The new RBC Mortgage: after ditching a net branch model, RBC Mortgage is now ready to grow its...

IN AN ERA OF CENTRALIZATION AND VOLUME-DRIVEN BUSINESSES, EXECUTIVES at RBC Mortgage Co., Chicago, see decentralization and a focus on margin as the keys to their company's growth plans. * The company recently dropped its net branching strategy, a change that led to a sharp drop in refinancing

volume in the first quarter of the year, according to company Chief Executive Officer Jonathan Legg. * Jettisoning the net branches, formerly known as Prism Mortgage, meant that the company no longer had the volume those branches produced--hence the drop in the company's overall origination volume, Legg explains. Yet he and other company officials see that change in strategy as critical to the mortgage company's future growth, particularly in a rising rate environment that will produce sharp declines in refinance volumes. * Legg blames this decline, along with an inefficient technology structure that was replaced this summer, as major reasons New York-based Standard & Poor's (S & P) placed the mortgage company's U.S. parent, RBC Centura Bank, Rocky Mount, North Carolina, on its "credit watch" list. * Legg doesn't let the S & P move discourage him from his goal of turning RBC Mortgage into the most profitable mortgage bank in the United States, as measured by return on equity (ROE), by 2006. By that time, RBC Mortgage officials also expect the company to be a top-10 mortgage originator in the United States. RBC Mortgage further expects organic growth of 20 percent per annum as measured by net income before tax. * Now that RBC Mortgage has refocused on margin and has completed a major technology overhaul, Legg expects his company to grow relative to its competition. While rising interest rates will slow down the mortgage market as a whole, people will continue to move and buy homes, Legg says. So, he contends, RBC Mortgage's focus on the purchase market should help it continue to grow despite the expected volatility in the market. * The first step to reach the company's new goals was to redirect RBC Mortgage's strategy, according to company executives.

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"We felt like [RBC Mortgage Co.] was still immature," explains Jonathan Threadgill, RBC Mortgage's president and a 27-year mortgage industry veteran. "This company was basically acquired by the Royal Bank [of Canada] three years ago, and it's just now getting its arms around what the Royal Bank can leverage. So we still think we have tremendous growth potential. People underestimate the value of Royal Bank. The Royal Bank of Canada is a powerful financial institution that wants the mortgage banking business. We think that having them come into the mix has let us think far larger in terms of balance sheet and capital."

Now, the new RBC Mortgage is using one platform, one strategy, one philosophy. Threadgill was named president of the "new" RBC Mortgage, as he terms it, when RBC acquired Sterling Capital Mortgage, Houston, in September 2003. Threadgill was founder and president of Sterling. Threadgill is part of a relatively new senior management team. Three of the lender's four top officers started with RBC Mortgage in the last couple of years.

In addition to the financial backing of 130-year-old RBC Financial Group (the trade name for Royal Bank of Canada), RBC Mortgage works closely with sister company RBC Builder Finance, Houston, brokers and its own individual loan officers, says Legg, who has been with RBC Financial Group for 22 years. Legg, who is also chief operating officer of RBC Centura Bank, was named chief executive officer of RBC Mortgage in September 2003.

"We haven't fully leveraged the power of RBC and its sister companies in the U.S.," Legg adds.

Craig Focardi, senior analyst for consumer lending and banking with TowerGroup, Needham, Massachusetts, points out that one of the major reasons that Royal Bank of Canada is the No. 5 lender north of the border is the leverage of the RBC brand. He adds that much of the success the lender will have in the United States will come from better leveraging of RBC Centura Bank.

RBC Financial Group provides support without micromanaging the mortgage company, Threadgill says. "They're not in our meetings every day, but they want to know what's going on, and we certainly want them to know what's going on. I feel that they're not an overbearing parent, but they are a parent."

RBC Mortgage history

RBC Mortgage came into being when Royal Bank of Canada purchased Chicago-based Prism Mortgage in 2000. The bank purchased other mortgage companies over the next few years, but the mix of firms was only loosely affiliated without a central strategy until the Sterling acquisition and the decision to go with Sterling's operating philosophy, according to Threadgill.

Under the previous structure, RBC Mortgage's affiliates still largely operated with their own business agendas, strategies and goals. That kind of decentralized approach is typical of a net branch operation. That lack of uniform focus changed with the Sterling acquisition, Threadgill says.

"The challenges to this company have always been on the operational side," Threadgill adds. "When you have a federation of companies to operate, there are a lot of operational challenges. RBC Mortgage did not have good delivery. It struggled in that arena. The volume overwhelmed the platform. The defining moment was Sept. 30, 2003, when it bought Sterling and decided to go with [its] technology, [its] ideology. If you look at the short life of RBC Mortgage, that was the turning point," he says.

