Too Big to Fail Banks and the
financial consolidation that created them are hot topics. A famous chart from Mother Jones shows that the big four banks (Citi, JP Morgan Chase,
Bank of America, and Wells Fargo) got that way by swallowing up 33 other large
banks since 1990. The chart does not
reflect many of the smaller local and regional banks that were already in the bellies
of the regional banks that disappeared.
Both independently and because of
this mortgage lending was also contracting rapidly. Fannie Mae’s Economic
Strategic Research Group says that the share of the mortgage
market held by the top ten originators doubled, from just below 40 percent in
1998 to nearly 80 percent by 2010. But recently
that trend reversed. In one of its
regular Housing Insights reports the group says that over the last three
years “the market
has experienced significant deconsolidation as top lender share retreated to slightly more than 60 percent
in the first half of 2013. Market
deconsolidation was driven largely
by the withdrawal of large lenders,
with only 5 of the top 20 single-family mortgage
originators in 2006 remaining active in the market today.”
The authors of Deconsolidation in the Primary Mortgage
Market: Temporary or Structural Trend? point
out that “Increasing
[primary market] concentration
standard deviation reduces
the overall impact of a decline in MBS
yields by approximately 50 percent.”
Their paper attempts to answer
the question posed by its title; is this decline in the share of the market
held by top lenders temporary or permanent?
Is it a function of cyclical or structural market factors?
Economies of scale and scope is
the first structural factor favoring large mortgage lenders. They can spread fixed costs across more
loans, reducing the average production expenses of each. The authors cite servicing as an
example. Figures from the Mortgage
Bankers Association (MBA) for the four quarters ended in March 2013 show that
direct servicing expenses for servicers who handled fewer than 2,500 loans were
13 percent higher per loan than for those servicing more than 50,000
In this same vein, larger
lenders are able to offer a wider variety of products and services and further
distribute fixed costs against other lines of business. They are also in a better position to cross
sell mortgage products to non-mortgage customers of these other profit centers.
Second, larger banks generally have
lower debt costs and broader access to funding in the bond market than smaller
lenders. Goldman Sachs estimates that
large banks have had an average advantage of 31 basis points in the cost of debt
since 1999 but during the financial crisis this expanded to 800 points. Today however they are at a 10 basis point disadvantage. The authors say the average tangible common equity
ratio (TCER) for small banks is also meaningfully higher than it is for the
largest U.S. banks.
Another factor favoring large lenders
arises out of the combination of tighter credit standards and the government’s
responses to the financial crisis. These
have led to a more standardized and commoditized mortgage market. This will likely make operating costs more
important in competition than the value of product and service differences.
Fourth, larger banks are better
positioned than smaller ones to obtain the help of experts. This will help them navigate the increasingly
complex areas such as compliance and financial modeling.
The fifth advantage arises out of the
consolidation of the banking industry independent of any mergers and
acquisitions related to their mortgage business. Between 1990 and 2012 the number of U.S.
banks and savings institutions declined by more than 50 percent and the share
of assets and deposits held by the top 20 bank holding companies nearly
Label Securities (PLS) Market for conforming loans went dormant with the
financial crisis. It had been
significant in attracting private capital and a resurgence in PLS issuance
would signal a return of private capital.
This would advantage large lenders who can gather the required
collateral and perform necessary securitization and servicing functions.
On the other
side of the ledger are factors the authors identify as favoring less consolidation. The first is a shift to retail mortgage
origination. A sustained shift in that
direction would indicate a future with a more diversified group of originators
because larger lenders are more suited for wholesale origination. The authors believe that the shift that has
happened since the financial crisis came from lenders’ desire to more tightly
control underwriting and production because of the weak performance and high
defect rates for wholesale originations during the crisis period.
Capacity constraints of the larger banks allow smaller lenders to be
relatively more nimble. They can react more swiftly to market changes
as they did when refinancing began to drive originations in 2012 as interest
rates fell to all-time lows. The recent rise in those rates could, however,
test that nimbleness as refinancing gives way to a purchase dominated market.
advantage of smaller lenders is their knowledge of their own markets. This was manifest in the superior performance
of small bank originated single-family loans during the recent crisis and
fairly consistently since 1992. The
authors say that this discrepancy might also be explained by a different risk
appetite between large and small banks.
are spared some of the enhanced regulatory and supervisory requirements of
large institutions such as increased capital standards and stress tests. Heightened requirements may be one factor
that will discourage banks from holding mortgage servicing rights (MSR) assets.
Both large and
small lenders received loan repurchase requests from secondary market
participants. The authors say a
significant number of legacy issues have now been resolved and should recede as
a business issue.
all of these factors the authors conclude that the recent decline in the large
lender share of the mortgage market is temporary and principally a result of
cyclical factors. Their analysis did not
consider possible changes to the housing finance system but absent “meaningful
restructuring” they believe there is a significant probability that in the long
term the large bank share will increase.
Of the eight
factors they outline that favor consolidation, all are what they consider to be
sustainable in the mid-term. However, of
the six that favor deconsolidation, three, capacity limits for large lenders,
legacy issues, and a shift to a retail market, they conclude are only temporary
conditions. For example, they view the
sustainability of the shift to retail as uncertain. “Lender concerns about poor loan performance and repurchase risk are expected to decline as the housing
market outlook and manufacturing processes improve, but some smaller
lenders are expected to be less willing
to sell their mortgage
production to larger lenders in the future.”