How to build mortgage banking business.

Although some financial institutions have always been heavily involved with mortgage banking, today we are seeing banks entering, re-entering, or enhancing their mortgage banking operations. They are doing so through de novo growth, expansion of existing operations, or, most commonly, through

The field is open to the aggressive. The mortgage banking industry is relatively fragmented and therefore provides many opportunities for growth through gains in market share. The top producer of residential mortgages, based on 1992 dollar volume, has less than 4% of the total market share. The top ten producers in 1992 collectively had 21% of total market share versus 16% for the top ten producers in 1991.

Three sources of profit

The mortgage banking business provides opportunities for profit in each of its three main disciplines; origination, secondary marketing, and servicing. Overall, this represents a good way to earn fee income without putting assets on the balance sheet (unless servicing is purchased or acquired through a merger.

The greatest profits generally result from servicing, once a critical mass is achieved and economies of scale realized. Additionally, in this steep-yield-curve environment, there are profits to be made from the interest spread between mortgage loans held for sale and the debt to finance those loans for the 30 to 90 days the loans are held. And, with the exception of certain state requirements to pay interest on them, escrow accounts are a low-cost deposit source.

Mortgage banking activities, such as new loan originations, loan purchases, and servicing purchases provide new customers--and cross-selling opportunities--to a bank.

One possible drawback of mortgage banking to most financial institutions is the volatility of earnings, especially resulting from production operations. A further source of volatile earnings is the amortization of purchased mortgage servicing rights. in periods of high mortgage refinancing, this asset is subject to accelerated amortization due to prepayments.

What factors to weigh

There are pros and cons to each of the three routes to mortgage banking growth--establishing a de novo effort; expanding an existing operation; or acquiring someone else's shop.