Focardi agrees that RBC Mortgage had an inefficient strategy. Under the net branching model, loan officers weren't tied to RBC Mortgage. As independents, they could follow their own strategies and could represent several different lenders, rather than just RBC. So many would focus on volume rather than on margin.

Local autonomy key to retail

Whereas some other large mortgage players are combining parts of their operations to save on overhead and administrative costs, RBC Mortgage executives see local autonomy as the differentiating factor in luring and keeping top loan officers. Growth will come as the by-product of that strategy, according to Threadgill.

While many other mortgage lenders are merging offices, RBC Mortgage moved into the fifth floor of Chicago's Merchandise Mart (at one time known as "the world's largest building") a year ago and has no plans to consolidate other regional operations there.

"At the heart of our organization is the loan officer," Threadgill adds. "We need to provide those services and that platform that attracts those kinds of people."

Loan officers working for RBC Mortgage need to follow the lender's philosophies of discipline and operational excellence.

"We're a very disciplined operation," Threadgill explains. "It's a very blocking-and-tackling environment. You don't get outside yourself. You need to know who you are, know what your strategy is. Everybody has to be on the same page. We are an originator, and our strategy is 'localness.'"

Threadgill quickly adds that even though "localness" isn't a real word, it's still the best term to describe RBC Mortgage's strategy.

Local autonomy attracts talented loan officers, because whether they are servicing a consumer, real estate agent or a builder, they need to have control of the loan origination process, Threadgill says. "It's hard to sell something when you don't have control over it. If you keep it local, they, in turn, have some sense of control. Everything that affects the consumer is at the local level--the funding, underwriting, etc. We think it's a better way to manage profitability."

Focardi agrees that lending is still largely a local business, because loan officers need to build relationships in the community in order to build business.

Within the retail channel, RBC Mortgage has four divisions: Northwest, Southwest, North Central and Southeast. Each division has multiple regions. On the wholesale side, there are eight sales regions.

"We put our operations where [the loan officers] are," Threadgill adds. "In our industry, loan officers want a place to go. Working out of the home is a great idea, but the time has not arrived yet [for that]. We put in a lot of smaller branches that house these people."

RBC Mortgage looks for loan officers who want to be part of a large organization, who need and want the technology and who want to be in control of the delivery service.

The local autonomy extends to mortgage interest rates as well. Each of RBC Mortgage's geographic sales regions headquarters provides rates for each of the four geographic regions and provides margin spreads the regional managers can work from to tweak rates, as long as they don't go below corporate-established minimums. Any discounts that regional managers give customers could come out of their own compensation, which is based on the region's profitability, Threadgill says.

There are other changes that the company has put in place as well. "Our platform [RBC's way of doing business] is not for everybody," Threadgill admits. "We don't put round pegs in square holes. If they decide that it's not for them, that's OK. We know that ongoing there are a lot of people that will move to this platform. We do have rules in place. We do have significant discipline in-house. Someone who wants to be on his own probably won't fit in very well."

Top-line revenue growth doesn't address profitability, Legg adds. RBC Mortgage focuses on profitability through every type of loan as well as every loan officer. Those employees who are volume-driven or who otherwise don't fit in with the RBC Mortgage business model won't likely be with the company for the long haul.

"Several of the lenders are focused on the refinance market," Legg says. "They will be hurt by the spike-up in interest rates. Companies that succeed will be those that don't have refinancing as their bread and butter."

"One of the things that we try to do is to provide the product mix that allows loan officers to make that transition over [from a low-rate environment]," Threadgill adds. "We believe that the cry at the end of the day will be product, product, product. We spend an enormous amount of time developing products."

The upcoming slowdown in the mortgage business will produce a high casualty rate for loan officers, Threadgill predicts. The average loan officer has about seven years of experience, so he or she wasn't involved during the last rising-interest-rate cycle.

Threadgill expects RBC Mortgage and its loan officers to be less affected by rising interest rates and a slower refinance market due to RBC Mortgage's mix of products and market focus.

RBC Mortgage focuses on three primary channels: retail, wholesale and joint-venture affiliated business arrangements (ABAs). The ideal percentage of these business, according to Threadgill, is 40-40-20.

"At the heart of the company, we feel that retail still is where the higher margin is," Threadgill says. However, RBC doesn't want to drive more retail business and downplay wholesale lending.

"Wholesale is more sustainable than retail--you have a better dispersion of the demographics," Threadgill explains. "With retail, you're kind of stuck with brick and mortar; with wholesale, we can change very quickly."

Technology

Legg also expects RBC Mortgage to continue to grow via continuing efficiencies from Fidelity National Financial's Empower loan origination system (LOS). Retail branches completed their installation of the software in July. The wholesale channel began its installation in late October. Empower is the central component of what RBC Mortgage officials feel is a technology platform that entices sales professionals and brokers to do business with the company.

