On
Saturday mornings I like to catch up on the mortgage industry and assess what paths the
various participants are following. Why? I have a
passion for business case studies, predicting outcomes, and finding the solutions
needed to create sustainable growth and profitable enterprises.
The
mortgage industry has been a fascination for me for over 25 years and the
ability to survive and prosper in a regulated and sometimes interesting
competitive response environment has stimulated my academic and athletic
senses.
I think we are at an inflection point and employees in this industry should assess their career plan and ensure their pilot has made it through a few recessions. Recessions cleanse weak business plans and reward those that are positioned properly. This is why you need to understand what type of company you work for.
Digging into the quantitative side of a company is more productive than the informal qualitative input generally delivered from biased sources. I think people spend more time researching the purchase of a new car than researching the company they intend to work for that will support their family. Mortgage Companies can differ as much as a SMART CAR compared to FORD F350 Truck. Automobile such as Mortgage Company have a wide range in definition.
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| Smart Car |
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| Ford F350 Truck |
Just because they are technically automobiles we all know how different they can be. Its the same issue with Mortgage Companies, many people think they are all the same; however, they are extremely different if you know what to look for. I am going to try to point out what the primary differences are.
In
the mortgage industry, you have three types of strategy and three types of
organizational structures for Non-Bank Mortgage Originating Companies. I have seen the
same participants pre-recession three times with only one category of type and
structure making it through all recessions assuming they respected Sustainable
Growth Rates (SGR). As a reminder I attached a link to the implode list. Note how many imploded in a short period
after the recession was confirmed. http://ml-implode.com/fulllist.html#lists Some of you may have worked for a few of these. Hopefully, this blog will help you find a safe path through the next recession.
- Momentum Players - These are the newly formed (less
than 10 years) after a recession that grow rapidly with
claims of unlocking the largest family reunion ever with no
growing pains. They tend to grow rapidly (Pump and Dump) focusing on paths
that create an exit strategy for the few founders (Sale, Public Stock
Offering, Etc.)
- Works fine as long as the economy is growing. If the economy turns down owners of an LLC have to use their
own money to save others. Owner self-preservation ensures the company goes
under and employees move on. Many momentum players are LLCs. LLCs collapsed fast
in the 2008-2009 downturn.
- Sustainable growth
falls apart due to production at any loss mentality. They focus on
national production comparisons rather than what if something slows?
- Regional Legacy Lenders - These are the vertically
integrated no debt / low debt mortgage originators that are long term players. They follow basic sustainable business practices that are grounded in solid Sales/Production theory and have a diverse client base
without concentrations.
- No debt and Shareholder
Cash on balance sheet is the bedrock that employees future and foundation is built on. If
economy turns, all shareholders are willing to use company cash to survive
and take advantage of LLCs going out of business.
- They manage Sustainable
Growth and monitor financial health of the company rather than focus on volume
comparisons
- Mom & Pop - These are the brokers that lease their
funding, production, facility etc. Primarily a middle man/woman that have tight margins. These are the people who want to have freedom to do what
they want with no responsibility if things go south. During 1997 - 2007, this was
the largest sector in Non-Bank originators. Once the regulations
monitored them with their tight margins and practices most closed down. Very few
exist today and generally 1-5 people shops.
- In a downturn, brokers
simply work in other industries until the market is good again.
- No regard for
Sustainable Growth, does not apply
In
the three types above, you will find one of three types of organizational
structure below. Each have their own relevance to employees who work for them. Every
employee should know what type of company they work for.
LLC - (Limited Liability Corporation) this structure is easy to form and is
governed by an operating agreement that consists of a few members that
draw up how they split up the proceeds of the company. There is no
employee equity and the company only has a finite life. If a member dies
or is purchased the LLC in its current form dies. The Members tend to diversify into other ventures such as Banks, Fast Food "Zaxbys" etc., just in case their mortgage operation fails or has to dissolve. Mortgage employees want their owners to focus on their livelihood and what pays their checks not a back up plan that they are not a part of.
Common Stock Corporation - this is a company owned by
the shareholders and has perpetual life. This is what is traded on stock exchanges and your 401K and mutual funds are primarily invested in. Employees can own this type of company and benefit from the growth they
create. Employee / Shareholders can ensure their leadership only focuses on their company.
Sole Proprietor - These are rare and unless you are a kamikaze, not a good idea. Owner has unlimited liability and does not share
anything with employees.
100%
Our Industry is made up of the above three types and the above three organizational structures. You pick the combination and it exists.
For
those that have studied Finance, Accounting, Production Management,
Organizational Management, and Psychology;
the issues with each will pop out. Based on the above disciplines and business
theory, the probable winning combination for the MLO and Employee is the Common Stock Corporation during
a recovery or recession.
Companies
that operate as a Common Stock Corporation with no debt, diverse client base,
diverse geographic area, focusing on client need, Great Service, and
sustainable fair pricing will prevail in recessions and recoveries. They may not
be on TV as much, build cities, or venture outside their core business, but,
they can provide an equitable rewarding career for the 98% of the employees
that do the work day in and day out.
The primary factor that takes out the volume at any cost Momentum Players is ignoring sustainable growth rates which ultimately strips cash from the balance sheet. As a result, LLC structures secure what they can and shut down. 2 + 2 has to equal 4 and those pricing like 2 + 2 = 10 will eventually pay the difference from their cash or liquidated assets. We all sell the same commodity.
The
sustainable growth rate (SGR) is the maximum growth rate a company can achieve
consistent with the firm`s established growth plan and financial policy.
Basically, it is calculated as:
SGR
= (pm*(1-d)*(1+L)) / (T-(pm*(1-d)*(1+L)))
▪
pm is existing profit margin ▪ d is the owner payout ratio ▪ L is total debt to
equity ratio ▪ T is ratio of total assets to sales
Size is not a Safe Haven when it comes to Sustainable Growth. SGR efficiently ends big or small companies when not managed. In
order to grow faster, a company has to invest more Equity / Partner
capital, increase its financial leverage, or increase the target profit margin. Higher margins sustain steeper growth rates. The key is to know when you cross the point of diminishing returns. This is what many current articles in mortgage publications are referencing when the talk about tighter margins per deal and reduced profitability. This is the "Be Ready" in the title.
SGR can remain in check if the company's business plans is prudent. Although more sales are good,
you have to ensure you do not grow beyond your base or strip your balance sheet.
At
the end of the day, doing the right thing for your family, clients, partners,
and your employees is the measure of your impact on this world.
I hope everyone
looks under the hood before buying the next shiny new car or company. Be sure it can get
you further than a few blocks before you need another new car.
