We’re doing CFO search for one of our mortgage banking clients and have interviewed several candidates over the past week.  In addition to the obvious questions asked during an interview, we try to find out if candidates have the tenacity to debate CEOs on the importance of Return on Capital. 

Many mortgage banking CEOs are past production people that believe a company’s success is based on growing production.  Production is part of the equation, but Return on Capital is the end game. 

Let me elaborate on this.

Let’s assume a mortgage bank has $2M in capital, originates FHA and GSE loans through a retail channel and has a $20M warehouse line of credit.  Based on a leverage ratio of 10:1 and the ability to turn the warehouse line 2 times a month, the company can fund a maximum of $40M per month.  

Currently the Company is originating 80% GSE and 20% FHA loans with gain-on-sale being 60 basis points and 100 basis points respectively.  Commissions for loan officers are an average of 60% for both loan products. 

You probably know where I’m going with this.  Based on the above assumptions, the strategy should be to originate more FHA loans because the margins are better.  Let’s switch the percentage to 20% GSE and 80% FHA and compare the financial results.

The results speak for themselves. 

The company can make much more money and get a better return on capital if it develops a strategy to originate more FHA loans.  In order to generate a better return on capital regardless of the product mix, management may increase GOS margins on GSE loans or reduce commissions on GSE loans. 

The end game is to maximize the return on capital.