The business of Internet lending.
The last two years have been a period of momentous change in the mortgage industry. During this time, we have witnessed huge consolidations, formation of strategic alliances, development of alternate distribution channels, deployment of value-adding technologies, horizontal integration and new ownership structures. Heightened consumer awareness and expectations, evolving accounting regulations and technological possibilities contribute to these new dynamics in the business.
Change is a continuum in our industry; however, technological innovations and the new business practices made possible by these technologies, coupled with aggressive (and relatively new) major players, will accelerate the pace of change. This article presents a few scenarios of how mortgage lending - in both the primary markets and secondary markets - may operate in the emerging world of electronic networks and who the new players may be. We also will explore potential success strategies for those who want to win in the new marketplace.
Computer networks, the Internet and the World Wide Web
Computer networks are emerging as a viable medium of commerce that is redefining the roles of participants in the business food chain. Electronic network-based business operates in an entirely different dimension. Professors John Sviokla and Jeffrey Rayport of Harvard Business School coined the term "market space" for Internet or similar-based business. Such business features activity that is transacted through electronic networks where there are no physical boundaries or physical locations, and where markets are defined and controlled by information. Market space, in contrast to marketplace, conceptually provides a cheap, efficient, customizable medium to create new ways of doing business, without the various barriers to entry that generally impede the creation of physical markets.
While Internet-based business, in general, is in its embryonic stage and is practically nonexistent in the mortgage business, it is worth exploring the key attributes of the Internet environment as a first step to developing strategies that will enhance the lending business. Some lenders have already established Web sites for advertisement purposes; Every week brings new announcements by mortgage companies that are launching sites with growing capabilities. This article also provides insight into the types of firms likely to succeed in this radically different environment where many of the traditional marketplace standards and conventions do not apply.
While the issues of speed of access and security of information are not yet fully resolved for Internet/World Wide Web transactions, the market forces and the sheer momentum of "internetization" will soon forge a solution to these problems.
Consumer behavior and business operations on the Internet model, as it exists today, can be summarized quickly. There are three types of consumers: price-driven, product-(lifestyle choice) driven and convenience-driven. The Internet can satisfy each of these types.
In addition, it provides an opportunity where a consumer can consider all these factors together when making a choice - the best of all possibilities. From a marketing perspective, the Internet provides the ability to "narrowcast" (aiming a product or service at a specific audience or market) and to "broadcast" (aiming the product to a wider audience) without much incremental expense.
The Internet is content rich. This, combined with the operational ease of access and navigation from subject matter to subject matter, invariably makes the shopper or consumer information rich. Consumers can compare product and price attributes from an array of choices with a few clicks of a mouse.
The Internet provides 24-hour access to information and products. Consumers can decide to do business at their own preferred time, in the privacy of their homes or other desired location.
On the surface, the Internet provides a level playing field for all lenders. However, the level playing field may be limited to "brochureware," or putting general information on the Internet. Operational excellence in the hassle-free completion of business transactions, such as taking full loan applications, closing and accepting payments, will favor technology-savvy companies with money to invest in network, connectivity, application-enabling and other technologies.
The Internet will put price and margin pressures on the supplier. Partly this is due to consumers' expectation that everything on the Internet is free. Price and margin pressures can be alleviated only by creating a perception of a value offering.
The Internet allows lenders an opportunity to close product and distribution gaps through easy linkage with other providers.
The Internet's World Wide Web and similar market space directly connects the buyer (in the mortgage business the borrower) and the seller (in the mortgage business the "investor/lender"). Just like middle management shrank when networked systems were introduced in corporate America, interconnective technologies in the residential finance business may eliminate, minimize or redefine the role of middlemen such as a typical mortgage firm, loan agent and Realtors.
Possibly, a new kind of middleman may emerge to function as an on-line matchmaker or to function as a consultant to either party in a transaction. The typical middleman role of gathering information, transacting and searching is handled by the Internet itself, and, hence, to justify the existence of any middleman over the Internet, such a professional would have to add new types of value.
With the changing roles of middlemen, the Internet model may also cause functions and processes to transform or combine. For example, a customer viewing a lender advertisement on the Internet also may want to perform a transaction, thus turning inquiries into sales.
Lender profiles for the Internet model
Given current consumer behavior and the way the Internet operates, it is worth exploring the profiles of lenders that would be best positioned to take advantage of this environment.
