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Margin Dynamics Update

Margin Dynamics Update

This is the first of a regular post intended to provide margin insights through a review of recently-priced loan margin data. 

Highly competitive, profitable lenders use dynamic margin management to blunt the adverse effects of high compliance, loan officer compensation and operating costs on profitability.  In this post we’ll explore the impact of margin decisions at the product level, providing current margin color and suggestions for building a more responsive margin pricing approach. 

There is good news in the trends (see the chart below) – margin is up slightly after a long period of erosion.  It’s clear that lenders are adopting a slightly less aggressive pricing stance due to full pipelines and capacity limits as rates drop and the summer vacation season continues.  The optimists among us will wonder if this signals a turning point after the last 12 months of erosion, but the truth is that wider margins will only last as long as pipelines remain full.

Next, let’s revisit the July lock volume distribution in the following table (see our earlier post).  Government share fell 7% vs. June.  Despite the shift away from higher-margin government loans, the improvement in conventional margin helped push overall weighted average margin up 3.8 basis points to 229 in July. 

Now to the heart of the matter.  This next table show recent gross margin for locked loans (defined as secondary market execution price minus the price locked to the consumer) among the products priced by Compass clients, ranked by each product group’s weighted average margin.

Unsurprisingly, among conventional products, the core 15- and 30-year terms exhibit fairly tight margin – that’s where the conventional volume is and where everyone competes most aggressively.  Tight margin on ARMs is a bit odd, though ARM volume is low – more on that later. 

The government products are a bit surprising, though strong government margin is not news – after all, they do cost more for most lenders to originate, and tend to be smaller loans, so one needs more margin to operate profitably.  Nevertheless, look at the Govt 15 year – despite a significant margin decrease over the last month (85 bp) it’s a full 67 bp richer than the Govt 30 year.   Thin volume in the 15 year is no surprise – government loans are about affordable payments after all – but the few that are closed do seem rich.

Things get even more interesting when you look at margin for odd term products. 

The conventional odd terms all show wider margin than the more common ones – though with much lower volume the actual impact on industry profitability is small (in the extreme for the 10 year).  The question for lenders is whether these niche products should continue to be priced less aggressively, or if there’s potential to be more competitive with the 10- or 20- year products.  Going where the competition is not can be a winning strategy so it’s worth looking at whether you’re leaving deals on the table by not calibrating margin on them. 

Let’s look at the dollar margin – actual gross margin – in the table below, now sorted by average margin in dollars. 

Let’s start with the noise - the pricing of the ARMs seems interesting, but it’s a very tiny market segment. The large loan amounts for the 5- 7- and 10-year ARMS are striking, but the market share is so small that we will treat them as outliers. 

The large margin swing in the Govt ARMs last month is also striking – over the last 12 months Government ARMs averaged 241 bp, so this swing is a bit of a course correction.  Again, volume for this product is small, so interesting but not impactful.

The 20-year conventional loans are showing lower average loan sizes vs. the 30 year, so the higher margin rates are rational.  The extra 18 bp of margin is actually delivering less margin than the 30 year, but they’re significantly better than the 15 year’s cash margin.  The 10 year is even worse. With other complexities inherent to the odd terms, lenders who do them earn every penny, so making priced margin rational is important.  If one decided to tighten pricing of the 20 year because of the wide margin, this data indicates that it would only be a win if you can attract higher loan sizes.   Nevertheless, borrowers rarely warm to a 20-year term, so it’ll take creative marketing to move the volume needle that direction. 

Most lenders use market surveys to help align pricing with competitors.  The reliability of surveys has long been questioned, but without an alternative, lenders can only hope to follow the market.  Look beyond the competition to identify lucrative niche products – like the 20-year conventional or a competitive investor’s ARM product– where you can lead on price comfortably.  This analysis suggests that study of actual margin – particularly for the niche ARM and term products – informs thinking about price AND volume more cohesively.  So, determine your priced margin and analyze the data across products, branches, even loan officers.  Stay tuned to Compass Community for regular updates of this margin analysis. 

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