Choices, Choices...

By Bill Stoneman

Online loan aggregators could provoke revolutionary change in the mortgage origination market. Will customers get on board?

In a radio advertisement for E-Loan Inc., a mortgage broker tries to convince a prospective borrower that he's beating the bushes for the best home loan around, but after some cajoling concedes that he's called only three banks.

The customer, who turns out to be the broker's mother, stalks out as an announcer recommends trying E-Loan the next time. "We scour the planet to find you a great rate," the voice intones.

That in a nutshell is the consumer value proposition offered by online aggregators, which post on their Web sites a selection of loan rates from various providers. The aggregators, whose product offerings now encompass mortgages, home equity lines and auto loans, promise consumers a better deal than any one institution could offer. They also sell convenience by enabling customers to avoid the hassle of comparison-shopping on their own.

For lenders, the pitch is: you'll get a stream of business that doesn't depend on high-priced sales representatives or independent brokers. In theory everyone wins, except perhaps mortgage brokers, mostly local mom-and-pop businesses that now originate an estimated 60% of home mortgages.

Between the promise and the reality of aggregator lending, however, yawns a sizeable gap. For one thing, it isn't clear that aggregators give consumers a better deal. After all, they're not really scouring the planet for great rates; they're polling a finite list of lenders that have agreed to pay them referral fees. Lenders, in turn, run the risk of commoditizing their products and further squeezing margins. It also remains to be seen whether aggregators can make money. Those that disclose financial results are posting heavy losses, largely provoked by high marketing expenses. For example, E-Loan and Charlotte, N.C.-based LendingTree Inc. together are poised to spend about $50 million on advertising this year.

Profitable or not, online loan aggregators present traditional lenders with a challenge they cannot afford to ignore. Online lending will account for nearly 10% of mortgage originations by 2003, up from about 1.5% in 1999, according to Forrester Research Inc., Cambridge, Mass.

The first decision strategists face is whether or not to participate in multi-lender sites. That depends partly on whether, given different business models, they believe aggregators can cut loan origination costs. Individual institutions also must weigh the risk that their brand will be subsumed within the host's Web site.

Most of all, players will have to gauge overall consumer response to multi-lender sites. "At the end of the day, the question is: what does the customer want?" says William J. Jucha, senior vice president for retail production with First Nationwide Mortgage Corp., Frederick, Md. A unit of Golden State Bancorp's California Federal Bank, First Nationwide hasn't yet joined any multi-lender sites. But Jucha says it probably would if such sites really catch on with the public.

Even if consumer adoption is lackluster, the emergence of multi-lender sites will still pit lender against lender, intensifying price competition. Consumers are likely to use the Internet for rate-shopping as never before. That will increase the already-considerable pressure on margins, forcing mortgage lenders to redouble efforts to wring out inefficiencies. "You're going to see fewer and fewer players investing more and more in technology trying to outdo one another in lowering unit costs," says Daniel T. Schauble, executive vice president and chief information officer of Homeside Lending, Jacksonville, Fla.

Comparison Shopping

Although online aggregators widely differ from one another, they generally fall into two basic categories. Originators, such as E-Loan and Intuit Inc.'s Quickenloans.com, operate much the same as off-line mortgage brokers and mortgage banks. They accept, process and underwrite loan applications. Pricing is based on a mark-up of rates and points quoted by lenders' wholesale and conduit departments.

By contrast, referral sites, which include LendingTree and Providian Financial Corp.'s GetSmart.com, pass along leads to retail lenders, who then handle the application and underwriting process. GetSmart collects fees strictly for its leads; LendingTree assesses "a few dollars" for each referral and "several hundred dollars" when a loan closes.

So far, neither business model is remotely profitable. E-Loan lost $40 million last year; LendingTree, $25 million. E-Loan has been burning through its cash so fast that it recently had to secure $40 million in new funding from a consortium of investors that included Charles Schwab & Co.

From the consumer perspective, originators and referral sites both offer the same kind of deal. At least in theory, borrowers get a wider selection of lenders and the pick of favorable rates and fees. They can track the status of their application online and, in most cases, talk with a loan consultant by phone. As with all things Internet, customers can also do business at any hour of the day or night.

Lenders, meanwhile, are enticed by the idea that they'll be able to trim origination costs, mostly by cutting well-paid sales people out of many transactions. But guess who replaces the mortgage brokers? It's the aggregators, of course. For that reason, online aggregation threatens mortgage brokers more than lenders.

Mortgage brokers grabbed 60% of the origination business over the past 25 years by promising consumers that they'll help them find the best deal and, perhaps more importantly, help walk them through the complicated process of closing a mortgage. Most are small businesses operating within a confined geographic area. With mortgage originations totaling more than $1 trillion a year, broker or loan agent commissions of more than $5 billion may be at stake.

Regardless of whom it hurts the most, online aggregation is becoming a significant force. Launched in 1997, E-Loan is one of the oldest and most prominent aggregators. About two-thirds of its revenue stems from the mortgage business, 30% from auto lending and the remainder from other consumer and small business lending. Though it boasts of representing more than 70 lenders, borrowers don't actually get to compare loan offerings side by side. E-Loan does that job based on a questionnaire that borrowers complete. Then, nine times out of 10, the automated comparison comes up with an E-Loan brand loan, which the company funds from warehouse lines of credit like any other mortgage bank.

Joseph Kennedy, president and chief operating officer, describes this process as "comparison shopping." But rather than letting customers compare offers from various retail lending departments, E-Loan acts on customers' behalf to sift through terms from more than two dozen conduit departments, which buy closed mortgage loans. Though wholesale and conduit lenders don't earn the origination fees that their retail department counterparts do, they still make money by servicing loans after selling them to investors.

