Mortgage banking production profits fell to negative $50 per loan in 2006 from positive $258 per loan in 2005, according to the Mortgage Bankers Association's (MBA) annual cost study.

While production revenues increased on a per-loan basis, this increase did not keep pace with the increase in production operating expenses which grew by 17 percent to $3,416 per loan in 2006, Douglas Duncan, the group’s chief economist, said.

"Production profits began to slip in 2004, and we see a continuation of this trend in 2006," said Marina Walsh, a senior director in MBA's research and economics department. "Despite some companies' best efforts to boost production revenues through the origination of higher-yielding mortgage products, several factors worked against the industry as a whole -- the negative yield curve which increased the cost of funds, lower sales productivity and higher per-loan sales and fulfillment costs, particularly personnel-related costs.

“Servicing profits in 2006 partially offset production losses, but even these profits declined from 2005 levels due to mortgage servicing hedge losses," Walsh said.

The 189 mortgage banking companies in the sample originated an estimated 54 percent of total residential industry volume in 2006 and serviced an estimated 48 percent of home mortgage debt outstanding.

Mortgage companies that were affiliated with banks benefited from favorable short-term borrowing rates and fared the best in terms of net interest spread. On the other hand, privately held companies tended to earn less spread with higher borrowing costs and fewer days in the warehouse.

Net servicing financial income averaged $58 per loan in 2006, from $104 per loan in 2005. Compared with the losses reported in 2001–2003, this performance was strong, albeit only about half the 2005 per-loan profit, MBA officials said.

Total residential mortgage industry origination volume decreased by 7 percent in 2006, driven by lower purchase and refinance originations. Annual purchase originations dropped in 2006 for the first time since 1995, declining to $1,459 billion in 2006 from $1,512 billion in 2005.

Refinancings continued to drop to $1,357 billion from $1,514 billion in 2005. While refinancings accounted for 66 percent of total originations in 2003 and 53 percent of total originations in 2004, the refinancing share was only 48 percent in 2006. Adjustable rate mortgages continued to decline as a percentage of total originations. ARMs comprised 22 percent of originations in 2006 from 30 percent of originations in 2005.

Housing activity showed signs of weakening in 2006. Based on units, existing home sales declined 8.5 percent in 2006, the first decline since 1995. New home sales declined by 18 percent, the first decline since 1999, according to the MBA.

Employment continued to increase in the mortgage banking industry, albeit at a slower pace than previous years. Average U.S. mortgage industry employment rose 2.3 percent to over 500,000 employees in 2006, according to the Bureau of Labor Statistics.

Excluding loan servicing operations, the three major components of mortgage operations are: loan production operations; warehousing; and secondary marketing (including capitalized servicing and servicing released premiums). Combining all of the revenues and expenses of these components provides a better understanding of the “all in” profit to a mortgage company for originating a loan, said Duncan.

Concurrent with the increased cost of originating a loan, sales productivity declined in 2006. In the retail production channel, for example, the number of loans closed per loan officer dropped by 25 percent in 2006 to 62 loans per year, or about five loans per month.

Overall, the average firm posted pre-tax net financial income of $6.4 million in 2006 compared to $26 million in 2005. For repeater companies only, there was a similar outcome. Pre-tax net financial income was $5.9 million in 2006 compared to $30.9 million in 2005.

On a per-loan basis, the net “cost to originate” was $2,476 in 2006, compared with $2,049 in 2005. Retail sales productivity averaged 62 loans per loan officer in 2006, compared to 83 loans per loan officer in 2005.

Net warehousing income, which represents the net interest spread between the mortgage rate on a loan and the interest rate paid on a warehouse line of credit, dropped to $245 per loan, from $294 per loan in 2005 and $481 per loan in 2004 -- the result of a flat yield curve.

Net marketing income, which includes the gain or loss on the sale of loans in the secondary market, pricing subsidies and overages, as well as capitalized servicing and servicing released premiums, averaged $2,180 per loan in 2006.

Servicing financial profits per loan serviced declined by 44 percent primarily because of mortgage servicing right hedging losses that were only partially offset by gains in servicing valuations. Per-loan financial profits averaged $58 per loan in 2006, from $104 per loan in 2005.

The largest servicers outperformed their smaller peers operationally, with the lowest cost to service and the highest direct servicing net income. However, these servicers also had the highest hedging losses which hurt their financial bottom line, the MBA reported.