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iFive Decades of Mortgage LendingFive decades on, credit union mortgage lending comes into its own. Market share, measured in terms of annual credit union originations versus annual U.S., originations is at an all-time high. So areoriginations when expressed in total dollars. 2012’s results, at 7.03% market share and $123 billion in originations, makes a statement: housing finance has become an important core strategyBalance sheets and income statements show it too. Credit union financial performance of the last several years is mortgage-lending driven. No other consumer loan demonstrates the financialversatility, not to mention the sheer income opportunity. Making money making mortgages has been easy the past several years because loans have been abundant. Profitability could have been evengreater, though, with close attention paid to the four metrics which are the subject of this book. As the mortgage market changes we hope you find the concepts presented here useful in increasingperformance, profitability and market share.- Nizar Hashlamon & Dan GreenFOREWORD

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This is not a book about mathematics, not really. M3T is about simply and quickly mastering four basic ways of measuring retail mortgage lending operations in pursuit of greater competitiveadvantage. That’s the key to thriving in the mortgage market that lies just ahead: every aspect of lending execution has to be efficient, productive and cost-effective, starting with how borrowersare targeted and, once reached, nurtured all the way through the mortgage cycle until their loan closes and they’ve comfortably moved into their new home.If this isn’t a book about mathematics, what’s with the equation? Years of gathering data, analyzing it, running it through models and equations such as the one you see yielded the simplemethods you’ll find in these pages. Using just a few facts you probably have on the tip of your tongue or at the tips of your fingers you’ll quickly have a better understanding of your mortgageoperation, as well as improving your competitive position.CHAPTER ONE2Concepts

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SECTION 1M3T purposefully simplifies these four measures, and as such, they pro-duce directionally correct results that are diagnostically oriented.Directionally Correct? Diagnostically Oriented? Directionally correctmeans the results these metrics produce are in the ballpark. They are pur-posefully easy to calculate so they will be calculated. And, the answersprovide a reasonable starting point for further, deeper inquiry. In otherwords, they head you in the right direction and will lead you to valid con-clusions.Diagnostically oriented means these metrics, once known, should raisequestions - - lots of them - - the answers to which often result in pro-found improvement. Why are the results what they are? Why are mymembers behaving in such a way? What in my operations are producingthese results? M3T starts you on a journey of discovery.Measurement Simplified1. There are as many ways to measureand quantify performance as there arelenders and borrowers. Standardizingand getting to ‘simple’ requiredstandardizing and normalizing data andcalculation methods.2. Data was provided by lenders hopingfor a better understanding of theirlending performance. It was alsogathered from publicly available sourcesincluding NCUA and FFEIC.3. Industry standard methods for measuringproductivity and for determining the costof mortgage operations were consultedand adapted to create the methodsused here.Directionally Correct & Diagnostically Oriented3

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SECTION 2These are simple measures. The first three are ‘back of the envelope’calculations easily derived through simple division, so long as the nu-merator and denominator are known. The fourth measure, cost-to-close, is more difficult. It, too, is the end result of simple division, onewhere the denominator, the number of closed loans, is readily known.The numerator, on the other hand, is an altogether different story.Until M3T there’s not been an easy way to get at this elusive numberbecause there’s no universal agreement on cost accounting practices.M3T proposes a standard approach, which Chapter Five presents.Four Metrics for Success1. Member Share. How many of yourmembers are you reaching? When itcomes to credit unions the measure issimple. What percentage close amortgage in any given year?2. Pull Through. The bane of every lender’sexistence and the most costly metric toignore. What percentage of loansoriginated actually close?3. Productivity. No single measuredetermines cost more than productivity.How many closed loans per employeeclose each month?4. Cost-to-Close. This is it, the holy grail.With a firm grasp on this metric it ispossible to be the most competitive lenderin the market.The Four Metrics4

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Member Share is one form of market share calculation. While there are many ways to measure share, this one is elegant in its simplicity because it makescomparing credit unions, one-to-the-other, very easy. It is also very diagnostic, not only in terms of the measure itself but what it can reveal aboutindividual business models and strategies when compared against the universe of mortgage lending credit unions.CHAPTER TWO5Member Share

