Examining Mortgage Origination

Examining the Bank- Mortgage Brokerage Business Model

It seems evident that banking regulators and banks themselves are questioning the continued viability of the wholesale mortgage brokerage business model. Up until the past few years, mortgage brokers consistently gained market share for the past couple decades in terms of residential mortgage loan originations. This was a profitable channel of business for the banks, as they had a sales force of mortgage brokers selling their products to the actual homeowners, while not being on the hook for the fixed costs of having an internal sales force and/or a retail branch network. With the current combination of a “commoditization” of loan products (Fannie/Freddie 30-year fixed world), many national banks establishing an extensive nationwide branch network, and a distrust of mortgage broker origination business, I believe many are wondering if mortgage brokers still serve a purpose.

While there are a great deal of mortgage brokers who should never have been in the business, the current housing crisis goes much deeper than simply blaming it on the mortgage broker. Generalizing, I think it is fair to say that the overwhelming factor in this housing crisis was America as a whole’s attitude of believing the good times would last forever and the resultant careless issuance and use of debt. Regarding the latter, no doubt our government and banking leaders greatly contributed to this abuse of debt. With the passage of the Community Reinvestment Act and the constant push on HUD by Congress to lend to more and more people (even up to 2005), the mechanisms were put in place to really open the lending spigots. Wall Street and the banks, flush with money, came out with crazier and crazier loan products, which culminated in the 100% no income/ no asset loan program. Then, if all that wasn’t enough, the credit agencies were paid by the sellers of these packages of mortgages (MBS’s) to rate them and through supposed financial wizardry, they rated them much higher than was worthy. I believe a great majority of the problem stems form borrowers who knew they were taking a risk on the housing market. However, looking back, it is hard to blame working class people who bought beyond their means when our whole system of capitalism essentially failed them (“surely, banks wouldn’t lend if I wasn’t a good credit risk”).

Well, obviously what went wrong is we based everything on the worst assumption imaginable, namely that the real estate market would just keep going up and that a house could be used like a piggy bank. We are all paying the price for it now. From a mortgage perspective, the industry is increasingly becoming “commoditized” with Fannie/Freddie (and the Federal government’s purchase and implicit guarantee) being the only real buyer of mortgages. Largely gone is jumbo lending, 2nd mortgages, and loan product choices. It has become a 30-year fixed, par-priced conforming world. Along with this lack of choices is often a lack of intelligible advice and communication to prospective borrowers. Whether a borrower goes directly to the bank or through a broker, it has becoming very hard to communicate on the simplest of issues (changing loan size by a couple thousand dollars to cover closing costs, deciding whether it makes sense to pay 1 or 2 points, can we payoff some credit card debt, etc.).

With that said, I want to examine the bank-broker relationship and offer a suggestion on how to greatly improve this channel.


KNOW THE ORIGINATOR PARTNER

Where underwriting individual borrower files is critical, I believe knowing who is originating the loan has a great correlation to loan performance. Identify those originators that over an extended period of time have given you performing loans and reward them with better pricing and service.

A professional mortgage brokerage business involves a high degree of personal communication with the client. This begins by listening to the borrower’s wants and needs, then analyzing a borrower’s loan application to see what loan choices may best fit each specific borrower’s wants and needs. It includes educating the borrower on the details of the loan process, the crucial importance of locking in a rate and what exactly “locking” means. In the case of a purchase, it all also includes educating a borrower on the details of the entire sales process, going over prospective home purchases and the underlying numbers, and issuing pre-qualification letters.

Once a client commits to moving forward and we submit a loan application to a bank, it is our job to give daily attention to this file and communicate on a consistent basis with the client. Often, a client may want to make some minor changes to loan sizing, loan program, borrower profile (say a pay increase), etc. In a more efficient lending environment, this should be a simple call to discuss details with a decision maker at the bank, but here is where it has become increasingly difficult to communicate with a rep from the bank that can actually make decisions. I understand the rational of many bank employees who don’t want to be held accountable and risk their job for a potentially poor decision, but the result is often inaction and inefficiency. Of course, making sure every deal funds on time and loan lock is met is of utmost importance. A good mortgage broker will also go over post-closing details with borrowers and regularly stay in touch with them in the future to ascertain they are in the best possible loan situation.

Going back to those originators that have displayed a history of performing loan production, ethical conduct, and high client satisfaction, why not give them superior resources to close more performing deals and give the bank opportunities to cross-sell products because of the great service they provided? This brings me back to the whole quality vs. quantity issue. For many years prior to the housing downturn, it seemed whomever did the most loans was rewarded. I know of brokers who would churn the same loans over and over again to make maximum rebates and some banks not only allowed this behavior, but actually encouraged it as it improved their volume numbers. After all, they didn’t own that paper and hence, prepayment risk was someone else’s problem. Once again, reputable mortgage brokers and borrowers are now are paying the price with the material restriction of rebate pricing and hence, borrower choices.

The new HVCC regulations (Home Valuation Code of Conduct) are very ill-conceived. I think it is a great stretch to place a major blame on mortgage brokers coercing appraisers for this housing debacle. Once again, it is ultimately the borrower who will be paying higher costs. In looking at a purchase or refinance opportunity, appraisers always performed a vital function in “comping” a property to find a likely range of value, even if it was very broad. Now, a borrower is supposed to pay one of these big, non-personal appraisal management companies upfront for an appraisal, even though they have no idea if the value will even be close to what is needed for a deal to make sense. In addition, borrowers are frequently being charged for two or more appraisals, as many banks now have mandatory review appraisals, often performed by one of their subsidiary companies, even at LTV’s below 50%! Maybe the pending legislation will change some of these new rules, but again it seems like we are losing a grasp on capitalism as an idealogy. The way events have been unfolding, I fear that we are going to have an industry dominated by a few major institutions (maybe just the Federal government) and borrowers will be forced to accept whatever fees and loans are thrust upon them. We all need to save ourselves from this Orwellian outcome!