Compensation trends.

COMPENSATION Trends

There is no question that compensation influences human behavior. People will focus on goals when there is opportunity to maximize their earnings potential. Because of this, companies should ensure that goals are the result of a strategic thought process. Consequently, any compensation system and organizational structure should reinforce a thorough strategic plan.

Industry trends and strategies

Serious and effective strategic planning by mortgage banking firms cannot be done in a vacuum. Today, a number of industry trends must be taken into account as these strategies are developed and as implementation plans are formulated. For example, during the last 18 months or more, there has been tremendous consolidation within the mortgage lending industry. There have been many reasons behind this trend.

First of all, many institutions diversified into both commercial and residential real estate lending, and nonperforming commercial real estate portfolios have brought about the demise of many organizations. Second, residential lending volume has been more volatile, due to a variety of factors, including interest rates and consumer confidence. Furthermore, the cost of business in residential mortgage banking, like most industries, has become more expensive, and yet the delivery system, for the most part, has not become more efficient.

Without the volume, it is almost prohibitive to run a branch system profitably. But other direct marketing techniques, such as affiliations with residential brokers or telemarketing, have yet to prove more efficient. In addition, both servicing and secondary marketing activities are technologically intensive, and that clearly points to increased cost as well.

What do these trends mean for the residential mortgage banking industry? As is true in virtually all maturing industries, there is polarization. In short, the large will become larger, and only well-managed, smaller niche players will survive. Among the larger firms, there seems to be a consistent theme that residential mortgage banking fits well into a diversified, consumer-driven organization, whether it's a commercial bank, insurance company or retailer, or another type of firm. The difficulty for many of these larger institutions, specifically the banks and thrifts, is that there is limited capital to invest, given their current commercial portfolio problems.

Among the larger residential mortgage banks that are operating businesses of publicly held companies, clearly their strategic objectives must conform with the corporation's goals. Typically, the top priority is profitability. This is sometimes difficult to achieve given the cyclical nature of the mortgage banking business. Other key objectives are operating efficiency, maintaining precaution against excessive risk taking, cooperation in cross-selling the corporation's other consumer services and maintaining the quality of the servicing portfolio.

1990 compensation trends

The results of the 1990 Compensation Review by Ferguson Partners, Ltd., a Chicago-based real estate advisory firm, confirm current industry trends and the consequent strategic direction of many residential mortgage banks. The Compensation Review, part of an annual survey conducted by Ferguson Partners, focuses on the responses of the larger players in the mortgage banking industry.

Ferguson surveyed 95 residential mortgage banks, approximately 37 percent of which were owned by thrifts - typically firms holding servicing portfolios of $5 billion or more. The firms responded to the survey during the close of 1990. The geographical representation was ensured through the breadth of the study, although given the nature of the population, there were more participants headquartered in the western part of the United States. One issue to keep in mind in assessing the survey results is that many thrifts across the United States are experiencing tremendous difficulties in working out their commercial real estate lending portfolios. As a result, the executives working for mortgage banks owned by thrifts were impacted by the thrifts' earnings pressures (see Table 1).

Table : Table 1 Compensation Relative to Ownership: Thrift vs. Non-Thrift RESIDENTIAL MORTGAGE BANK

Servicing             $0-2.5 Billion                 $2.5+Billion
                   Non-Thrift   Thrift   Non-Thrift   Thrift

CEO 

Base               $150K        $125K    $225K        $175K
Bonus              0-50%        0-25%    50%          25-50%
Change from 1989   (-5%)        (-10%)   (-10%)       (-20%)

VP Production

Base               $100-125K    $75K     $175         $125K
Bonus              0-50%        0-50%    0-50%        0-50%
Change from 1989   (-5%)        (-10%)   (-10%)       (-15%)

Because of the significant number of participants in our compensation survey, we chose to focus on one variable, namely size of servicing portfolio. While chosen in a somewhat arbitrary fashion, there is some rationale underlying the decision to sort the results by size of the servicing portfolio. Typically, there are a number of other factors that can impact compensation besides servicing portfolio size, such as origination volume, ownership, growth, trading volume and headquarters location. However, all of these factors are taken into account in our survey. For example, of those organizations with $5 billion or less (approximately 35 percent of those surveyed) in servicing, most are autonomous, having no parent company, and tend to have smaller origination volumes. On the other hand, organizations with servicing portfolios in excess of $5 billion (approximately 65 percent surveyed) tend to be owned by larger, publicly held companies, and originate a greater volume of loans.

Our advisory experience in the residential mortgage banking industry would indicate that there is significantly less correlation between compensation and growth or ownership. There is a more direct correlation between origination volume and compensation, but once again, in our survey, those organizations with large servicing portfolios tended to be originating a greater volume of loans.

As compensation relates to geography, we found minimal discrepancy among the top 20 residential mortgage banks nationally, ranked by servicing portfolio, save some minor cost-of-living adjustments. These are the organizations that compete most directly for resources, primarily executive talent, and consequently, compensation levels among those firms is remarkably comparable.

However, for companies ranked below these 20 largest residential mortgage banks, headquarters location tends to have a significant impact on executive compensation.