Empower takes the loan data from origination to closing, eliminating rekeying of information that slowed down the four separate systems that the LOS replaced. When loan volumes peaked in 2003, RBC Mortgage had to broker mortgages to outside lenders because RBC's technology couldn't handle the volume, Legg says.

The new system improves turnaround time from 15 percent to 25 percent from application to closing, estimates RBC Mortgage Chief Operating Officer John Hedlund, enabling lending professionals to concentrate on growing their book of business.

Hedlund came to RBC Mortgage from the parent company in November 2002. He had been with the parent company for 16 years, working in a variety of management positions.

Though it's not an end-to-end paperless system, Empower goes a long way toward getting there by using images rather than paper documents throughout much of the processing, Hedlund says.

For the company's wholesale business, brokers work with RBC Broker Online on the front-end interface to access RBC Mortgage products, pricing and guidelines. This technology combination provides lenders and brokers the freedom and latitude to grow their book of business, Hedlund says. So the technology attracts brokers and lenders that want to leverage these systems.

"There are three things you can compete on: product, price and service. We try to differentiate ourselves on service," Threadgill says. "[Borrowers] don't talk about service, but at the end of the day that's what they want. That's the differential. That's why our platform works so well. We can take an application on Monday and close on Wednesday. We feel that speed is a big differential for us."

Wholesale lending

"Our wholesale area is the most underserved, undertapped area that we have," Threadgill says. "We are now in the process of growing that into a true, significant growth channel for us."

Edward "Ted" Ahern, senior vice president of secondary marketing, says wholesale lending growth will be driven by the lender's unique product mix that includes conforming fixed loans, jumbo and super-jumbo loans, no-doc loan programs and home-equity lines of credit (HELOCs).

Ahern is the senior member of the RBC Management team in years of service with the lender. Ahern assumed his current role in 1999 after serving as vice president of secondary marketing since 1997, when he initially joined the organization.

"We have the products to compete and succeed," Ahern says, pointing to products including home equity, portfolio adjustable-rate mortgages (ARMs), alternative-A mortgages and jumbo loans.

With that product mix, RBC Mortgage's secondary business has performed well in the last 12 months, Ahern says, and is positioned to take advantage of the changing interest rate environment. He sees better price-execution opportunities in the secondary market via private securitizations of ARMs and HELOCs and holding ARMs in portfolio.

Focardi says that RBC Mortgage's secondary lending business is still largely untapped, and is an area where the lender and competitors will be vying for business as interest rates increase and refinancing declines.

RBC Mortgage works with more than 1,800 brokers, about one-third of whom were approved in the last year. Brokers are approved at the regional level. The approval process considers a broker's years of experience, reputation, transaction volume and history.

Affiliated business arrangements

Affiliated business arrangements provide RBC Mortgage with additional revenue and profits while the affiliated business gets a financing arm to help facilitate real estate transactions.

The ABAs are joint-venture mortgage entities formed between RBC Mortgage and builders, real estate firms and affinity groups. The joint venture handles the financing needs of the builder or real estate firms' customers. RBC Mortgage acts as the general partner, and the other party is a limited partner in the venture.

"We believe that these arrangements will become more and more valuable and more and more predominant," Threadgill says. "We've been doing them for more than a decade."

In addition to the joint-venture mortgage entities, RBC Mortgage offers builders and real estate firms marketing agreements and desk rental origination arrangements. Marketing agreements enable builders and real estate brokerage firms to generate marketing income by marketing RBC Mortgage as the preferred lender to their clients for a monthly fee. There are no upfront costs associated with marketing agreements, which the builder or real estate agent can terminate at any time.

A desk rental arrangement provides the builder or real estate firm with a dedicated loan officer to provide an on-the-spot financing resource to customers.

More acquisitions on the horizon?

While Legg expects much of RBC Mortgage's growth to come from the continued refinement of the lender's processes, procedures and technology as well as a growing number of ABAs, the expected market consolidation could provide some acquisition opportunities.

"We will grow through acquisition when appropriate," Legg says. "The current environment [prior to the Fed's summer interest rate increases] makes it harder to make good acquisitions. Industry consolidation could create opportunities, says Legg.

"The capability to create sustainable earnings will be the key to success," Legg adds. He sees challenges coming from global financial markets volatility from terrorist threats as well as potential volatility in worldwide oil supplies or interest rates.

Adaptability is the key to handling those challenges, Legg says. "We will maintain the ability to shrink and/or grow our business quickly. We will do this through management of the component of noninterest expense that is variable. We want to manage growth appropriately, with an adaptable and flexible fixed-cost infrastructure."

Phil Britt is a freelance writer based in South Holland, Illinois. He can be reached at spenterprises@comcast.net.