Stemming Losses, Regaining Profitability.(Point of View)

Byline: Clayton Baker

Clayton Baker, an 18-year financial services veteran focusing on mortgages and consumer lending, leads consumer finance advisory services at Ernst & Young. The views expressed herein are those of the author and do not necessarily reflect the views of Ernst & Young.

What a difference three short years make. In 2005, mortgage originations were at historic highs, and the industry was riding the wave of increased volume. But today, lenders with significant mortgage lending activities are suffering. They are being squeezed by an almost unprecedented combination of internal and external forces impacting their operations.

As of late September, the FDIC had been called in as receiver or conservator for 13 U.S. commercial banks, compared with only four in 2007. In 2005 and 2006, there were no bank failures. Among the most vexing problems facing today's lending organizations are shrinking loan volumes, swelling credit losses, liquidity challenges and significant volume shifts from production to servicing and default operations.

To deal with this onslaught, many institutions with substantial mortgage lending operations need to rewrite their playbooks. While lenders must continue to vigilantly - and profitably - originate new loans, they must also focus on multifaceted approaches for safeguarding and managing held assets while minimizing losses.

For mortgage lenders and other market entrants such as private equity firms, reducing losses requires them to deal effectively with nonperforming loans. In the second quarter, according to TransUnion, national mortgage delinquency rates hit 3.53 million, an increase of nearly 51% over 2007. An additional 3 million borrowers could face trouble by the end of 2009, experts estimate. Mortgage servicers must restructure these problem loans and find creative workout options to stave off more foreclosures. And they are in dire need of new strategies and tools to do so: creative ways to modify the loans to mitigate losses, proactive approaches to handle loans on the verge of defaulting, and better analytical tools to pinpoint and prioritize borrowers more likely to become delinquent.

Meanwhile, market shifts have compelled banks to alter their products and distribution models. Many institutions are curtailing third party-originated loans and emphasizing retail production. Certain secondary markets - such as those for subprime and alt-A loans - have dried up, forcing many lenders to focus on originating conforming conventional and government loans. At the end of 2007, Fannie Mae and Freddie Mac owned or guaranteed $4.9 trillion worth of mortgages. As of September 2008, that figure had risen to $5.4 trillion.