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The technology gap.

The leaders in the mortgage lending business are starting to pull away from the pack with investments in technology and with strategic planning that builds around systems' advantages. Increasingly, smaller lenders, especially thrifts, are handicapped by their technology choices and their lack of capital to invest in the best systems available.

In the mortgage market, a growing gap has opened between the technology haves and have nots. This development is demonstrated clearly in results from the most recent edition of a study called: MORTECH92: Technology Use in the Mortgage Industry.

MORTECH92 is a joint product of Strategic Systems Partners (SSP), Chevy Chase, Maryland, and Real Estate Solutions (RES), Washington D.C. The findings are based on completed interviews with 453 mortgage institutions; 154 mortgage banks, 167 thrifts and 132 of the top 300 commercial banks.

This most recent edition of the SSP/RES Research study uncovered important changes in the business profiles and technological sophistication of those competing in the mortgage banking business.

Consolidation benefits the $1 billion-plus

mortgage company

In this year's survey (comprised of a randomly drawn, representative sample of lenders), 13 percent of mortgage bankers and thrifts originated in excess of $1 billion; this compares to 6.5 percent originating more than $1 billion in the 1990 survey.

Growth in the segment of originators with the largest volume (those having originations in excess of $1 billion) came, in part, at the expense of the smallest originations segment ($1 million to $100 million) of mortgage firms. The proportion of firms in the smallest segment fell to 58.4 percent from 64.6 percent in 1990. In view of the general level of consolidation in the industry, mortality has been greatest among the smallest originators.

In a similar manner, the MORTECH survey indicates that the proportion of firms in the industry servicing more than $1 billion has increased 60 percent to 28 percent of thrifts and mortgage banks surveyed. Here again, the proportion of the smallest servicers ($100 million or less) in the industry has declined by almost 30 percent from the 1990 to the 1992 MORTECH studies.

Thrifts fail to adapt to changing times

Since the first MORTECH survey in 1988, a relatively constant 80 percent of firms interviewed have considered themselves primarily as retail originators. In MORTECH92, 79.9 percent of firms reported to be retailers.

But, the results revealed that there is a profound difference in the origination strategies of thrifts and mortgage banks. The thrifts are locked into a single approach to gathering loans, while mortgage banks are much more diversified.

Of the mortgage companies, 33 percent are either wholesale or operated a combined retail and wholesale origination strategy. By contrast, 91.6 percent of the thrifts in the sample stated that they primarily pursued retail origination (versus 67.1 percent of mortgage companies.)

The thrifts are most likely to be bound to a small company approach to mortgage banking. Size and diversified origination strategies clearly are positively correlated. MORTECH92 shows that 60 percent of originators with volume exceeding $1 billion are purely retailers, while 84 percent of originators with less than $1 billion solely pursue a retail strategy.

In addition to the capital problems of the thrift industry - but receiving less attention - is the fact that they seem to be operating under the wrong business paradigm.

According to MORTECH, more than 40 percent of mortgage companies treat servicing as a tradeable commodity - they customarily sell servicing-released or will alternatively retain or sell servicing-released. By contrast, only 16 percent of thrifts surveyed are flexible enough to actively make the decision between holding servicing in portfolio or selling servicing-released.

The evidence showed-that the majority of thrifts, then, are fundamentally locked into a retail, portfolio-building strategy. And, relative to their mortgage banking competitors, they appear to be unadaptable in their execution of their mortgage business strategies.

Technology underlies

successful strategy

In the course of doing this study, we found that while much is written about the capital and financial problems of the thrifts, analysts and regulators should be paying more attention to the operating and technological shortcomings of thrifts as competitors in the mortgage industry.

We found a growing "sophistication gap" in the application of technology between thrifts and mortgage banks and between small competitors and large.

Management technology (i.e., decision support systems) is the area where fewest firms report having made a significant investment. Of the major mortgage banking functions, origination, secondary marketing and servicing, secondary marketing is the least likely to be automated, the study found.

