FRBSF Economic Letter
2000-23 | July 28, 2000
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 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.
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.
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).
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