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Warning: This Gets NerdyRemember bell curves and normal distributions from statistics class? Turns out they’re helpful in real life, too. The curve on this page illustrates Member Share of the top 300 mortgage lendingcredit unions for 2011. Member share is an easy calculation: simply divide the totalnumber of first mortgage loans originated in any given year by the number of mem-bers in that year. We use 2011 here since it was the most recent data available as ofthis writing.Applying the member share metric to the top 300 mortgage lending credit unionsyields a group average of 1.09%. What this means is that the average credit unioncan expect to make a mortgage to just over 1.00% of its membership in any givenyear. Seem low? While the member share measure has varied over the decades,2011’s result is not atypical.It is also important to note that the standard deviation around the average is .80%.The shaded portion of the graph highlights this area. All but 47 of the top 300 lend-ers in 2011 had member shares within this range, and all but 13 found themselves on the right side of the curve, far above the average.How can you use this? Determine where on the curve your credit union falls. If you find yourself on the right-hand side of the shaded portion of the graph, your member share is fairly strong andlikely indicates mortgage as a strategic focus. If you find yourself on the right-hand side of the shaded area, in the realm of the 35, you’re in rare company. Business model, more than anything else,distinguishes these credit unions.6

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A fun credit union mortgage lending fact: the long-run average pull-through rate from application to closing is less than 45%. That means credit unionsare not closing as many as 35% of all mortgage applications. The remaining 20% are loan denials, which is another fairly constant trend. Why is thishappening? Why can’t the industry get over the 45% pull-through barrier? Where are the missing 35% going? It’s a mystery.CHAPTER THREE7Pull-Through

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Mystery SolvedOr is it? As in every mystery there are likely suspects. Current evidence points to two culpritsin particular. The first is the housing crisis. Pull-through was on the rise prior to the housingcrisis and may have peaked at about 50% in 2007. It’s been downhill ever since, driven thatdirection by tight credit standards and, recently, the availability of housing. The twin problemsof credit and collateral are structural issues that must be overcome for housing to truly recover.Both must also be addressed for pull-through to increase significantly as well.The other likely suspect is pipeline poaching. From the largest lenders to community lenders,including credit unions, buyers and refinancers alike are automatically targeted within 48 hoursof their initial application. The race is on. Big banks, when hungry for home loans, turn on theirmarketing machines and their call centers. They go on the offensive as soon as potential homebuyers and refinancers apply. Their follow-through is relentless, too, because every closingdrives higher profits. He who is most persistent gets the loan is the positive way of saying hewho hesitates is lost.Go on the offense. Remain in constant contact with new applicants. Benign neglect, hoping,in other words, that borrowers will stick through closing is not a strategy that improves pull-through.The Pull-Through CalculationFor our purposes the definition of Pull-Through could not be simpler. Divide closed loans byapplications taken.The only trick, if you can call it that, is timing. Closed loans and applications must be meas-ured in the same time period. One month at a time keeps this measure on the top of yourmind. A whole year at a time illustrates longer-term trends. We recommend measuring it bothways.Like member share, this is a diagnostic measure that should lead to deeper inquiry. Why areborrowers falling out? When are they falling out? Where are they closing their loans, if notwith us? 8Calculating Pull-ThroughClosed LoansPull-Through equals ___________________ Applications Taken

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Productivity should be a primary concern for all mortgage lenders. Why? Because labor is the single largest component in the mortgage lending costequation. Having a firm grasp on productivity, as we illustrate in the next chapter, leads to a directionally correct estimate of the cost-to-close, the mostdifficult metric to derive of the four presented here.CHAPTER FOUR9Productivity

