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Medium Profitability Return on Capital Competitive Strategy

MBS Co.

#Financial Services #Mortgage Banking
ProHub Comment

This case requires candidates to diagnose a ROC decline driven by adverse portfolio selection—banks are retaining high-quality mortgages while selling lower-quality loans to MBS Co. The solution involves both quantitative ROC analysis and strategic brainstorming around how to rebalance the portfolio mix, testing both analytical and creative problem-solving skills.

Estimated Time 15 minutes
Difficulty Medium
Source Darden
50 / 100
Your client is MBS Co., a government sponsored enterprise (GSE), that purchases mortgages from banks, packages them into mortgage-backed securities (MBS), and sells them in the secondary market to investors. MBS Co.’s return on capital (ROC) has declined since last year, and the management team is looking for your help in understanding why this has happened and how to improve ROC going forward.

Clarifying Information

  1. MBS Co. buys individual mortgages from banks and packages several thousand of them into a given security. Shares in that security are sold to investors.
  2. When a homeowner makes a monthly mortgages payment, the payment passes through the bank first, then through MBS Co., then to investors (primarily institutional investors).
  3. MBS Co. keeps a small fee on each payment that passes through. The fee amount is based on a percentage of mortgage volume (i.e. how much money was loaned to homeowners).
  4. MBS Co. has one other GSE competitor that buys mortgages and creates mortgage-backed securities. The securities from both companies are fungible to investors.
  5. Banks can also choose to hold mortgages – rather than sell to a GSE – and keep the full monthly mortgage payments from homeowners.
  6. There is no target ROC. Any improvement in ROC would be considered a success.
  7. Return on Capital (ROC) = profits / capital