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Forward on Reverse ... The Zero-Payment Home Loan

May 31, 2004

An Interview with Vanguard National Mortgage and Title CEO Michael KnightMortgagePress.comMichael Knight, Colorado Associaiton of Mortgage Brokers, Vanguard National Mortgage and Title, affiliated business partnerships, warehouse lines, HUD Proposed Rule Vanguard: A Partnership Sharing the Wealth The Mortgage Press: Mike, can you give us your background and a brief history of your company? Michael Knight: I started in this industry in 1977 and now have two mortgage companies located in Denver. I started my current companies out of my basement in early 1996, and we now have 33 employees, including our title company, with 10 originators. I was out of the industry from 1980-1996, and was with Merrill Lynch the bulk of that time as a stockbroker, commodities trader, and a financial and estate planner. The call of entrepreneurial enterprise and the stock market crash of October 1987 are the reasons I eventually left Wall Street activities. The natural thing for me to do was reenter the mortgage industry. TMP: You caught my attention at the Western Regional Mortgage Brokers Convention in Las Vegas the last two years. I noticed that Vanguard is also a National Association of Mortgage Brokers Gold Industry Partner for 2002 and 2003, and is planning another splash at the NAMB Annual Convention this June in Baltimore. I guess you are ready to go mainstream with your concept? Can you explain the basic idea of the Vanguard model? MK: It is the first national mortgage and title partnership. It is owned by Mortgage Brokers, and the real estate agents and builders with whom they work. This is known as an Affiliated Business Arrangement (ABA) under the Real Estate Settlement Procedures Act. There are many small ABAs around the country, but we are the first to scale out the model into a national partnership. TMP: A national partnership? MK: A partnership business model is nothing new. Large accounting and legal firms have used this model for decades. We formed a strategic alliance with Deloitte & Touche 18 months ago, and one of the values they passed on to us was a clear understanding of their model. The time is now for that model in the mortgage industry. TMP: What advantages are there to becoming a national partnership? MK: There are powerful economies of scale and other efficiencies that can be brought to bear in the mortgage brokerage industry because of the very large volume of business we do collectively. By most measures, brokers originated around 70 percent of all mortgages in 2002 in a $2.5 trillion market. That is market domination, yet we each operate independently. Not only is this terribly inefficient, it also means we pass up significant sources of revenue on every loan. TMP: Most Mortgage Brokers just had several record years in a row. You might get an argument from them that they are already pretty successful and efficient. MK: Yes, we all just had record years, thriving and working in an incredibly lucrative industry. But cash flow alone is a very one-dimensional measure of efficiency and success. What I am referring to is the creation of value; an asset with liquidity for retirement. The current model in the industry only provides cash flow, but has little accrued value or liquidity. TMP: I don't follow where you are going with this. MK: Let me put it this wayin many other industries and businesses, let's use a hardware store as an example, when a business owner ends their career, they have a business they can easily sell. This is usually a significant part of their retirement nest egg. Mortgage Brokers usually cannot sell their businesses because they are relationship-based. Would you buy a business, knowing that the relationships on which it is based will inevitably realign themselves with another known source when the previous owner who built the relationships, leaves? You cannot simply transfer a high percentage of relationships cultivated over time with real estate agents, builders and past clients. This is what I mean when I say broker/owners have no liquid or accrued asset to sell for retirement. There is intrinsic value there, but only to the owner. I don't like the cash flow-only, one-dimensional model we have all assumed for years is the only way, so we began operating an improved model, changing and tweaking it along the way over the last seven years. The marketplace has indicated it is a great idea, and its time has come! TMP: How has the market "indicated" to you that this is a good idea? MK: Well, we very quietly have hand-picked 30 founding partners (FPs) in 20 states to be the initial group that we start operations with in March/April 2003. We raised $7.3 million to acquire these companies and build the systems, processes, and the technology to make this operational. These FPs are typically very established and successful broker/owners who took a look at the model and said, "Count me in." TMP: You said something earlier about running this business concept for seven years? MK: Yes. I knew a conservative mortgage industry would be slow to embrace a new model unless we first tested out and proved the model. This "pilot program" we operated grew at a 25-percent faster compound annual growth rate than our traditional mortgage shop. The marketplace not only accepted the new model, but embraced it with a vengeance! We are now scaling out the model into a national company. TMP: What exactly is the model, and what makes it so unique? MK: The basic tenets of our model are a roll-up or aggregation, creating a national ABA, with resulting conduit pricing, new channels of revenue for brokers, bundled services and empowerment through mutual ownership with a common goal. We have spent a great sum of money over the last seven years with RESPA and SEC attorneys to make sure our model is compliant with RESPA and securities laws. We've also engaged a corporate financial planner who caught my attention in September 2000 at a seminar titled, "Alternative Ways to Finance Growth." That topic made me sit up and take notice, because I had been looking for two years for an individual of this caliber with the right ideas and experiences. He outlined eight success stories he had pioneered in the last 10 years with various companies. One of them had remarkable similarities to the mortgage industry and their business plan was uncannily similar to mine. He likes to say that he takes small companies with big ideas and turns them into whatever size enterprises they want to