BLOG VIEW: Everyone knows the numbers are important, but which numbers really matter, especially to the people making the decisions? For mortgage bankers, the timing is as crucial as the numbers themselves. After the reports are complete, it is time to be realistic about what they say and what can be expected in the future. What follows are the activities and reports that successful executives employ:
Not An Open Book
Closing the books timely takes discipline, the ability to estimate accurately and flexibility. On a cash basis, a company should be able to close the books by the second business day of the month because everything that is to be recorded had cash tied to it. For everyone else, closing should be no later than the 15th calendar day of the month.
Without the books being closed, no dependable report can be published. Without meaningful financial reporting, no decisions can be made, no adjustments can be implemented and more importantly, you cannot calculate how many linear feet of boat you can afford! (More than 26 feet and it is a yacht.)
A well-run accounting department has a complete checklist of accounting issues that should be addressed each month, from calculating loan loss reserves to preparing the hedge accounting transactions to accruing operating expenses. The people in this department should know what transactions have been entered, what supporting documentation is coming and what documentation they will not have in hand by the time financials are due. Great mortgage banking accountants can virtually complete their month-end closing in their sleep. It sometimes takes a demanding executive to raise the urgency of getting financials completed accurately and on time, knowing those reports are critical for managing the company.
After the books are closed, it is time to review the company's performance. Financial reports should be available within two business days after the books are closed. The basic reports are the balance sheet, the profit and loss statement and the cash flow statement. If you have the tendency to look at the bottom line income, the net worth and the change in cash for the period and gloss over the rest, it is time to take a closer look.
Take the time to review financials alone before discussing them with others. Print the reports and make notations so that you can draw your own conclusions without the help of others. This is also a great time to write down the things you really do not understand so that you can make it a point to clear any confusion when you meet with others. In particular, take note of the following:
For comparison, ask for a balance sheet that has the previous month's balance sheet next to the current balance sheet with third and fourth columns showing the change in dollars and percent. Look through the change columns and circle any account that went to or from zero or moved by more than what appears to be a reasonable percentage. Review the loan loss reserve as a percentage of the loan portfolio to identify significant changes. Highlight any account that shows a negative sign or brackets – these are not typical and require an explanation.
Profit And Loss Statements
Again, for comparison, ask for a profit and loss (P&L) statement that has the previous month's P&L with added columns showing the change in dollars and percent. In addition, ask that the volume in units and dollars be included. Ask that all accounts be shown in basis points against production and dollars per loan. A second P&L should be produced that looks like the first, but instead of the prior month, it should be compared to the budget or most recent forecast and variances should be explained in one sentence comments next to the specific lines. Compare the comments you were given from last month's comparison to ensure consistency.
Given the fluctuations in the income statement prepared in conformity with GAAP, consider developing an operational income statement that eliminates the deferrals of revenue and expense required by GAAP to better understand company performance based on loan production each month. Over a six- to 12-month period, the GAAP and operational income statements should be similar, but the operational statements remove the monthly fluctuations caused by the GAAP deferrals.
Cash Flow Statement
There are three sections: operations, financing and investing. You have already looked at the bottom line of the cash flow statement so you know if cash is going up or down. The majority of the report for a mortgage banker is in the operating activities section. Pay attention to receivables and the payables, and compare them to last month. You can also tell if your profits are paper profits or cash profits by comparing the increase in cash with net income. When considering equity draws or dividends you hope to make, it is a good idea to perform a thorough analysis of your cash flow statement and cashflow projections prior to taking cash out of the company.
Chances are that your accounting system will spit out the reports listed above without much effort on the part of you or your staff. The reports above are all that is really needed to determine the financial health of the company, but they lack the information needed to manage the company.
Here is a list of the additional reports you should be reviewing every month as a part of the financial package that you require:
This report should show the cost of warehouse, utilization and dwell time averages, minimums and maximums for the month with comparisons for the last three months. The report should show all the applicable warehouse covenants and thresholds next to the actuals from your company that are calculated the same as the warehouse bank calculates them. A weighted average note rate and a weighted average cost of funds rate should be shown along with the net cost or revenue associated with loan interest income and expense.
Loans Per Full-Time Equivalent Report
This should show the efficiency of your staff. The break out should be monthly and compared to previous months to note trends. Your human resources department needs to provide gross wages paid for the departments listed. Overtime hours need to be counted fractionally for headcount. The categories or departments you use should have three or more people in them – any less will be of little value.
Revenue Analysis Report
This report should show the revenue generated directly by the sales force (points and fees), the margin allocated to the corporate office and the secondary marketing income. Depending on the method and timing of the accounting transactions, it may not be possible to tie this report to your financial statements (differences between GAAP and operational revenue). In some cases, it is easier to measure revenue in these categories by waiting until the final sale of the loans, especially if all loans are sold on a best efforts basis. When hedging activity is present, a separate and slightly more complex calculation and report is needed to accurately measure secondary marketing revenue.
Loan Loss Reserve Adequacy Report
This report should show the activity in the loan loss reserve account and the adequacy of the account to cover future losses. It should calculate two separate portions of the loss reserve: A small, ‘general’ reserve for all loans within the repurchase window using historical benchmarks of frequency and loss severity and a ‘specific’ reserve for all the loans on which a repurchase request or documentation inquiry has been made that may result in a repurchase request. Based on the information available, a loss estimate should be assigned based on historical loss severity benchmarks.
The adequacy of reserves can be measured based on historical activity paired with the probable losses known. The question that you as the executive need to ask is the following: ‘If our company stopped originating loans today, would the current loan loss reserve cover the losses we would incur after all the repurchase demands we have currently and will receive in the future have been settled?’ The second question is this: ‘If the company stopped originating loans today, is the current loan loss reserve balance much more that is necessary to cover current and potential losses?’ In the event the company ever has a legal fight pertaining to repurchases, an opposing lawyer can look at your balance sheet and see what you believe your losses will be, and that will be a huge disadvantage for you if you have over-reserved for loan losses.
Most companies go through an annual budget process. Good companies update the budget with a new, detailed forecast at least quarterly based on new information as the year progresses. The really great companies can update their high level forecast on a monthly basis.
The key reasons to update the budget or forecast on a monthly or quarterly basis are as follows:
- Measure actual performance against your best and most recent estimate;
- Make decisions to change origination volume and sourcing, fees, loan flow sold to investors, staffing structure and operating expenses; and
- Suspend unsuccessful strategies or move forward with new strategies depending on the performance of the business compared to forecast goals.
It's A Process
Every mortgage banking executive is pulled in eight directions, and although we all know that accounting is critically important, it is not always the most satisfying part of our responsibilities. Building a routine checklist of areas we have found to be important in our experience and then adding areas where we need understanding can reduce the time we spend in the books and improve the company's financial performance.
Matt Kiker is managing director for Mortgage Executive Consulting LLC, which serves the mortgage banking community with a full menu of management and accounting offerings including projects, oversight, review, training and interim chief financial officer (CFO) and controller services. He has been a board member and CFO and has held management positions in capital markets, IT and operations for small and large mortgage bankers.