As the first quarter unfolded, macroeconomic risks created strong headwinds for mortgage companies. The greatest concern is quickly rising mortgage rates, resulting in overall margin compression and essentially a nonexistent market for refinances. Fannie Mae forecasted in early March that mortgage rates would approximate between 3.7% and 3.9% this year, but by April 7, the national average for a 30-year mortgage had already reached 4.72%.
The current volatility, combined with the likelihood of additional rate hikes on the horizon, has caused originators to focus on the purchase market as well as non-agency loan products like non-QM. Adaptability will be critical to navigating the rapidly changing market but it’s just as important to have a comprehensive understanding of your business’ KPIs.
Amid this challenging environment, mortgage companies must focus on their financial health, efficiency and effectiveness. One way to gain and maintain that knowledge is by utilizing key performance indicators, which allow a company to holistically assess critical components through relevant metrics. A few financial-related KPIs to consider include:
- KPI – Realized revenue vs. cash realized revenue: It’s critical to understand how much revenue your company is generating, as well as the ratio of cash to non-cash. For example, if a mortgage company sells a loan to an agency but retains the servicing rights, those rights are non-cash so you could end up short on liquidity. Especially in times like these, liquidity is pivotal to keeping your business going. So it’s important to know how much you make on a loan not only in terms of margins, but also the actual revenue realized versus the cash revenue because capital must be deployed to finance that spread. Startups sometimes refer to “cash burn” when conveying how cash is used, and it’s important for mortgage companies to understand cash usage as well.
- KPI – Cost to originate a loan: In the manufacturing industry, it’s common to analyze standard costs. This entails figuratively breaking a product apart into all the raw materials and labor required to create it. I believe most mortgage companies try to know their cost to produce a loan, but many don’t segment it enough to truly understand the relative cost of each function. Input costs can vary but typically include credit reports, tax verifications, flood certifications, closed-loan fees, labor costs, commissions, etc. Additionally, each function in mortgage operations is a specific labor component. To the extent that you know the percentage of those costs applied to a loan, you can determine where greater efficiency is needed. For example, consider a comparison of labor costs per loan vs. closed loans per full-time equivalent.
- KPI -Cycle times (from application to lock, lock to fund, and fund to sale): Along with calculating the cost to produce, it’s important to understand the efficiency cycle. The cycle of a loan initially goes from application to lock (interest rate lock). Through operational processes, it is then funded and eventually sold. Understanding conversion rates and cycle times can help identify leakage and drive efficiency. Whenever an employee touches a file or application, it represents a labor cost. The less time people need to spend on loans that don’t make it through the system, the more efficient your process. You also want to determine how fast your company can go from a lock to funding that loan. As the overall market contracts for mortgages and moves to primarily a purchase business, borrowers have a tight timeline to close loans. The more you understand each component along the way and how rapidly it can be completed, the better you can streamline to drive greater efficiency and customer service.
Driven by data
In addition to KPIs, there should be a healthy focus on financial metrics such as debt to equity, tangible net worth, liquidity ratios, etc. It’s also important to always know how your company is generating return on equity and which levers you can pull to increase profitability. To this end, conducting a DuPont Analysis could prove helpful.
At any point in time, regardless of business cycle, you should have a good handle on your company and how it’s performing. Building and consistently measuring applicable KPIs will enable you to keep a pulse on the business and ensure you can effectively adjust to changing conditions. Data is what fundamentally supports all KPIs. Accordingly, data integrity and quality are critical for generating reliable and accurate KPIs to help manage your business and improve adaptability in uncertain times.
Ravi Correa is the CFO of Angel Oak Lending.
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