Lender Qualms

In terms of shopping convenience, the online model seems quite advantageous to the customer. Online databases make the Web an excellent tool for comparison-shopping, which is crucial but laborious in the off-line mortgage world. Legions of borrowers discover each week that either they don't qualify for a vendor's listed rate or that the rate changed before they even called the lender. That makes shopping outside of normal business hours and traditional channels all the more appealing. In addition, the Web offers an efficient means of capturing and storing consumer information, often eliminating the need to key in personal data again and again.

Early last year, Forrester Research projected that online mortgage originations, including those at single- and multi-lender Web sites, would grow from an estimated $18.7 billion in 1999 to over $91.2 billion in 2003, representing an increase in the online portion of market share from 1.5% to 9.6%. "I would be surprised if the multi-lender sites don't have a majority of that business," says E-Loan's Kennedy.

But shopping convenience is not the only factor in consumer acceptance. Owing to the complexities of the mortgage business, some experts say, most consumers will want to work with a live representative who can explain options and escort them through the gauntlet of documentation, appraisal, title and other requirements. From that perspective, Forrester's projections "are all wet," contends Tom LaMalfa, a managing director of Wholesale Access, a Columbia, Md.-based mortgage industry research company. "I don't think it's going to be a fraction of that amount."

In LaMalfa's view, consumers want a broker or a loan agent to help them decide which product suits their needs. And for all the potential benefits of comparing mortgage offers online, the fact remains that most consumers, especially first-time home buyers, are happy to take financing advice from real estate agents, who typically recommend local banks or mortgage brokers.

Security issues also remain a big concern, according to Richard Beidl, an analyst with TowerGroup, a financial services technology research company based in Needham, Mass. "It's one thing to submit a credit card number online to buy a product. It's quite another thing to put your entire personal dossier online and hope that no one intercepts it, particularly if you're not familiar with the lender."

These kinds of concerns leave lenders in a quandary. On the one hand, some of the nation's largest mortgage lenders have signed up with aggregators. Chase Manhattan Corp., for example, is working with E-Loan, LendingTree, Quickenloans and Microsoft Corp.'s Homeadvisor.com. On the other hand, many players remain noncommittal, including First Nationwide Mortgage and National City Mortgage. The holdouts are reluctant to pay for third-party leads, uncertain about the quality of service customers will receive from third parties and dubious about the supposed cost savings.

PNC Mortgage Corp., a unit of the Pittsburgh-based bank, is in the process of signing up with LendingTree, which tells consumers that it will provide them with up to four lenders for comparison-shopping. LendingTree matches customer- supplied information with criteria provided by the lenders. But it remains to be seen whether PNC's reps will be able to serve the LendingTree referrals any more expeditiously than their regular customers, says Richard Lovett, an executive vice president with PNC Mortgage.

Nor is it clear that aggregators are marketing originators' loans any more efficiently than the originators themselves, says Wayne H. Natalie, a vice president with National City Mortgage, a unit of Cleveland-based National City Corp. Both originator-affiliated retail outlets and online aggregators access wholesale credit at the same price, so you would expect to see the online players posting less of a retail markup if they really are more efficient. But that's not happening, Natalie says, and the lack of a price advantage weakens the appeal of the online channel to the consumer.

Still, those qualms ultimately don't matter if ambitious projections by Forrester and other analysts are on the mark, as lenders generally recognize. Just as wholesale and conduit departments were established in response to the emergence of mortgage brokers and mortgage banks in the mid-1970s, major lenders will gear up to sell loans through online aggregators if they must. "The consumer will drive this, without question," says National City's Natalie.

Share Battle

Few observers expect all of today's online players to survive. Those that do will probably make plenty of sharp strategic turns in search of consumer acceptance and profitability. "The online mortgage market is similar to other e-commerce sites right now in that it's a share battle," says Carl Reese, a vice president of Quickloans.com.

Indicative of the struggle to find a workable approach, Quickenloans switched last fall from a referral model to an originator model. Simultaneously, it acquired Rock Financial Corp., a Detroit-based mortgage banking company that itself was migrating from retail branches to the Internet. Meanwhile, mortgage.com and FiNet.com have entirely abandoned direct consumer marketing, citing heavy expenses and disappointing volume. Their new focus is business-to-business strategy.

Whether large numbers of consumers eventually apply for loans online with aggregators such as E-Loan, Iown.com, Homeadvisor.com or Keystroke.com, may not be so important as whether the Internet influences their search for a loan. By all accounts, the Web will be a starting point and an educational tool for vast numbers of consumers in search of a mortgage – and probably other types of loans.

Consumers will compare by visiting individual lender sites; by filling out profiles at aggregator sites; or by checking with sites that merely list rates, such as Bank Rate Monitor's bankrate.com. Even then they might still complete an application at the lender's local office. The bottom line: mortgage price competition will only intensify, even if individual aggregators don't prosper.

The biggest impact of multi-lender Web sites, therefore, might be to accelerate the major mortgage industry trends of the last two decades: commoditization and margin compression. In that case, strategists will need to focus less on the aggregator threat than on automating their manual operations to cut costs; building online tools to enhance communications with traditional brokers; and learning about the Internet in general.

One way or another, lenders will have to learn how to serve the segment of consumers who want to do business on the Internet. E-Loan's Kennedy, for example, advises lenders to speed up the underwriting process by reducing documentation required from borrowers who possess sterling credit and make large down payments. "That's what the Internet-Age customer is looking for," he says.

Mr. Stoneman is a freelance writer based in Albany, N.Y.

Copyright © 2003 by Banking Strategies, published by BAI.

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