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Thinking for a change
Risk Vs. ReturnsKelly A. GrangerWarehouse lines, broker or banker, risk, returns, secondary marketing
How Should I Fund My Loans in Today's
Marketplace?
Someone asks me that question everyday.
Many successful mortgage originators have recently taken a step
back from funding their loan volume as direct lenders and are once
again delivering their production as brokers. Is this a prudent
response to what seems to be the never-ending turmoil in the
mortgage industry? Or, is it an overreaction to risk that misses
unique opportunities for growth in volume, revenue and market
position?
Certainly, the "return for risk" trade-off of operating as a
direct lender--by funding your loans through the use of a warehouse
or other means--has tightened somewhat. In many cases, there has
been an increase in the risk associated with the secondary
marketing of closed loans while there has been a decrease in the
additional margin or return from the funding and sale of closed
loan products. Since this varies by product types and markets, does
this mean that it is automatically a losing proposition? Or, does
it simply require better execution designed to meet the challenges
of the different loan products? If the answer to the latter
question is "yes," then originators who have developed strong
organizations have an opportunity to leverage off of their
expertise to fill a void.
So, Should I Be a Banker or Broker?
As is often the case with these types of questions, there is
more than one correct answer. The correct answer for particular
originators depend on several key factors specific to them, their
operation and their market position. The questions that originators
must answer for themselves in order to make the right decision for
their companies are:
++With full control over my lending process, can I become more
competitive in my market?
++Will expanded pricing flexibility and control give me more
market opportunities?
++Have I done the in-depth research and gathered the information
needed to fully analyze the incremental revenues and costs
associated with direct lending?
++Can I qualify for the correspondent programs and warehouse
facilities needed to implement my plan?
++Are premium disclosure issues important to me?
++Can I develop the infrastructure to support an efficient
direct lending operation?
As a non-traditional warehouse provider, I have the unique
opportunity to interact with lenders in almost all segments of the
mortgage industry--originators and end-investors, brokers and
bankers, retail and wholesale, conventional, government and
sub-prime, big and small, new and mature companies. Feedback from
these sources leads me to conclude that, contrary to popular
belief, the benefits of delivering funded loans versus brokered
loans are as viable as ever for lenders who identify a need for the
advantages listed above. Making the "return for risk" trade-off
work for you just requires digging a little deeper to find the
gold.
How Do You Make It Work for You?
++Do Your Homework
Many brokers considering the transition don't fully examine all
of the changes involved. I don't know how many individuals have
said that they don't think banking is right for them because they
don't want to assume all that work and risk just to obtain a modest
increase in yield spread premiums. This perception may be fueled by
their investor sales representatives, some of whom strongly
discourage the move because they will lose the relationship and
their commission. Some of the other direct enhancements of
correspondent lending should be investigated and taken into
account. These include:
++a lower par rate sheet allowing for more pricing flexibility
and a more competitive position in the market;
++a smaller incremental rate margin required to increase yield
spread premium;
++the ability to structure and collect virtually all lender loan
fees; and
++much lower lender fees charged by your end investor.
Remember that strong existing relationships with investors may
be taken into account when meeting their higher qualifications for
approval as a correspondent.
Besides the end investor loan programs, many perspective bankers
overlook the important differences in service levels provided by
available warehouse lenders. While there has been a reduction in
the number of warehouse lenders in the market, there are still
plenty of funding facilities available. The important consideration
is that there are significant differences that must be analyzed in
order to pick the facility right for you. While price is always a
consideration, it is only one of many. Funding turnaround time will
determine how much your facility contributes to your improved
service. The tolerance for different loan product types should fit
your lending plans for not only the present, but also the future.
Haircuts--the reduction in the funding amount sent to the
table--may be required by some providers or for certain loan
product types. Easy access to detailed information on your funding
activities should be made available by your provider so you can
efficiently manage your process to the lower cost. Some warehouse
programs actually help you manage your risk by providing additional
services in conjunction with the line. These can include assistance
in developing your quality control and fraud avoidance programs,
performing limited cross-checks on funding requests, contract
quality control programs, and interim servicing of loans while they
are on the line to protect their value. Qualification to obtain the
funding facilities varies widely from traditional lines that are
primarily net worth-based to small-cap lines that are more
flexible. Small-cap lines can offer this flexibility by looking at
a variety of other factors, including operational experience.
