MBA’s Mike Fratantoni on measuring mortgage competition
Mortgage industry participants can strongly disagree on many different topics. However, I expect you will find no argument with the following statement: Mortgage lending is a highly competitive business.
While the breadth of the market, which has totaled around $4 trillion in volume each of the past two years, might suggest plenty of opportunities, loan officers and businesses need to stay on their toes to survive, let alone thrive in this environment.
Make no mistake: the mortgage market has become more competitive.
There are several ways to measure the level of competition within an industry. First, just look at the number of competitors. Data from the 2020 Home Mortgage Disclosure Act (HMDA) showed that more than 4,300 lenders took out enough mortgages to meet the disclosure requirement, while many other lenders likely took out only a few loans this that year.
These lenders included banks, credit unions and independent mortgage banks (IMBs), all offering a similar product to millions of potential customers across the country through retail, wholesale and direct-to-consumer channels. . Consumers can instantly compare mortgage products and rate offers online, either directly on lenders’ websites or through the various websites that offer price comparisons.
Some might argue that even though there are many potential competitors vying for a consumer loan, if there are certain competitors who persistently dominate the market share over time, one might have a false perception of the intensity of competition.
Are there any lenders that have consistently dominated the mortgage market? Exhibit 1 shows lender rankings from MBA analysis of HMDA data over the past 20 years, in this case showing the top 20 lenders by four-point retail and brokerage volume over that period. The lenders in bold were in the Top 20 in 2005 and in successive years.
Clearly, the impact of the Great Financial Crisis (GFC) was significant, as there were a large number of failures and an extraordinary number of mergers and acquisitions among banks and IMBs. Anyway, aside from the three largest banks in the country, it certainly seems difficult to stay at the top of the industry in terms of volume.
Exhibit 1: Top 20 lenders over time
Perhaps more than just looking at the rankings at different points in time, it is interesting to see the proportion of industry volume represented by lenders outside the top 50, according to Appendix 2.
This data suggests that the industry has become somewhat less focused over the past decade compared to the decade around GFC. The fact that small lenders (outside of the top 50) as a group can account for half or more of total retailer and brokerage volume highlights another important point. Although it is very difficult for a new entrant to jump into the top 20 immediately, the prevalence of so many small lenders suggests that there are many choices for potential borrowers.
Exhibit 2: Market share of small lenders
Some published lender rankings include not only retailer and broker volume, but correspondent volume as well. For some purposes this is very relevant. We know from industry benchmarking efforts that half or more of many large lenders’ total volume may come from the matched channel.
However, competition policy is properly focused on consumer welfare. Thus, measuring the level of competition in the mortgage industry should also focus on competitors that interact with the consumer at the point of sale: personal loan officers and brokers.
Using correspondent volume would distort the fact that underlying these correspondent volumes are hundreds, if not thousands, of small originators that reach the consumer – each lender making their own pricing and credit and offering its own level and quality of service to the borrower. Therefore, it makes sense to focus here on retailer and broker volume.
Now, this informal analysis of the competitive landscape in the mortgage industry, together with their lived experience, may convince some. However, there are certainly more formal ways to assess the competitive structure of markets.
First, one could calculate the summary measure of market concentration that justice department (DOJ) uses the HHI. According to the DOJ website:
“The term ‘HHI’ refers to the Herfindahl-Hirschman Index, a commonly accepted measure of market concentration. The HHI is calculated by squaring the market share of each company competing in the market and then adding the resulting numbers. For example, for a market consisting of four companies with shares of 30, 30, 20, and 20%, the HHI is 2,600 (302 + 302 + 202 + 202 = 2600).
The HHI takes into account the relative size distribution of firms in a market. It tends to zero when a market is occupied by a large number of companies of relatively equal size and reaches its maximum of 10,000 points when a market is controlled by a single company. The HHI increases both when the number of firms in the market decreases and as the size disparity among those firms increases.