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The Productivity CalculationProductivity, defined here as the number of closed loans per employee per month is another ofour simple calculations. Divide loans closed in any given month by the number of productionemployees working in that month.More productivity is almost always better, and it stands to reason that the higher the productiv-ity, the lower the cost-to-close, since the two measures are inversely related, which the nextchapter illustrates. What’s possible? What should productivity be?We studied productivity over a six year period, beginning just before the housing crisis through2011. The range of results is wide, from as little as 2 closed loans per employee per month, toas many as 14. Less than 5 closed loans per employee per month results in a cost-to-closesituation that is not sustainable. Achieve more than 9 closed loans per month and profitabilityrises dramatically.People, Process, Strategy and TechnologyPeople, Process, Strategy and Technology (PPST) working in concert result in the greatestefficiencies and the lowest cost-to-close.People, Process and Strategy matter. No more than buying a horse makes one a cowboydoes buying technology make one an efficient, low-cost mortgage lender. The best technologymust be coupled with extreme attention to process engineering and re-engineering, training andcoaching mortgage teams on new technologies and processes, and employing focused strat-egy. People, process, strategy and technology are integral to maximizing productivity whilelowering costs.Technology matters, too. One-system lenders, those whose on-line mortgage application andloan origination systems are one in the same, are more efficient and enjoy a lower cost-to-closethan lenders who rely on multiple systems to originate and close mortgage loans.Moreover, having one, cloud-resident system appears to produce the highest efficiencies due tothe fact lending teams are able to access their pipelines from any internet-connected computer.Members, too, can make application from wherever they are at their convenience. With thesesystems, originating and processing mortgage loans becomes an anytime, anywhere proposi-tion. Lenders using enterprise systems, in contrast, typically process loans during normal busi-ness hours since their platforms are not easily web-accessible. 10Calculating ProductivityMonthly Loans ClosedProductivity equals ___________________ Number of Production Staff

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Cost-to-Close (CTC) and Productivity are inversely related, one to the other. Where high productivity exists low cost-to-close surely follows. In fact,achieving a CTC that creates competitive advantage is impossible without high productivity. Chapter Five illustrates in direct terms the relation betweenthe two. If you know your productivity we’ll show you how to estimate your cost-to-close.CHAPTER FIVE11Cost-to-Close

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The Cost of Mortgage LendingWhat does it cost to close a mortgage loan? Like most questions of this type the answer is it depends. Cost-to-close is the hardest of the four metrics to calculate for several reasons. The mainreason this important metric is so much harder to calculate is that there are somany ways of going about it with no real agreement on a standard approach todoing so. So the results of our study we conducted could be used comparatively,we derived a standard cost-to-close formula based on early work by the MortgageBankers Association (MBA) as well as work done by Fannie Mae in the early2000s for its Mortgage Focus Study.While the formula is a very useful calculation it is not simple enough for M3T’spurposes, hence the graph on this page. As Chapter Four points out, productivityis a very important metric in its own right. When combined with other data fromour study it can be used, accurately, to estimate the cost-to-close.Want to estimate your operation’s cost-to-close? Easily done. Read your produc-tivity metric along the horizontal axis, and then draw a straight line up to the curve.For example, if your operation closes five loans per employee per month, your cost-to-close is approximately $1,570.And, as Chapter Four points out, productivity and cost-to-close are inversely correlative. As productivity increases, cost-to-close decreases, though our study shows diminishing returns the furtheryou travel down the horizontal axis. Pursue it anyway, every dollar counts.12

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What could be gained by reducing the cost to close by 50%? There are at least three answers to this question. The first is drop thesavings to the bottom line. Profitability is increasingly hard to achieve. Or, split the gains between the house and the borrower. The thirdoption is use it to competitive advantage. How? Improve the rate to the borrower. Chapter Six shows you how.CHAPTER SIX13Competitive Advantage

