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Digital Domination


Editor's note: This article was originally featured in the October issue of MReport, out now


Fitch Ratings believes the growing trend of digitization in the U.S.
mortgage application process will continue over the medium term as
changing demographics and increased competition force industry players
to improve the ease and efficiency of obtaining a mortgage. While many
financial-technology (fintech) firms and non-bank financial
institutions (NBFIs) have had a first-mover advantage on this trend,
larger banks are likely to catch up quickly given their bigger
investment budgets, extensive risk management capabilities, and
broader customer relationships. Firms that do not invest in this area
will risk losing market share and could have their profitability
negatively impacted, which over the longer term could also put
downward pressure on a company’s ratings.

Online Lenders Gaining Ground

Changes in demographics and technology (i.e., mobile banking
applications) are helping to drive the evolution in the mortgage
lending process. A National Housing Survey in October 2015 by Fannie
Mae on consumer attitudes showed that increasing numbers of homebuyers
are going online to get their mortgage and that the appetite for
future shopping and application through a mobile device was more than
twice the current rate due to improved ease and efficiency of the
overall process. Driving this trend are millennials, who are
increasingly using technology to complete transactions and interact
with their banks and financial service providers, according to the
Fair Isaac Corporation (FICO), a data analytics and consumer credit
scoring company. While definitions vary, millennials represent the
generational group who were born from the early 1980s to the mid-1990s
or early 2000s, according to Wikipedia. Buyers aged 36 and younger,
which includes millennials, represented the largest share of
homebuyers for the last four consecutive years, according to the
National Association of Realtors, and accounted for over 86 percent of
loans for new home purchases in February, according to Ellie Mae’s
Millennial Tracker.

Some larger non-bank mortgage companies were early adopters of online
lending and have grown rather rapidly. For example, Guaranteed Rate
Inc. launched the first digital mortgage in June 2015 and recently
sought to expand its online business through a joint venture with real
estate services company Realogy. Quicken Loans Inc. (Quicken) followed
with its own online product in November 2015 through Rocket Mortgage.
Within a year, Rocket Mortgage closed $7 billion in conventional,
Veterans Affairs (VA), and Federal Housing Administration (FHA) loans,
which was just over 7 percent of Quicken’s total closed volume of $96
billion of mortgage originations in 2016. According to Quicken, Rocket
Mortgage’s origination volume alone would rank as a top-30 national
mortgage lender, among the 50,000 banks, credit unions, brokers, and
mortgage companies in the U.S.

Digitization has also opened the door for new and non-traditional
entrants, including online marketplace lenders and internet banks such
as Social Finance Inc. (SoFi) and Ally Financial Inc. (Ally),
respectively, both of which have successfully leveraged their digital
technology platforms to grow within the mortgage sector. Since
entering the mortgage business in 2014, SoFi has grown to become one
of the largest online residential mortgage retailers, having
originated approximately $883 million in prime jumbo loans in the
first nine months of 2016 and $750 million as of July 2017. Ally
launched its direct-to-consumer mortgage product in December 2016 and
expects it will help diversify company earnings over time as it ramps
up origination capabilities. Ally’s management anticipates $5 billion
of mortgage volume in 2017.

Big Banks Talk Back

More recently, large brick-and-mortar banks have responded by
investing heavily in their online platforms and mobile capabilities or
have sought to partner with vendors to digitize their mortgage
process. Bank of America announced a new online Home Loan Navigator in
June 2016, a web-based portal designed to make the application process
easier and more transparent for consumers. JPMorgan Chase announced a
similar program this past February where it would partner with
Roostify, a fintech firm, to build a digital mortgage platform through
which customers can apply online and track applications by mobile

Over time, Fitch believes the larger budgets and IT resources of the
banks should provide a competitive advantage over non-bank mortgage
originators in the digital arena. In 2016, JPMorgan Chase invested
more than $9.5 billion (roughly 10 percent of 2016 revenue) in
technology, of which $3 billion went toward new projects. Of this
amount, $600 million went toward “emerging fintech” technology, which
includes building digital and mobile services and partnering with
fintech companies like Roostify. According to CEO Jamie Dimon, the
goal is to “benefit customers with better, faster, and often cheaper
products and services, to reduce errors, and to make the firm more

Larger banks are also expected to continue to benefit from their lower
cost of funds (relative to NBFIs) and scale, which help them maintain
competitive pricing, as rates should remain a significant factor when
consumers choose a mortgage provider. “Millennials are the most
rate-sensitive,” said Jonathan Smoke, chief economist of Realtor.com,
“in part because they haven’t hit their peak earning years.” A
first-time homebuyer getting a mortgage today may be a home-equity
customer 10 years down the line. Additionally, banks’ deposit accounts
and other financial product offerings naturally provide multiple
points of contact for the consumer, which make it easier to reach
potential customers to cross-sell and integrate mortgages with other
bank products. Consumers value the variety of different products and
the convenience bigger banks offer, which is a major reason why they
tend to remain at a given institution.

