America's biggest banks are offloading parts of their home loan businesses to machine-powered startups, as they try and fend off sagging profits

Alex Morrell

Apr 26, 2019, 20:39 IST

America's biggest banks are offloading parts of their home loan businesses to machine-powered startups, as they try and fend off sagging profits

Thomas H. Mitchell/Getty Images

Amid mounting industry pressures, America's banks are delegating home lending to the machines.

Amid mounting industry pressures, banks are increasingly outsourcing home lending to the machines.
In recent years giants like Wells Fargo and JPMorgan Chase have handed off key components of their mortgage businesses to scrappy tech start-ups armed with data and machine-learning capabilities.
Last week, online-only Ally Bank became the latest entry in this chapter, announcing it was outsourcing most of its mortgage operation to Better.com.
With competition intensifying and margins thinning, a top-flight digital-mortgage offering is becoming a standard requirement, and banks without one risk falling behind and ceding market share.
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The business of buying a home has long been the dominion of banks, requiring time and human interaction. But amid mounting industry pressures, home lending is being delegated to the machines.

In recent years, banks have been handing off key components of their mortgage businesses to scrappy tech start-ups armed with data and algorithms, betting they'll be able to trim costs or sharpen a competitive edge in an industry reckoning with heightened competition, regulatory headaches, and thinning margins.

Wells Fargo has turned to Blend, a startup offering lenders a platform fortified by machine learning that automates and streamlines home loans into a smartphone friendly setup. JPMorgan Chase last year enlisted Roostify, a Blend competitor, to build a "digital, self-service mortgage platform," as did TD Bank.

"Machine learning" and "automation" have become gimmicky buzzwords in some corners, but in home lending it's fast becoming a basic competitive requirement. Banks without a top-flight digital mortgage offering risk falling behind and ceding market share.

And it's not just branch-heavy behemoths turning to fintechs for help - even seemingly more nimble online banks are outsourcing their mortgage operations.

Last week, digital-only Ally Bank became the latest entry in this chapter, announcing during its quarterly earnings call a partnership with Better.com, a start-up formerly known as Better Mortgage.

Better is carving out turf in the same field as Blend and Roostify, offering a streamlined mortgage experience, including preapproval for a home loan in minutes through its website. But up until this point it has offered its services directly to consumers, rather than selling its tools to banks.

Come June, Better will start taking over Ally's mortgage operation. The start-up will carry the process end-to-end, originating, approving, underwriting, and closing on mortgages. The loans will be issued in Ally's name, and the bank will retain some on its balance sheet and others will be sold into the marketplace.

Better

Vishal Garg, founder and CEO of Better.com.

In other words, even one of the largest and highest-rated online banks in the US is offloading most of its mortgage business to an upstart with more digital sophistication in an effort to gain ground in the challenging home-lending market.

The mortgage business has become a slog

It's no secret the mortgage business has become a slog for the big banks: Industry giants posted hefty declines in mortgage revenues and originations in 2018, and the first quarter of 2019 provided no respite.

At Wells Fargo, the largest home lender, originations fell 23% and mortgage income declined 24% to $708 million compared with the first quarter of 2018. JPMorgan Chase, the next largest bank lender, saw originations fall 18% in the first quarter while income and fees dropped 15% to $396 million.

The sources of sagging profits are manifold - intense competition from nonbank lenders, more rules and scrutiny from regulatory authorities, increased costs, and weaker consumer appetite.

In his annual letter to shareholders, JPMorgan CEO Jamie Dimon groused about the mortgage business, noting that "banks are under constant pressure" to make home loans, and that they take the heat and scrutiny when something goes awry, even when their underwriting passes muster.

"We are intensely reviewing our role in originating, servicing and holding mortgages. The odds are increasing that we will need to materially change our mortgage strategy going forward," Dimon wrote in the letter, adding that regulatory requirements have made owning mortgages "hugely unprofitable" for banks.

Dimon's pain has been Better's gain, as fintechs and other industry challengers have seized on the opening.

"A lot of the banks have been getting out of the mortgage industry, and that's great," Better founder and CEO Vishal Garg said on a panel at a consumer finance conference in March.

But most major banks haven't completely capitulated, but rather they've teamed up with a digital provider to gain an edge.

Or, like Bank of America, which anticipates 50% of its mortgage applications will be digital in 2019, they've built a competitive offering in house.

Ally's situation is a little different than giants like Wells, JPMorgan, and Bank of America, as it's still a comparatively small player challenging for a bigger piece of the pie.

But they face the same headwinds and stiff competition as their brick-and-mortar peers, many of which, perhaps ironically, now have digital mortgage offerings more sophisticated than their own.

The firm - formerly the finance arm of General Motors until a post-crisis overhaul and rebrand - reentered the home-lending business in 2016 after largely retreating from mortgages in 2012. At $186 million in revenues, 3% of the firm's total, the mortgage division is a small but growing business at Ally, which has $180 billion in assets.

Currently, applying through their digital mortgage process involves filling out a form on the Ally website or app and waiting for a call from a company representative, who then manually enters in more info into the system to complete the application. Compared with machine-learning powered approaches that trim preapproval down to mere minutes entirely online, the application process isn't much more advanced than driving over to your local bank branch.

Other parts of the loan process are outsourced to a separate company called LenderLive.

But after Better takes over in June, prospective homebuyers will apply and move through the process on a site with an Ally-branded body and the start-up's powerful engine on the inside.

Better will start by handling Ally's mortgage business in nine states, roughly 20% of its flow, and aims to ramp up to 100% by the end of the year.

As part of the deal, the bank is also upping its investment in Better to $20 million, according to multiple sources familiar with the deal, which values the start-up at $550 million.

Ally believes its partnership with Better will put the digital bank back on the cutting edge.

The new experience "will be truly a differentiating factor," Ally CFO Jennifer LaClair said in the earnings call, adding that she expects it will also help the bank shed costs and become more efficient.

Given the direction the mortgage industry is moving, this type of digital lending capability may soon become status quo rather than a differentiator. But banks without it may quickly find themselves surrendering a business that they dominated for decades.