Fallacy of "Web" presence and putting rates on the Internet: In the Internet world, it will be easier for customers to browse and compare all the rates for all lenders. Thus, unless you are the lender with the lowest rates, posting rates will be counterproductive and may take business away from you. Because secondary market agency-oriented lenders generally do not have the pricing and product flexibilities that portfolio lenders possess, lower rates may be possible only for dominant lenders who have a cost advantage. Lenders without this pricing advantage should think through carefully how they could be served by a presence on a Web page.
Built-in advantages for the portfolio/niche lenders: The lure of the Internet is to fulfill personal need and offer customized product. Because the content (product parameters and price) of a mortgage is almost the same for every secondary market (government and conforming) lender, it will be the portfolio or nonconforming (niche) lenders who will generate business from the Internet. This is so because they are the only ones who can offer content variation - prices (teasers) and lifestyle or financial situation-based products (B&C loans, for example).
Mortgage banker/generic lender strategies: The vast number of secondary market lenders offer generic mortgage products. Because their operating environment prevents them from offering pricing and product flexibilities, these lenders will have to figure out ways to offer additional value to the customer if they want to compete in the market space. This value proposition may take the form of a connection with other products or services to call attention to their unique offering (such as an investment feature add-on, akin to frequent flier miles or lower credit card rates).
A new element in the mix - context: Lenders wanting to create an opportunity through the Internet will have to carefully assess the context of their offering. The elements of context include customer service, speed of approval, speed and ease of completing the full mortgage application and closing services. The customer service dimension may encompass software, network and PC support, in addition to mortgage-related issues. If there is any hardware, software or network problem during a transaction, customers are more likely to call the lenders with support questions. Lenders also will have to face the demands of backup systems and technology to protect the site from being overloaded and obsolete. Lenders that do not have an internal technical staff to address these issues or those that want to leverage existing infrastructure facilities can join other companies such as AT&T and OpenMarket for "hassle-free" end-to-end solutions, from implementing to managing Web sites to facilitating electronic commerce and electronic financial transaction processing.
Intercompany marketing instead of cross-marketing: The Internet, with its easy-to-use connectivity to related Web pages, makes it easier for intercompany joint marketing and possible new alliances. For example, investment companies such as Charles Schwab & Co. and Fidelity Investments with their capabilities in marketing and distribution, and with an already well-established Internet presence can offer mortgage services relatively easily by aligning with large national lenders like Countrywide and Norwest. A Fidelity customer, for example, clicking into "mortgages" in the Fidelity home page can be electronically connected to its mortgage partner instantaneously without the customer even knowing that he or she is interacting with another company. For lenders, access to these other firms' customers for mortgage loans may be more lucrative than cross-marketing other products to their existing customer base.
Operational leverage through public networks
Although effective marketing and volume sourcing through the Internet may not happen in the near term, lenders can realize significant operational advantages now by leveraging the Internet structure already available. Lenders should be able to deploy the existing Internet technology and capabilities for improved operations and enhanced relations with business providers, even with today's substandard speed and inadequate security constraints. (Both of these issues, as mentioned earlier, likely will be resolved soon because of the general commercial market push to open up this mode of commerce.) Operations models inherent in the Internet provide help in locking in the business opportunities, process efficiencies and quality transactions. The connectivity and navigation facilities of the Internet makes doing business with third parties, business providers and other business partners easier; thus resulting in a "locking in" advantage for lenders that take initiatives to implement systems using these facilities.
Electronic networks that operate only within a single company or defined business operating environment are called Intranets. They take advantage of Internet/World Wide Web's open standards and Web browser tools and allow for easy dissemination of information such as price, policy guidelines or product parameters throughout the organization. In a mortgage company, this could include communicating to remote lending offices/loan officers and to business partners/providers such as correspondent lenders and brokers.
The Internet's capacity to distribute information relieves the tedious and error-prone practices currently used by the lending community to update individual workstation proprietary software. It also eliminates integrity and access problems. Until now, price distribution has generally been accomplished by proprietary systems plagued by recurring problems, such as the field and head offices being at different software release levels, problems with updating loan officer software and so on. With Inter/Intranet alternatives, the field employee or the remote business partner is using standard access software and protocols that he or she is already using for other purposes.
The Internet, as it becomes universal, provides new business channels, as well as exclusivity or "lock-in" opportunities and other captive advantages with business providers. One leading lender, Countrywide Home Loans, Pasadena, California, has already demonstrated the potential of this powerful business lock-in opportunity with its Internet initiative, Platinum Plus[TM]. Through this initiative, Countrywide has connected its correspondent lenders to its internal operations through the Internet, enabling each correspondent to get its rates, guidelines, funding information and related transaction information, including interactive underwriting discussions.