Millennials Go Mobile

While millennials are less loyal to their primary banks than other
consumers, according to FICO, they are also significantly more likely
to transact with their bank through mobile applications than other age
groups. Customers who are frequent users of their bank’s mobile
applications are more satisfied with their bank and will recommend
that bank to others—especially younger consumers who prefer the
largest banks because they think their technology is better, according
to Jim Miller of information services company J.D. Power. Customers
under the age of 40 give the bigger banks higher satisfaction marks
for things like mobile banking. Therefore, strong customer
satisfaction with a bank’s mobile application is likely to be another
competitive advantage in the digital mortgage race.

Getting Their Fair Share

The increasing digitization of the mortgage process has the potential
to significantly improve lender efficiency, reducing the time and cost
required for processing some types of applications, as well as
speeding up loan funding and delivery to the securitization market.
Currently, it costs $42 billion per year to process mortgages,
according to global information services provider Experian plc.
Recently, the company partnered with data aggregator Finicity in a
data-sharing agreement to automate the income and asset verification
process of a mortgage application, which could reduce costs for
lenders by up to 20 percent and loan approval times to as little as 10
days, according to Experian. For consumers, the data-sharing
arrangement also eases the burdens of completing paperwork. This setup
improves automation within a lender’s credit approval process by
connecting with its financial service providers, which could directly
benefit millennials, who want a mortgage application process that
feels more straightforward and is easier.

According to Experian and Finicity, the data-sharing partnership could
also improve credit availability to communities that remain
underserved because of an inability to prove income or assets to
lenders. “While these consumers may have a limited credit history,
most consumers have a checking and savings account, as well as other
payment obligations such as rent, utility, and phone bills, which can
demonstrate they are capable of repaying a loan.” Once online mortgage
lending becomes a significant portion of overall originations, lenders
will need to focus on underserved communities, including low- to
moderate-income consumers. Millennials’ socially conscious mindset may
be crucial to a lender’s innovation strategy, according to consultancy
firm SpencerHall. This cohort may seek lenders that act ethically and
have demonstrated fair lending practices.

Obstacles and Opportunities

While the digital mortgage has gained considerable traction with
mortgage lenders and consumers, the lack of readiness by key industry
participants (e.g., banks that provide financing to lenders; document
providers; custodians; title/settlement agents, etc.) and policy
alignment by the government sponsored enterprises (GSEs) represent
potential roadblocks to the full adoption of an end-to-end digital
mortgage, according to a joint survey by Fannie Mae and Freddie Mac.
Given the growing importance of this issue to market participants, the
GSEs expect to publish a follow-on report in the coming months to
identify ways to address barriers and provide a plan for GSE strategy
and policy alignment.

Additional challenges to successfully implementing digital mortgages
include fraud-risk, cyber-risks, and regulatory compliance concerns
regarding the extent to which digital automation can replace human
underwriting effectively. Violations of representations and warranties
and “safe harbor” issues could also be amplified with automation due
to the possibility of increased error rates, which means a lender may
have to repurchase a loan previously sold to investors, negatively
impacting its profitability.

Unlike banks, fintech firms, along with mortgage lenders and other
NBFIs, are not directly overseen by a federal regulatory agency.
However, they may be subject to certain federal regulations that fall
under the supervisory authority of the Consumer Financial Protection
Bureau (CFPB), Federal Trade Commission, Department of Justice, and
state regulators that enforce consumer protection laws. Regulators can
take enforcement actions against companies that they believe have
engaged in unfair, deceptive, or abusive acts or practices on the part
of consumers, as evidenced by CFPB actions in recent years against
banks and NBFIs engaged in mortgage activities. Fitch believes larger
banks and financial companies with greater compliance resources and
existing large IT teams should be in a better position to build an
appropriate compliance framework to ensure adherence with governing
laws and regulations, address quality control issues, and take
corrective actions as required.

Fitch believes continued progress toward full digitization of the
mortgage application process has the potential to drive significant
efficiencies, benefiting both mortgage companies and the end-consumer.
Potential margin compression resulting from the initial start-up or
infrastructure investment could be vastly outweighed by future scale
benefits. Mortgage originators that do not adjust to the changing
technological and consumer landscape could risk losing market share
and scale, which in turn could impact future profitability, thus
negatively impacting ratings, in Fitch’s view.

Johann Juan is Director of Financial Institutions at Fitch Ratings
where he serves as the primary analyst for Fitch-rated mortgage
companies and other non-bank financial institutions across various
sectors in North America including, captive finance companies,
aircraft leasing companies, commercial fleet leasing companies,
commercial finance companies, business development companies.

About Author: Nicole Casperson

Nicole Casperson is the Associate Editor of DS News and MReport. She graduated from Texas Tech University where she received her M.A. in Mass Communications and her B.A. in Journalism. Casperson previously worked as a graduate teaching instructor at Texas Tech's College of Media and Communications. To contact Casperson, e-mail: nicole.casperson@thefivestar.com.

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