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Achieving Price AdvantagePursuing greater productivity decreases cost-to-close, as Chapter Five illustrates. The next logical question, then, is what to do with those savings, a question to which there are at least three answers. The first isuse every dollar of savings to improve your bottom line. Another perfectly acceptable answer is sharethem with your borrowers. On the other end of the spectrum is share every dollar of savings with yourborrowers by using them to enhance the mortgage rates you offer.The table on this page illustrates a fictional lender’s transformation as it cuts its cost-to-close by 43%from $1,500 to $850 per loan using the pricing formula all lenders learn in the early days of their mort-gage careers. The pricing exercise typically begins with the current market offer at a specific rate. In thiscase the rate is 3.625%; for a 60 day delivery investors are paying 101.7116. To that price lenders addother loan income and then subtract lending costs, including the cost-to-close (cost-to-originate in theTable). Note that the cost-to-originate is the second largest variable in the formula and the single larg-est variable within lender control. Stringent management of cost-to-close, therefore, is the key to com-petitive advantage.Our fictional lender’s pre-transformation situation is shown in column one. Offering borrowers 3.625%yields a gain on sale of 286 basis points which is shown in the Total line. Column two shows the effectof cutting the cost-to-originate by 43%. Gain on sale increases to 322 basis points or by 12.59%. It’sdecision time. What does our lender do with this newly found 37 basis points?One answer is record it as income. The second answer is split the gain between the bottom line and the borrower. The third answer is use it to competitive advantage by applying the total improvement to therate. Rather than charge 3.625% our fictional lender would, in this example, decrease the rate by 9.29 basis points.14

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An almost 10 basis point improvement is certainly helpful especially given the highly competitive nature of mortgage pricing. How much greater advantage could be achieved by doubling the advantage to 18basis points? Investors offer pricing based on delivery period, typically 10, 15, 30, 45, 60 and 90 days; the shorter the period the better the pricing. Column three shows how such a move is possible.The assumption in Column Three goes like this: a more efficient lender processes and closes loans more quickly than a less efficient lender. There’s an added benefit, therefore, to increasing the number ofclosed loans per employee: cost-to-close decreases while processing velocity increases enabling our fictional lender to take advantage of 45 day rather than 60 day pricing. Delivering 15 days earlier means theinvestor pays more. Between the increased sales price and the reduction in CTC there’s an additional 18 basis points to work with, when, translated to price, provides an extra 13 basis points that can be sharedwith the member. That’s slightly greater than a full 1/8% improvement in the rate shown to the borrower. The advantage is clear: mastering cost-to-close delivers distinct competitive advantage.15

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Mortgage lending has become irrevocably important to credit unions and their members. Housing finance drives balance sheets, income statements andprofitability. It also heavily influences the decisions members make about their finances, and where they establish relationships. Opportunity abounds thisyear and beyond. The following pages talk about 2013, focusing on where mortgage lenders should place their attentions.AFTERWORD16What Next?

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Three Factors for 2013’s Mortgage MarketThree factors will heavily influence the mortgage market during 2013. Two of them are immensely positive for credit unions and for our industry overall. The third is a reflection of the mortgage market generallyand, when seen in a certain light, is positive as well.Factor One – RefinanceYes, refinancing will continue in 2013. The Mortgage Bankers Association’s (MBA) January forecast is bullish through the first half of the year, less so in the second half. Why? Two reasons.First, rates remain abnormally low. Homeowners who refinanced last year are refinancing again, perhaps for the last time. Ever. Let’s face it, with a mortgage rate in the mid- to high 3% range, why would anyhomeowner, unless forced, give it up? Which leads to a sobering fact: many of us may have seen the last refinance wave of our careers. Coping with this eventuality is covered in the second factor.While the MBA may only be bullish through the first six months of the year, there is one reason to believe robust refinance will be a year-long phenomenon: the Home Affordable Refinance Program (HARP). HARP helped 1 million or so homeowners in 2012, up from the 900,000 it helped from 2009 through 2011. These aren’t bad numbers. Though, before we congratulate ourselves, recognize that they belie theopportunity: somewhere in the broad range of 2 to 7 million is the number of homeowners who potentially remain HARP eligible. That is a lot of loans. Considering this year’s entire market is expected to pro-duce about 7.5 million mortgages, HARP could represent 25% to more than 90% of the total.Why more HARP? It is tactically good business from a pure volume perspective. Helping underwater homeowners in the last 12 months of the Program could almost equal an entire year of production. Itsaves them money, too, anywhere from $100 per month to more than a $1,000. Like all mortgage loans in this rate environment, they are profitable, too. HARP is a win for members, your credit union andyour community. Get engaged. This is an important strategy for 2013.17

