the top ten originators captured only about a 16%
share of the overall market through this channel. Excluding the retail
channel, the remaining 57% of conventional loans originated through wholesale
(23%) and correspondent (34%) channels involved other parties (usually
mortgage brokers or mortgage banking companies) in the customer contact.
The wholesale (origination of loans through brokers) and correspondent
channels are relatively concentrated on the mortgage funding side: The
top ten wholesalers had a 51% market share, and the top ten sponsors of
correspondents had a 50% market share of the ultimate funding of whole
loans. But these channels are much more diffuse on the customer contact
side: Research by Wholesale Access suggests that at the end of 1998, in
addition to the many firms with direct (retail) customer contact, about
36,000 independent mortgage broker firms handled the majority of customer
contact in the wholesale and correspondent channels.
Emerging developments in mortgage
B2B e-commerce
One of the e-commerce technology developments most likely to have a large
impact in the residential mortgage market is Electronic Partner Networks
(EPNs). According to Graham (2000), EPNs facilitate B2B e-commerce by
combining integration technologies (such as XML as a universal data language),
security technologies (such as virtual private networks (VPNs)), business
policy technologies (such as directories and entitlements), and business
collaboration technologies (such as workflow software). Many of these
same building blocks are identified as key in the Microsoft (2000a) whitepaper
that announces that company's vision for the next generation of the Internet.
Beidl (2000) of TowerGroup usefully explains how the EPN concept is likely
to take form in the mortgage business.
Indeed, some elements of mortgage EPNs are beginning to gel. For example,
developing XML mortgage standards appears to be proceeding rapidly under
the auspices of the Mortgage Industry Standards Maintenance Organization
(MISMO). Operating system software vendors have announced plans to provide
improved security, directory, and entitlement technologies relatively
soon. So, current mortgage industry efforts to build EPNs are focusing
on the other key building block, tools to improve collaborative workflow
(see, for example, Microsoft 2000b).
Rapid growth of EPNs could have a noticeable impact on mortgage market
structure. One possibility is that EPNs could reduce brokers' costs of
interacting with numerous loan underwriters and funders. Such a cost reduction
would favor the brokering model of loan origination over retail and correspondent
channels. However, the emerging B2B mortgage technologies also potentially
make brokering technology so commonplace that today's large number of
brokers could be replaced by non-traditional competitors who gain access
to brokering technology.
Another possibility is that EPNs could improve the efficiency of the
interactions between brokers or other "originators" and third-party
providers of services, such as credit reports, property appraisals, and
title, hazard, and mortgage insurance. Much of the current competitive
battle in the mortgage market is over who will be the earliest adopters
of technologies with such efficiencies. Early adopters might be able to
gain market share by bidding more aggressively for loan applications and
passing on technology-enabled cost savings to consumers in the form of
lower mortgage rates and fees.
Joe Mattey
Research Officer
References
Beidl, Richard A. 2000. "Executive
Summary of Key Trends in the U.S. Residential Mortgage Lending Market."
TowerGroup Research Note 023:29C (June).
Graham, Gig. 2000. "Electronic
Partner Networks." The Giga Information Group (April). http://www.ncommand.net/html/EPN040620001.pdf
(accessed June 28, 2000).
Microsoft (2000a). "Microsoft
.NET: Realizing the Next Generation Internet." http://www.microsoft.com/net/whitepaper.asp
(accessed June 28, 2000).
Microsoft (2000b). "Ohio
Savings Bank Case Study." http://www.microsoft.com/biztalk/ohiosavings.htm
(accessed June 28, 2000).
Opinions expressed in this newsletter do not necessarily reflect
the views of the management of the Federal Reserve Bank of San Francisco
or of the Board of Governors of the Federal Reserve System. Editorial
comments may be addressed to the editor or to the author. Mail comments
to:
Research Department
Federal Reserve Bank of San Francisco
P.O. Box 7702
San Francisco, CA 94120
|