Of the firms interviewed, 53 percent indicated they have automated their secondary marketing function. But this compares to 69 percent of firms having automated loan processing and 98 percent with access to data processing for servicing.

Use of automation in decision-making lags other forms of automation and the gap in use between thrifts and mortgage banks is pronounced. According to MORTECH, mortgage banks are almost 50 percent more likely than thrifts to have automated secondary marketing. Indeed, 63 percent of mortgage companies have some form of automation in marketing, while only 43 percent of the thrifts report having implemented some systems support to secondary marketing.

The gap in technology application is typified by the fact that almost one-third of the interviewed thrifts with some form of automated secondary marketing, cited Freddie Mac's MIDANET as their system of choice. While MIDANET steadily expands its capabilities, Freddie Mac has not designed the decision and asset management routines of a secondary marketing system into MIDANET

The industry may have the

wrong technology attitude

In the course of doing this research, we are always surprised by the lack of strategic use of technology by mortgage lenders. Servicing, for instance, is a primary economic asset of the mortgage business; yet, only 28 percent of the firms we interviewed have implemented servicing valuation software. Servicing valuation software is something that is available in a relatively simple PC form to highly sophisticated mainframe applications.

According to MORTECH, the application of technology is generally a reflection of the attitudes and education of the top management of mortgage firms. In 48 percent of firms interviewed, the chief executive officer has ultimate authority for making major data processing investment decisions. It is rare that the technology staff or department heads are delegated such investment decisions. Among mortgage banks and thrifts, only 4 percent of the information managers or functional heads make the systems investment decisions that define the operating profile of a mortgage operation.

In most cases (84 percent), technology is considered by the industry as a run-of-the-mill operational tool. Although major technology decisions are made in the executive suite, only 13 percent of combined mortgage bank and thrift respondents think that technology provides a strategic marketing or competitive advantage. This attitude, contrasts sharply with responses from the MORTECH opinion sample taken from the top 300 commercial banks, where one-third of respondents regard technology as having strategic importance.

Over the past five years, we have seen mortgage companies broaden their technology objectives from only reducing operating costs to providing a higher level of service to customers. With the full-force reentry of commercial banks into the mortgage business, the importance of technology as a component of strategy will be pushed to the forefront of industry thinking.

Mortgage technology

vendors help, a little

MORTECH finds evidence that the mortgage industry is actively shopping for new technology. The refinancing bulge of the past two years has more than a third of originators considering a change in their loan processing system.

"Purchase intentions are at the highest level since SSP/RES Research began studying technology use in the mortgage industry," the report states. The boom in refinancing during the past two years and the aging of installed systems are driving lenders to expand capacity and update their technologies.

The mortgage banker shopping for new technology will find a fragmented supply market. Taken together the top five origination systems vendors claim less than a third of all installed clients in 1992. This concentration ratio for the top five vendors is essentially unchanged from the MORTECH study in 1990.

Market fragmentation has spawned a wave of supplier consolidation as firms have been acquired or have exited the business. OMNI Software, Data Communication Corporation (DCC), Dyatron Corporation and Fannie Mae Software Systems have merged into Stockholder Systems Inc (SSI) of Norcross, Georgia. Systematics, the banking facilities manager and software company of Little Rock acquired the leading mortgage service bureau, Computer Power Inc. (CPI) of Jacksonville, Florida.

INTERLINQ Software of Kirkland, Washington, bought the operations of Professional Information Management (PIM), Southfield, Michigan; FiTech Systems, Greensboro, North Carolina, acquired the SLIMS Corporation also of Greensboro; and BISYS of Houston acquired ADP Thrift Services of Houston, TRIDATATRON of Anaheim, California and Litton Mortgage Services, Houston. Encompass Software of San Jose, California and AT&T (AT&T Mortgageline Division) simply left the market.