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Factor Two – The Purchase MarketAll lenders, credit unions included, have been enjoying the refinance environment since it started in late 2009. This period of refinance has gone on far longer than any other in history which is fine because itwas so necessary. Many more homeowners are now in mortgage loans they can afford. As a result the housing market is moving on.What it is moving on to might be one of the longest purchase-money markets since post WWII. There are two reasons for this. First, just about everyone who could have or should have refinanced has, for-ever diminishing those types of loans from the market. Second, consumers have been putting off the housing decision since 2007. Here’s a great example: formation households over the past five years havebeen at record lows. The housing market, the employment situation and the economy have caused people to put their lives on hold, until 2011. More than 1 million new households are once again forming everyyear. Their need for housing will help drive the recovery, and your lending business. This segment, broadly defined as first-time homebuyers, demands your strategic planning attention. They serve the triple pur-pose of growing mortgage lending volume, decreasing the average age of credit union membership while increasing demand for all other products and services you offer. At no time in recent history have first-time homebuyers been so important to credit unions. At no time in history have you been so important to them: today’s borrowers look to lenders they trust. That’s the definition of a credit union.It may take the first six months of this year to truly ignite the purchase market. If rates slowly rise as they are expected to, borrowers will engage to take advantage. Housing prices are on the rise, too, which willalso excite demand. Be ready, 2013 is the start of a long-running purchase market. Your credit union needs to be part of it.Factor Three – Regulation, a sign of the timesAt least three mortgage regulations profoundly affect housing finance now and long into the future. None of the three take effect this year. In fact, we have about one year to get prepared for:1) New Disclosures. The disclosure changes also known as Know Before You Owe will not take effect until 2014 at the earliest. They represent, however, a seismic shift in how mortgage rates, fees and terms arecommunicated to borrowers. No more Truth-in-Lending Statement (TIL), no more Good Faith Estimate (GFE), no more HUD-1 Fee Itemization. In their place are new Loan Estimate and Closing Disclo-sure Forms designed by the Consumer Finance Protection Bureau as mandated by Dodd–Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank). While credit unions won’t be disclosingusing the new forms during 2013, time will be spent preparing for their introduction during 2014.18

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2) Servicing Rules. New servicing rules were announced in January. These are sweeping changes, designed to make sure homeowners and their loans are managed carefully, especially those who become delin-quent and move toward default. Two things to note. First, these changes take effect in January 2014. Second, they only apply to servicers with portfolios in excess of 5,000 loans, which means that less than200 credit unions are affected.3) Qualified Mortgage Rules. The definition of what constitutes a Qualified Mortgage was also released in January. Determining whether a mortgage is a qualified mortgage for purposes of the regulation boilsdown to an essential test: the borrower’s ability to repay based on 13 or 14 criteria. It’s somewhat more complicated than that, yet the point is the Rules stand to change the way we lend, how we lend and theproducts we use to finance homes. Complying will take time this year so we’re ready for next year.Despite the extra effort and cost to prepare for and lend under these regulations, credit unions can see them as positive. Why? Take the Qualified Mortgage Rules, for instance. While they will change lendingpractices, our industry practices are philosophically close to their intent: we must know borrowers can afford to repay their loans before we close their loan. This is the very essence of lending, something creditunions never forgot, even during the heady days of last decade’s housing rush. There’s another reason, too, that new regulations could be less stressful for credit unions than for other lenders: as an industry wetend to have better, more advanced technologies that makes compliance easier. If your technology isn’t being helpful, it might be a good year to look for a replacement.Will other factors influence lending this year? Undoubtedly. They always do. Pay attention to these three, however, and you’ll be in a strong strategic and competitive position.19

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We are eager to hear your thoughts about credit union mortgage lending in general and the concepts presented throughout M3T in particular. Reach usat :Nizar Hashlamon: nhashlamon@mortgagecadence.com and/or Dan Green: dgreen@mortgagecadence.com20Contact Information

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21(c) 2013 Mortgage Cadence, LLC. All Rights Reserved.