Average order size is rising. Most mortgages are processed through Ellie Mae's "success based pricing" format. That's a cloud based system. Originators are charged only for mortgages that get funding. No money is generated when applications are rejected. A declining share of the volume still is done with on premises software. Customers purchased those programs years ago and are not required to pay per unit fees. Many of the latter are converting to the variable pricing model, nonetheless, because software updates are delivered automatically via the cloud. Software running on a local computer needs to be serviced individually, creating delays. Demand for reliable updates is surging in response to the proliferation of mortgage regulations. Five groups within the Obama Administration are now involved. All 50 states are ramping up oversight, too. Revenue per loan is increasing as more elements of the lending process flow through Ellie Mae's system.
More billable features are being added. So far Ellie Mae has steered away from providing its own credit reporting and other key services. Moving directly against existing partners could provoke retaliation. High tech innovations are in the pipeline, though. Allowing home owners to provide information directly from smart phones and computers could be implemented before long.
Larger banks are signing up. In the past most of Ellie Mae's software customers were small banks and mortgage brokers who didn't have the resources to manage their own technology. Larger institutions have become candidates, mainly as a result of the Obama Administration's regulatory crossfire. Those banks haven't junked their existing systems yet. And that may never happen in many cases because they want to retain an in house technical staff. Some offloading has begun, though. And that trend is likely to continue as the need for fast turnaround time grows in a complex regulatory environment.
Mega banks have become customers, too. Wells Fargo and Citibank both are using Ellie Mae's data structure to collect mortgages from outside originators. Many of those originators use Ellie Mae's systems to begin with, making it easy to structure the data the way the big banks want it. Ellie Mae currently generates about $125 per loan from the origination side. Another $25 per loan is being collected from the mega banks, kind of as a license fee for using the company's standard format. That business remains unprofitable due to the start up costs associated with implementing the systems inside the mega bank's IT departments. But some profits are likely to emerge in 2013 as the programs exit the testing phase. Bigger impacts are possible beyond.
Our estimates assume that refinancing activity will decline in 2013. Those loans have dominated the industry over the past two years. New construction and resales may pick up some of the slack. Volume has the potential to increase even if refinancing rates stay flat or rise. Most home owners simply have rolled over existing balances to date. If home values climb new cash out loans could become a more significant factor. Assuming a falling mortgage market, we estimate sales will advance to $135 million to produce earnings of $.90 a share. Market share gains are likely to continue over the next several years. Average order size promises to expand. And the $25 fees from the mega banks could escalate, forming another river of recurring revenue.
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