Mortgage business makeover.

"Never have I been so excited about this industry," says David Lykken, who has been in the business 37 years and currently is president and managing partner at Mortgage Banking Solutions (MBS), Austin, Texas. "We have an unusual opportunity," he explains. "We get a mulligan."

But the newly remade mortgage industry also will be revamped operationally. Firms that are successful in this new environment must be "intensely compliant," notes Lykken. "They'll get used to intrusive exams."

He notes that Richard Cordray, the Consumer Financial Protection Bureau's (CFPB's) new director, has characterized mortgage industry practices as "the Wild West of lending."

In January 2012, CFPB released procedures for its examiners to employ with all mortgage originators. "Our supervision program will illuminate the entire marketplace by making non-banks play by the same rules as the banks," said Cordray.

Merger activity

Capital is flowing into the business to take advantage of the industry's remake, observes Lykken. He notes that both mortgage securities pioneer Lewis Ranieri and billionaire investor Wilbur Ross have purchased mortgage firms in recent years, and are in the process of expanding their operations.

Margins are healthy for all originators, says Lykken, whether they're operating as retail, correspondent or broker shops. He adds that business opportunities are evident to investors with capital.

Even higher interest rates won't affect mortgage company returns significantly, Lykken forecasts. "We'll have fat margins for a good number of years," he says.

A stricter compliance regimen is helping to shape this environment. Some originators will leave the business as a result, reducing competition that otherwise would cause loan-pricing discounts.

Lykken notes that successful mortgage companies today come in an array of sizes. Strategies also differ: some are pursuing Home Affordable Refinance Program (HARP) 2.0 refis, while others are focusing on purchase business.

Displaying "leadership and foresight" are the prerequisites for lenders to thrive now, says Lykken. "When production drops," he explains, "they manage by vision--not fear."

Unlikely industry leaders are emerging, Lykken adds. In some markets community banks "are dominating," he notes. These smaller banks are doing an amazing job" because they're used to regulatory oversight and have strong ties within their communities, says Lykken.

Originators at these institutions are paid salary plus commission, which is attractive to many loan officers today, Lykken adds. Although salaries are a fixed cost, a bank offering car loans and other financial products generally can keep loan officers productive at all times.

Capital requirements also are propelling industry consolidation now, asserts Lykken. "The M&A [mergers and acquisitions] business is on fire," he says. "I've never seen so much [activity]."

One driving force is that a year from now, Federal Housing Administration (FHA) lenders will need to have a net worth of $2.5 million--and at least 20 percent must be in liquid funds. Lenders that can't meet that standard will merge with larger firms or work as brokers or correspondents selling to "loan aggregators," Lykken explains. Yet even fulfilling the Department of Housing and Urban Development (HUD) networth requirement isn't enough to guarantee success, Lykken contends.

"You need $5 [million] to $15 million in tangible net worth to exist as an independent mortgage banker," he estimates. Funds are necessary for fueling a firm's growth, Lykken adds.

Yet expansion isn't as simple as opening new offices today. Lykken notes that some mortgage companies actually are closing branches in states where they do limited business. Increased attention from state regulators is the reason for these retreats. State regulatory agencies "are mini-CFPBs all around the country," asserts Lykken.

Because loan officers are licensed by states, those regulators also can enforce the Regulation Z originator compensation rules, which were released last April.

Aggressively reviewing mortgage operations provides states that are facing budget shortfalls with a "revenue opportunity," Lykken says. "We're an easy target."

Good business model

Keeping watch over regulatory and market developments as they occur is a challenge for mortgage company leaders. Yet companies can prosper, Lykken says, by keeping a dual focus on compliance and business operations.

However, penalties are severe for lenders that don't pay attention to compliance issues. Besides examining mortgage lenders, CFPB is expected to release guidelines for both Qualified Mortgages (QMs) and Qualified Residential Mortgages (QRMs) this year.

Qualified Mortgages will establish an "ability to repay" standard on originators, while Qualified Residential Mortgages will set up "skin in the game" rules for lenders that securitize. A proposed rule for a combined Truth in Lending Act (TILA)/Real Estate Settlement Procedures Act (RESPA) disclosure form also is scheduled to be released by July 21, 2012.

Mortgage brokers will continue to play a role, says Lykken, who also urges lenders to turn their fixed costs into variable ones by outsourcing "anything and everything." In this new regulatory and business environment, brokers still offer the industry a low-cost source of new business.

Howard Schneider is a freelance writer based in Ojai, California. He can be reached at [e-mail].