Competing for Deal Flow in Mortgage Markets ?

We analyze competitive dynamics in the mortgage market. Using discontinuities in mortgage acceptance models to generate shocks to a bank’s current local lending, we show that future applicants are attracted to growing lenders. Local mortgage markets resemble tournaments: a bank’s originations are reduced by the lending of its quickest-growing competitors, not that of its overall competitors nor of its largest competitors. Moreover, future lending activity is convex in current originations. Tougher competition leads a bank to charge higher interest rates, partially due to the increased risk of its loans, and results in worse mortgage performance. *Aiello and Garmaise are at UCLA Anderson (darren.aiello.1@anderson.ucla.edu and mark.garmaise@anderson.ucla.edu). Natividad is at Universidad de Piura (gabriel.natividad@udep.pe). We are grateful for comments from Tony Bernardo, Adair Morse and from seminar participants at CEIBS, the Peruvian Central Reserve Bank, SAIF, the Society for Institutional and Organizational Economics, UCLA and Universidad de Piura. We thank the UCLA Ziman Center for Real Estate’s Rosalinde and Arthur Gilbert Program in Real Estate, Finance and Urban Economics for generous funding The competitiveness of banking markets is important both for its direct impact on the quantity and pricing of financing made available to borrowers and for the potential spillover effects of lending terms on broad sectors of the economy. As a result, banking competition has been the subject of sustained interest both in academic and policy circles. In this paper, we show that across local mortgage markets in the U.S. lenders engage in tournament-like competition for applicant deal flow. We begin by showing that plausibly exogenous increases in a lender’s current period originations in a local area lead to increased applications and lending in the following year. Applicants are attracted to growing lenders. We then analyze the competitive dynamics of mortgage markets and show that only the quickest-growing lenders in a market have an impact on others. This feature of the market is consistent with a tournament model in which the fastest growing lenders receive disproportionate applicant attention. In support of this interpretation, we show that future lending is convex in current year originations. We also find, somewhat unexpectedly, that increased lending by their quickest-growing competitor leads banks to increase the interest rates they charge locally. Together these findings have implications for the strategies of banks striving for market share and for investors, regulators and depositors seeking to understand the evolution of banking markets and to assess which lenders are most vulnerable. Two central ideas from the theoretical literature motivate our analysis. The first is the argument that market share serves as a signal of quality to consumers (Caminal and Vives (1996)). Increased lending by a bank will therefore attract other potential borrowers. See Berger, Demsetz and Strahan (1999) and Degryse and Ongena (2008) for literature reviews and https://www.federalreserve. gov/bankinforeg/competitive-effects-mergers-acquisitions-faqs. htm (accessed Feb. 27, 2017) and DOJ-FTC (2010) for regulatory guidelines.