++Consider Indirect or "Hidden" Benefits Closely
Believe it or not, most of my warehouse clients tell me that the
biggest advantages they receive from being a direct lender are not
the obvious revenue enhancements. Rather, control of their lending
process is normally cited as the number one benefit. However, this
enhanced control can create greater revenues through more
competitive service and increased unit production. Another indirect
advantage they commonly mention is the ability to attract and, more
importantly, retain the best possible loan officers. Many clients
tell of investing significant time, money, and effort to hire and
train loan officers, only to have them migrate to a lender who
provides more opportunities for lending success and fee income once
they become productive. The status and flexibility of operating as
a banker presents a stronger profile to both the market and the
industry itself.
++Leverage Off of Your Strengths
By focusing on your area of expertise, whether that be sub-prime
or conforming loans, you greatly reduce your risk. For every
conventional lending expert who tells me that sub-prime is too
risky in relation to the return to fund it on the warehouse line,
there is a sub-prime lender who tells me that conventional loans
have margins that are too tight to justify funding them. Who is
right? Well, since both are profitably funding and selling what the
other considers inappropriate, neither can be considered correct in
all cases. Once again, it depends on your individual situation.
While you may want to initially fund only the products with which
you are most comfortable, you can explore new areas and deliver
these products as a broker. Then, once a comfort level is reached,
they can be moved to funded loan production to gain the advantages
outlined above. In this progressive approach, risk is limited. This
approach works not only as it pertains to product types, but also
as sources of origination, such as refinance or purchase and retail
or third-party origination. I know several lenders who have
leveraged off of strong investor relationships and an expertise in
certain loan products by expanding their origination in these
specific product lines to third party origination. They have a
competitive advantage in this area that is valuable to other
brokers in their market.
++Internal Controls and External Relationships
By operating as a banker, you are accepting many of the risks of
your lending transactions in order to gain the many benefits
outlined. An overriding focus on dedicated internal controls and
the development of strong external relationships is imperative to
making this trade-off work for you.
Guidelines for origination, processing, funding and quality
control must be well thought out, comprehensive and implemented
religiously. The risks that generate so much fear are all
essentially within your control. Attention to detail,
re-verifications, separation of duties and document reviews are
only a few of the features that must be present throughout the loan
process. While space does not allow for a comprehensive discussion
of this area, there are many resources available to help you ensure
that you have a plan in place that covers all of the pertinent
issues. Strong accounting and reporting processes will identify and
document areas for improvement and keep the operation strong and
healthy.
The commitment to the development of strong external
relationships must be taken to a much higher level than broker
origination requires. The payoff in correspondent lending isn't
realized until the last step in the process--the purchase of the
loan by the end investor. Up to this point, the originators base
their entire lending process on the expectation of purchase based
on a commitment from the investor. To make the transaction, the
expectations must be clearly understood by both parties.
Commitments to specific levels of service and detail must be met by
both sides. This requires that the relationships be nurtured and
developed to the point that they can withstand the strain of the
inevitable problem file. Too often, a short-term broker mentality
does not recognize the importance of win-win investor relationships
as an absolute requirement of prosperity and survival. Multiple
outlets for each loan type must also be made available so that
these problem loans can be marketed quickly with a minimum
reduction in sale price.
The relationship with your warehouse lender is just as crucial.
A mutual understanding of the commitment and expectations is
necessary to move your lending process forward with confidence.
There must be a clear understanding of the tolerances for certain
products, the service level to be expected, the availability of
increases to the line limit and the game plan for any aged loans on
the line. Aged problem files must be attacked and quickly removed
from the line to protect this important relationship. Be aware of
the increased risk that your warehouse providers are now subject
to, and be prepared to work within a more structured program. This
will ensure that you will both be around for the long haul. At the
same time, there must be an understanding of how the warehouse
provider will assist you by offering help with secondary marketing
or making work-out arrangements. Some warehouse providers will even
offer to bid on aged loans as an additional option.
I believe that where others see danger, the confident see
opportunities, just as the best returns in the stock market are not
realized by waiting until everyone is on the bandwagon and then
buying when the price is up. The successful investor does research,
leverages off of knowledge and gains a competitive advantage. With
preparation and confidence, you can have an edge over your
competition.
Kelly A. Granger is the regional warehouse business director
of PCFS Financial Services. He may be reached at (800) 838-9727,
ext. 15116, or e-mail [email protected].
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