Agencies generally consider markets in which the HHI is between 1,500 and 2,500 points as moderately concentrated, and markets in which the HHI is above 2,500 points as highly concentrated.
For comparison, consider the soft drink market in the United States. According to statista.com, in 2020, Coke had a market share of 44.9%, and Pepsi was 25.9%, indicating an HHI of 2,678 when considering only the top two companies. This corresponds to the level that the DOJ suggests is “very concentrated”.
No lender in the mortgage industry has near the level of market share claimed by Coke or Pepsi, so unsurprisingly the HHI for mortgage origination has been considerably lower over the past 20 years, peaking at around 350 in 2010, immediately after the financial crisis. crisis, and now at a level below 150. The mortgage industry’s level of concentration has been significantly below levels that would raise policy concerns by the DOJ.
Admittedly, this is a very high-level analysis. In actual regulatory investigations of the competitive nature of markets, market definition is a critical step. Is the volume of the US retail and brokerage market a single market? Or would it be more appropriate to examine concentration at the state or metropolitan level? There is no doubt that the ranking of lenders varies greatly from region to region of the country. And the requirement for IMBs and state-chartered banks to be licensed and regulated in a state in order to offer loans increases the costs of expanding into new markets.
However, technology has likely facilitated faster access to more markets over time. Looking at the national statistics from the HHI, the level of competition again seems to have increased – not decreased – over the past decade compared to the previous one. Technology has probably enabled more vigorous competition across more geographies than before.
Exhibit 3: HHI for the mortgage industry
By way of comparison, Appendix 4 compares the market shares of the main lenders in the mortgage sector with those of the main companies in other sectors of the economy. Obviously, the concentration is much higher in several other sectors.
Exhibit 4: Competition in mortgage lending versus other sectors
Finally, in addition to looking at the number of competitors, the persistence of market leaders, and more formal measures of market concentration such as the HHI, another factor to consider is whether incumbents/market leaders can maintain above-market returns for long periods of time, another indicator of excessive market power or excessive concentration.
Exhibit 5 presents PGR: MBA and Stratmor Peer Group Roundtable program data for the past two decades. This graph shows the level of net production income in basis points by type and size of lender.
Exhibit 5: Net production income (basis points) by peer group
A few themes stand out. First, the profitability of this industry is highly cyclical. Lenders tend to be more profitable in waves of refinancing, and less profitable during buy markets, which also tend to be periods of low origination volume.
Second, while the magnitudes may differ, profitability trends tend to be similar for lenders of different sizes and business models. On the contrary, cyclicality appears to be more pronounced for large lenders, which likely also have a larger fixed cost base.
Finally, note that banks report losses on their mortgage origination business during lean times. IMBs don’t, not because they don’t lose money, but rather because IMBs are monoline companies that only offer mortgages – if they consistently lose money , they go bankrupt and stop communicating data. Banks can sometimes lose money in mortgages and make money in other lines of business.
Examination of this data, in concert with the average of the MBA quarterly performance report, reveals that the average origination margin over time has been approximately 50 basis points of origination volume. However, this average requires lenders to be prepared to earn significantly less than this in tough years, with the potential to earn more during waves of refinancing. In short, large swings in profitability are the hallmark of a highly competitive market, not a concentrated oligopoly.
To end where I started, for participants in the mortgage market, the intense competition in the mortgage market is obvious. However, it is always beneficial to dive a little deeper into the data to examine how the competitive landscape has changed over time. In doing so, it appears that over the past 10 years the mortgage market has become even more competitive compared to the period just before and just after the Great Financial Crisis. This competition benefits mortgage borrowers who use their power to shop around with lenders of different sizes and different business models.
This column does not necessarily reflect the opinion of the editorial staff of HousingWire and its owners.
To contact the author of this story:
Mike Fratantoni at [email protected]
To contact the editor responsible for this story:
Sarah Wheeler at [email protected]