Andrew Peters of Lenderworks: Rethinking Growth Strategy for Smaller Lenders in an Era of Margin Compression

(Andrew Peters is President of Lenderworks, Fairfax, Va., a national mortgage services provider for lenders. He has more than 25 years’ experience in the housing industry and has worked both in the origination and servicing space as well as spending time at Fannie Mae. Before joining Lenderworks, he was a Vice President at Fannie Mae in charge of overall Corporate Strategy and a member of the Single-Family leadership team. Prior to Fannie Mae, he was the CEO of First Guaranty Mortgage for seven years.)

The coming months will be an interesting period for many smaller to mid-sized mortgage lenders planning growth strategies. Flush with cash after an amazing stretch of high refinance volume, more than a few lenders will be looking to invest some of their earnings into growing their footprints. Many forecasters agree that we’re soon likely to enter a more competitive, more purchase-oriented market cycle, so a growth strategy could be a sound approach. However, a purchase market can also require more time and resources for sales and marketing—at a time when overall origination volume could see some decline. It’s a Catch-22 for the smaller lender—how much to invest into growth when the revenue stream is not quite as strong as it had been previously.

In other industries, one typical approach to similar scenarios is to outsource functions that, while necessary to the business, are not traditional profit centers. But the mortgage industry, in so many ways, doesn’t always take the same road other industries might. Traditionally, most mortgage lenders—especially small to mid-size, non-bank lenders, have shown a reluctance to outsource functions such as human resources and finances or even tech/IT or compliance. Instead, faced with a rise in costs or a shifting market, many have chosen to make budget cuts to those expenses, enduring the resulting loss of productivity and effectiveness as a necessary evil.  Many lenders opt to pare back on labor, completing the “ramp up/cut back” cycle for staffing and citing margin compression as well as the inherently high cost of labor for a workforce that no longer matches order volume. While this approach has served to bring many smaller lenders through more competitive markets, it can also open the door to issues that could derail growth, such as decreased productivity and less effective processes, or even things like compliance failures and brand damage. Obviously, none of these results pair well with a true growth strategy.

The reason for this reluctance to outsource in the past could vary. In the past, lenders had few alternatives when it came to back-office service providers. The best providers tended to be large, less flexible and expensive. While the larger lenders and banks had the resources to take advantage of these services, smaller entities with growth in mind (and smaller budgets) were forced to choose from a smaller pool of unproven providers, often offshore.  Additionally, a good number of small to mid-sized lenders have traditionally grown from a private, closely held business model, one that has traditionally been loathe to cede control over elements of its own operation. Under that model, “in-house” resources were closer to home, easier to oversee and manage and, thus, inherently the proper fit. (The pre-pandemic reluctance to employ work-from-home policies is another great example of this).

As is the case with much of the mortgage lending industry, things are now different. It’s time for smaller to mid-sized lenders pursuing a growth strategy to strongly reconsider clinging to all of their back office and support functions.

The first reason for this is quite simple. While the remainder of 2021 and 2022 are likely to see continued high origination volume and, thus, ample opportunity to grow and succeed, it’s likely we will see a more competitive market, and one which begins to lean toward more purchase volume as well. This is the case for numerous reasons, but primary among them is the fact that the perfect storm of conditions that came together in 2019 and 2020 led to a volume zenith that simply couldn’t possibly be sustained forever. The market will be robust in the coming months. Just not quite as robust as it was at peak in 2020.

This naturally means that the number of market participants, mortgage lenders, which had swelled to meet the opportunity will be left with a little less to feed on. The natural result is a more competitive market, which in turn will demand that lenders need to invest more resources and time in sales, marketing and even customer service. Should rates rise even slightly more, or the market lean even more toward the more expensive to produce purchase product, that competition will increase accordingly. For smaller lenders eyeing a growth strategy, even more investment into sales and marketing will be necessary to differentiate.

All of these conditions come with the reality that margin compression is back. In fact, it never really left us. Originating a mortgage is an inherently expensive proposition. The record refinance volume of the past two years enabled lenders to employ a number of ways to scale production and leverage efficiencies, so margin compression was temporarily forgotten. However, a combination of a changing market, a modest decline of volume and now, the likelihood of a much more aggressive regulatory enforcement client, will all likely combine to thin profit margins. None of this will help smaller lenders seeking to grow.

With the dual threat of margin compression and heightened compliance requirements emerging, lenders of all sizes, but especially those intending to grow, need to focus on managing and reducing costs. While non-revenue producing functions might be the optimal target, simply reducing them, along with the services they provide, can be counterproductive. It’s time for the mortgage industry to buy into something most other industries have long since accepted. Outsourcing some or all of a lender’s back-office functions is an optimal means by which to eliminate unnecessary fixed costs in periods of market change or decreased revenue.

It has long been established that successful outsourcing brings increased scalability to an operation, allowing it to better adapt to changing marketing conditions and, more importantly, to put increased focus on sales, marketing and service. These are the necessary ingredients for growth in a competitive market, and any lender proposing to grow cannot afford to neglect them.

An effective third-party provider can also assist a smaller lender with fewer resources to maintain a solid footing when it comes to compliance and/or systems and technology. A good provider delivers a perspective a single business simply does not have: that of numerous other lenders. In other words, a qualified outsourcing partner can leverage what it knows about technology, compliance and other functions simply because it has seen what works, and what doesn’t, across the market place. That second set of proverbial eyes can also keep a growing lender, the focus of which is likely on its own sales and development efforts, apprised of widespread market developments.

Today, in an environment where more back-office service providers are specializing or offering a la cate style services instead of trying to be a one-size-fits-all to everyone (which invariably results in catering to the largest lenders), small and mid-sized lenders have better opportunities to mix-and-match their unique needs to providers willing to accommodate them and adapt to their models, rather than offering a take-it-or-leave it service. The value proposition of outsourcing support functions and services is difficult to challenge. And the most successful growing lenders in this market will be the ones who build the best aligned outsource partnerships to contain the costs that inherently come with growth in a changing market.

(Views expressed in this article do not necessarily reflect policy of the Mortgage Bankers Association, nor do they connote an MBA endorsement of a specific company, product or service. MBA NewsLink welcomes your submissions. Inquiries can be sent to Mike Sorohan, editor, at msorohan@mba.org; or Michael Tucker, editorial manager, at mtucker@mba.org.)