Our study indicates that institutions headquartered on the West Coast provide their executives with greater compensation potential based upon the average total cash compensation per region. Prior to the recent economic downturn in the Northeast, institutions there ranked second in regard to compensation potential. Midwestern residential mortgage banks now have moved into this second ranking, given that the midwestern economy has proven more stable than any other part of the country (See Table 2). Today, the Northeast, Southeast, and Southwest demonstrate no material variations in cash compensation.

Table : Table 2 Regional Compensation Trends(*) RANKING: TOTAL CASH COMPENSATION

       Northeast   Southeast   Midwest   Southwest   West
1990       4           3          2          5        1
1985       3           4          4          2        1

GEOGRAPHICAL PERCENTAGE DIFFERENTIALS

       Northeast   Southeast   Midwest   Southwest   West
1990      -5%        Norm       +10%       -10%      +20%

(*) = excluding 20 largest residential mortgage banks

The results of our 1990 Compensation Review (see Table 3) directly correlate with the industry's operating results and strategic direction. For example, profits were off in 1989 from average profit levels experienced from 1984-1988, and consequently, CEOs and vice presidents of production tended to feel the consequences from a compensation perspective.

Table : Table 3 RESIDENTIAL MORTGAGE BANK

Rounded to nearest $25,000

Servicing $0-5.0 Billion $5.1+Billion

CEO

Base               $150K            $225K
Bonus(1)           0-50%            50%
Change from 1989   (-5%)            (-10%)

VP Production

Base               $100-125K        $175K
Bonus(1)           0-50%            0-50%
Change from 1989   (-5%)            (-10%)

VP Secondary Marketing

Base               $125K            $175-200K
Bonus(1)           50%              50%
Change from 1989    0%              (-5%)

VP Servicing

Base               $125K            $175-200K
Bonus(1)           50%              50%
Change from 1989   (+5%)            (+5%)

(1) Bonuses are annualized, short-term cash bonus as a percent of salary

There were a number of reasons for reduced profitability. First of all, origination volume remained flat in 1989, and major organizations were concurrently making significant investments in upgrading systems as well as acquiring servicing portfolios. Furthermore, the secondary markets proved to be volatile for reasons related to the economy that backed up to the stock market crash of 1987. The percentage decrease in compensation tend to be greater for those executives in larger companies, because these organizations are under tremendous quarterly earnings pressures and will use available resources to meet their earnings goals. Conversely, executives at the larger companies tend to be compensated more aggressively in good times, based on our experience.

The 5 percent increase in compensation for servicing executives noted in Table 3, both in the smaller and larger residential mortgage banks, is a direct reflection of two factors. Most mortgage banks are aggressively looking at acquiring servicing, and analyzing servicing quality is critical to profitable acquisitions. Acquiring a servicing portfolio of poorly underwritten loans can have a significantly negative impact on cash flow and profitability. Second, servicing is becoming more of a profit contributor to the overall organization, based on volume. With volume comes sophistication, and consequently, servicing executives must have broad-based technological and management skills. In short, during the last few years, servicing has replaced other aspects of the business, particularly residential production, as one of the key elements in an organization's profitability mix.

Finally, the senior person in charge of secondary marketing is viewed as an absolutely critical position, especially given the increased volatility of worldwide markets. Some organizations literally went bankrupt with the crash the stock market in 1987 because their portfolios weren't sufficiently hedged. As is the case in servicing, secondary marketing has continued to grow in its sophistication, and consequently, stronger executives are needed to oversee the function.

In addition, many mortgage banking firms have developed the expertise to package and sell loans directly to institutional investors. This responsibility has typically fallen under the secondary marketing executive. On the other hand, no well-managed mortgage banks provide incentives to their senior secondary marketing executives to assume a significant amount of risk. For example, these executives typically are not being given financial incentives to run the secondary marketing function as a profit center, unlike many other business segments that use incentives for profitability. This is simply because of the inability to control much of what happens in the markets, and the potentially significant exposure on the down side. Because of their critical role, secondary marketing executives did not suffer any material decline in their compensation due to the factors that made average compensation for CEOs and production executives decline in 1990, as measured by our survey results. Invariably, secondary market executive bonuses were somewhat reduced, based on mortgage companys' less-than-satisfactory performance.

There are two other factors worth noting. First of all, it is generally true among the smaller firms that base salaries are lower, as a direct reflection of the company's capitalization level. Conversely, salaries tend to be proportionately better at those larger organizations, especially ones that are owned by larger (typically publicly held) corporations. If 1991 origination volume continues to improve, we will probably see a greater bonus potential (as a percentage of base salary) among the smaller firms. In contrast, bonus upside will be more limited at larger residential mortgage banks for a number of reasons. First of all, salaries tend to be higher, and consequently, bonuses should fit into cash compensation packages that are industry competitive. Furthermore, these bonus programs need to be somewhat consistent with incentive systems among other subsidiaries.

1991 and beyond

What are the compensation trends for the future? There will be a continued focus on achieving profitability thresholds, and then professionals will be compensated from that bonus pool, depending upon individual performance. As is true in other segments of the real estate business, the company must come first and the individual second. Furthermore, there will be an increased emphasis on value creation, so that the executive team is focusing on the quality of its business and is assuming a longer term perspective. Given the concern in all organizations today about overhead, base salaries will remain relatively moderate, and bonus programs as well as ownership opportunities will become more critical components of compensation programs.

William J. Ferguson is chairman and Jorge I. Valencia is a principal of Ferguson Partners, Ltd., a real estate business advisory firm based in Chicago.