In the long run, fragmentation is costly to the mortgage industry. Small firms simply do not have the development capital both to deliver leading-edge technology and keep their existing base of installed customers satisfied with product enhancements.

Small vendors are forced to choose between employing development resources to respond to user group demands for systems changes, and surveying the entire industry to conceptualize a radically new architecture. Most vendors choose the former option.

Vendors develop new features and functions at the request of individual user groups. They work from a list of mostly minor and short-term change requests. Managing systems development in that way impedes the introduction of new technology and operating concepts to the industry. What you get is an incremental approach to product enhancement, rarely a systems redesign addressing industry structural and operational restructuring.

So who is it that brings new technology concepts to the mortgage industry? Not the scattered origination and secondary marketing software vendors.

Technology innovation has come from specialized firms outside the mortgage technology industry. CY-BERTEK-COGENSYS, Dallas, introduced judgment processing to mortgage underwriting; risk management analysis was marketed directly and through vendors by Baldwin Financial, Parker, Colorado; loan-level servicing valuation technology was developed by Reserve Financial Corp., Miami; and graphic-based pricing flowed from the pioneering work of GHR Software, Wayne, Pennsylvania.

Lack of standardization

raises the cost of doing


Even though mortgage companies all perform essentially the same tasks, there has been little in the way of standardization in the automated tools used.

The extreme example of this takes place among the thrifts. More than half of the thrifts use software from vendors holding less than 2 percent market share. These very small vendors work in a very narrow community of lenders (e.g., small thrifts) and rarely incorporate advanced mortgage banking techniques or up-to-date regulatory requirements into their software.

The result of fractured technology supply lines is an industry with inhibited interchange due to a lack of common data language. Given the roughly trillion dollars of whole loans, servicing and mortgage-backed securities traded. each year, a lack of data interchange standards causes operating costs to rise and limits asset liquidity.

There is a massive amount of data to be analyzed in portfolio sales. The lack of standardized interchange and fragmented approaches to technology has resulted in a sub-industry of due diligence firms taking a portion of the trading spread in return for translating portfolio babel into a common language and data format.

Fannie Mae, Freddie Mac, GNMA and the Mortgage Bankers Association of America have announced a pilot to test loan delivery standards in the fourth quarter of 1992. In a joint publication, Standardizing Mortgage Information Exchange, they point to the obvious benefits of adopting standardized data requirements: "Standards will enable faster, cleaner delivery for lenders and improve the quality of data ... EDI will also reduce costs, increase flexibility and generally make it easier to do business."

Parties to the joint effort on standards have not said as much, but they have taken on the responsibility of rectifying the garbled exchanges emanating from fragmented operational technology in the mortgage industry.

Adoption of technology may

be accelerating

MORTECH92 turned up two important technology trends: mortgage companies are rapidly downsizing hardware installations; and the industry is embracing new technology at a faster rate than was the case in prior surveys.

Local area networks (LANS) have become the operating platform of choice. Among the mortgage companies planning new hardware purchases, 60 percent have budgeted for local area networks. Mortgage companies are adopting a work group organization, linking originations and processors by networking PC workstations.

We have found that the primary motivation to change systems configurations is to provide a higher level of service to borrowers. Sharing work files on a LAN allows any processor to field inquiries on any loan. This eliminates a queuing of unanswered customer inquiries, enhances productivity and leaves more applicants satisfied than is the case under a linear processing system.

Aging technology

The industry is faced with an aging technology base. More than 20 percent of origination systems are reported in MORTECH to be more than five years old, up from less than 10 percent this old in the 1988 survey. More than 60 percent of the ancients of mortgage banking technology - servicing systems - have been in use for more than five years. In 1988, roughly 40 percent of servicing systems had been in use for five years or more.

We see technology renewal as the primary motivation for new system acquisition. While capacity management is a major issue, we now find the largest group of respondents (a third to 40 percent of systems shoppers) reporting their existing technology base as obsolescent.