Possible new players
Success will belong to those companies that can exploit the marketing potential and operational leverage provided by the Internet. These companies will understand that consumers need mortgages, and not mortgage banks. The winners will not try to force-feed the old medium into the new; new models and alliances will emerge.
Companies such as Hospitality Franchise Systems (HFS) that are assembling a network of consumer-oriented franchises, such as residential real estate brokerages, car rental and hotel chains, will be at a great advantage to source mortgages through interconnected electronic networks. We may see lenders developing strategic alliances with companies such as HFS and with companies that excel in electronic network and distribution management, such as Federal Express, CUC International and similar companies. Enterprises such as CUC International (a technology-driven retail and membership services company that provides access to numerous financial and other services to 40 million consumers and has been a pioneer and a leading content provider in the electronic market space for more than a decade) are a natural fit for strategic partnerships.
The current mortgage business and regulatory model are not geared to operate in the electronic market space; pioneering companies that can influence the rules and redefine the boundaries will reap major benefits. In an electronic, interconnected 24-hour national (and international) market space, rules and concepts such as controlled business arrangements (CBAs), some of the current required disclosures and disclosure time frame requirements (In a 24-hour environment where the consumer can initiate a transaction whenever he or she wants, when does a "day" start and end?) may not have any relevance. The sharing, connectivity and community sense of the Internet, in a sense, is an antithesis of the separation, disclosure orientation of current regulatory models.
While public networks such as the Internet may redefine or minimize the role of middlemen such as mortgage bankers, it also will create opportunities for splitting certain processes or pieces of the mortgage value chain and enable the players to offer services such as processing and closing to other lenders. It is conceivable that companies that have expertise in various aspects of processing and closing will set up shops on the Net, and some lenders may decide to electronically transfer the back-office operations to these specialists for the loans they originate through the Net. Lenders too can isolate the aspects of their business where they offer the most value to the market and can decide to set up shop offering these services in the market space to leverage their core competencies.
Probable role of agencies/alternate aggregators
The business possibilities of the World Wide Web present opportunities and challenges to the secondary market agencies - Fannie Mae and Freddie Mac. This, coupled with the push for privatization from some circles, may result in new roles and new aggregators.
In the market space, borrowers and investors can be electronically connected without the need of a mortgage banker or secondary market conduit in between. Capital-rich, technology-savvy companies, if they want and if the returns are attractive, can perform the asset aggregation and securities structuring function, very much like the asset-backed securities (ABS) market, which operates without a Fannie Mac/Freddie Mactype entity. Such new entrants might get into the business not just for the core mortgage business but also for the transaction fees and add-on business possible through their network and operational expertise.
Although the secondary market agencies currently enjoy a lower cost of capital because of their implicit government guarantee, a push for privatization might ultimately erode that advantage. If and when it happens, other aggregators that may have already built a cost-effective sourcing and production operation based on the network model may be at an advantage compared with the agencies.
Obviously, Fannie Mae and Freddie Mac, being publicly traded companies, are under constant Wall Street pressure for revenue and earnings growth. Although they routinely say they have no plans to do this, it is conceivable that agencies, through networks and alliances, could originate loans or control the origination source and put the originated servicing up for bid or direct the servicing to a low-cost servicer. It also is possible for agencies to consolidate current servicing to realize or share cost advantages.
Negotiating the future
We have offered a glimpse at what the future might hold for lending in the evolving World Wide Web environment. Although the Internet medium is nascent now, its future implications are significant for lenders, from an operations and business perspective. Rushing into this new medium too early is as bad as being too late. Lenders should stay in tune with the general development of commerce over the Web to determine an appropriate strategy and timing.
In today's changing business environment, or in the radically altered business models of tomorrow, certain fundamentals remain the same. The basic need for customer convenience, quality products and services, and customer satisfaction have not changed and will not change. What will change are the ways they are delivered.
Delivery, as well as support and service systems, will have to adapt to the prevailing demographic patterns, customer expectations and technological possibilities. Successful companies will focus on brand-positioning, increasing delivery mechanisms and convenience, diversity of products and ownership of customer relationships by deploying consistent operational excellence throughout the enterprise. These firms will use their knowledge in addition to financial capital to create new opportunities to survive and thrive.
Sadu Thinakal is the senior vice president for products and services for Fiserv's mortgage products division. Milwaukee-based Fiserv is a provider of a complete array of software, systems and processing services to financial institutions including specialized software and services for the mortgage industry.
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|Date:||Oct 1, 1996|
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