The mortgage industry may be on the verge of a significant technological transition. The rate of increase of companies automating for the first time has slowed to approximately 5 percent per year. The widespread adoption of networked PCs, the desire to replace aging systems and the trend toward larger competitors creates an environment for operational reengineering and new systems architectures.

We are looking for an innovative technology supplier to step forward and push the industry to a new operating model. Except for specialized applications from the isolated small innovator, we have not seen a comprehensive agent of technology renewal appear on the scene.

Yet, we hear rumblings of change. CPI is gathering an interesting base of talent in Jacksonville that could extend their technology influence within the mortgage banking value chain. Lomas Information Systems is marketing its reconfigured and rewritten Excelis system. Marshall and Eisley in Milwaukee and Data Link in South Bend, Indiana, are rewriting their product and marketing strategies. And, the agencies have taken a fresh, sometimes cooperative view of how technology can best serve the industry.

We think that IBM could be the agent to assume the needed intellectual industry leadership position; if they are willing to apply their resources coherently to the mortgage industry. Under Bob Berini and Ken Miller, in IBM's financial services unit in Charlotte, North Carolina, IBM has made a significant effort to diagram the industry's technology needs.

In their model of the industry, IBM has included leading-edge technologies of image processing, artificial intelligence and voice response systems, as well as more conventional flat file and data-base technology approaches. If IBM allows itself to become more visible, and, if they ally themselves with the more influential factors in the industry (e.g., Fannie Mae and Freddie Mac), we might see the industry pushed towards comprehensive technology renewal.

The future

The MORTECH92 report concludes that the most important influence on the structure of the industry is the growing "sophistication gap" between large and small companies, and between the large commercial banks, mortgage banks and the lagging thrift industry.

The sophistication gap will intensify the need for technology "have nots" to form operating alliances with the more competitive technology innovators in the industry. The ability of leading industry firms to organize around the technology to measure economic value created from production and servicing operations will drive the restructuring of the industry.

Conventional industry observers point to elusive economies of scale as the cause of change in the mortgage industry. The authors of MORTECH92, SSP/RES Research, conclude that scale is a necessary, but insufficient predictor of how the mortgage industry will realign in the future.

For instance, the success of combined retail-wholesale strategies and the ability to measure the spread between street and economic value of mortgage assets by the technologically sophisticated few, could result in a permanent realignment of industry loan production facilities. The rise of "brokers may evolve into a permanent hierarchy of locationally specialized production shops as extensions of national retail-wholesalers' production arms.

I believe that the evolving structure of the industry began with implementation of delegated underwriting and negotiated transactions by Fannie Mae in 1982. In an attempt to reduce its marketing costs and to capture a large share of loan sales, Fannie Mae provided a pricing advantage to those firms that could deliver large pools of loans. These actions established tiers of lenders at the national versus the local level and created differences in retail and wholesale economics.

Restructuring of an industry can take decades. With the uneven adoption of technology that we have measured in MORTECH, we are witnessing profound operating changes at either end of the "sophistication gap." These differences may provide the impetus to finalize the restructuring that began in the early 1980s.

As for the vendors of technology to the industry, it is my belief that there is not enough business to go around. should see continued consolidation through mergers and exits from the business for those vendors with inadequate capital to update their technology.

"The spread of technology appears to be reaching natural limits. Most firms that will automate already have. While the number of new users will not grow rapidly, we will witness a deepening of the use of technology. The vendors that will succeed will be those that aid lenders in restructuring work and facilitating the electronic integration of internal business units and external trading partners," MORTECH92 predicts in its summary for management.

Jeffrey A. Lebowitz is president Systems Partners, Chevy Chase, Maryland.
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Title Annotation:Strategic Systems Partners and Real Estate Solutions conduct technology survey
Author:Lebowitz, Jeffrey A.
Publication:Mortgage Banking
Date:Jan 1, 1993
Previous Article:Not a black and white issue; data that many non-industry observers see as documenting mortgage discrimination, tells only a tiny part of the story.
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