become. Many of them wanted to go public and he has successfully directed a number of companies down this path to IPOs. You might say he is "access to capital," whether that means through private sources or Wall Street. He has been featured on the front page of The Wall Street Journal, in Forbes magazine, along with a number of other well-known publications, and is known as "the Deal Maker." TMP: Who is this mystery man? MK: He is a corporate financial planner: Gordon Tunstall of Tunstall Consulting. A Certified Public Accountant, he has a banker's background, is more than capable of being a CFO for a large corporation, sits on the Board of Directors for several companies, and is well-known in financial circles and with Wall Street investment bankers. When he brings a deal to the table, they take notice because of his past successes. TMP: You mentioned he had recent success with a company in another industry but with very close similarities to the mortgage industry. Can you elaborate? MK: Yes. The orthodontic industry was quite fragmented, and each orthodontist thrived on a relationship-driven business, and spent their own dollars on advertising and supplies. They had a business they could not sell, in spite of considerable cash flows generated. In short, no synergism, no economies of scale, no strength in numbers, and an incredibly inefficient business model other than cash flow. As I sat and listened to this success story, I sat up in my seat knowing I had found my guy, because he had implemented my business plan in another industry resulting in a huge success, all the way to an IPO. He had the template, all we needed to do was adapt it to the mortgage industry and hit the ground running. I engaged him in October 2000, and he has pushed me hard, dotting the Is, crossing the Ts, and making sure that we are compliant with RESPA and SEC regulations. TMP: That's quite a story, and its a bit fortunate for you that you stumbled across this guy. How is it going? MK: Well, I'm a believer that things happen for a reason. Yes, it was pure serendipity that I was invited to this seminar where Gordon spoke, but it was his topic that grabbed my attention. I said I'd been looking for two years for someone who could get me access to capital for aggressive growth and could crystallize my business plan. I am a patient man, but I like to think of myself as opportunistic when the right opportunity falls into my lap! He has pushed me hard and has me on a timeline for various goals at each step in our master plan. TMP: Let's go back to something else you said earlier. You referred to the mortgage industry as an "emerging" market. Mortgages have been around for a long time. Why do you refer to this as an emerging industry? MK: Mortgages have indeed been around for a long time, but as Mortgage Bankers working for one company. Up until the Savings & Loan debacle of the 80s, people went to either their local S&L or bank to get a home loan. Then S&Ls imploded. In the 80s and 90s, two really strong trends emerged in U.S. business. Self-employment and home-based businesses. Most brokers started out from their homes, and many of us grew into commercial office space. These two trends, along with the demise of the S&Ls, allowed the brokerage industry to emerge with very lucrative, entrepreneurial opportunities. Our industry has sprung from nowhere 20 years ago to capture nearly 70 percent of all originations in an enormously large industry. When any industry goes from zero to 70 percent of the market share in such a short period of time, there are bound to be inefficiencies in the model. In our case, the shortcomings are on almost all fronts. This causes each of us to spend much more than is necessary for everything we do and to leave much higher margins on the table with every loan we do. Our model is a large partnership that harnesses the incredible "buying" power to each of our advantages. In other words, the model captures the power and efficiencies of a larger group, turns them into savings for each mortgage owner, and adds 30 percent to 60 percent more profit to each loan we do! Those added profits are then leveraged and passed on to each owner. None of these remarkable dynamics can be achieved as an individual owner. Individually, our voice (measured by the volume of business) is just another tiny originator existing in a $2 trillion-plus market! TMP: How does the new HUD Proposed Rule affect your model? MK: While I disagree with most of the Proposed Rule, because it places Mortgage Brokers at a disadvantage, the HUD proposal really plays right into our model. If it passes, brokers will have to become bankers to survive, and out of the four ways you can become a banker, the Vanguard model offers the greatest benefits by far. If this rule passes, there is going to be a huge demand by brokers to become bankers, and we are poised to take advantage of that. We obviously knew nothing of the HUD Proposed Rule as we developed the model over the last seven years, but it could dramatically accelerate the growth forecast in our business plan. TMP: What four ways of becoming a banker are you referring to? MK: First, get a warehouse line. Sounds easy, but you must have good credit, the net worth, and the expertise to run one. Second, join a co-op, but co-ops offer limited upside potential, require a buy-in and dictate that you come in with your own warehouse line. Next, join a net branch. Again, there is limited upside and you still are not building any net worth under this one dimensional model. And finally, join the only partnership model in the marketVanguard. It harnesses the best of the co-op and net branch features and includes a warehouse line. Everyone owns stock in the company and accrues more through the stock option plan over time. If the economy and the markets cooperate, we may seek to take the company public creating that exit strategy I mentioned earlier. One never knows! TMP: How do you think the mortgage industry will receive this? MK: As I said earlier, we have shown the model to a very limited number of owners and hand-picked our initial group. Many have told us they thought of this before or had tried to do this on a smaller scale in their own city with a few mortgage colleagues, but couldn't quite figure out how to bring it all together. The initial idea was mine, but by surrounding myself with some pretty bright "idea people"attorneys and consultantsthe model blossomed into our current concept! The few owners who have seen it have stated, "It is an idea whose time has come!" TMP: You mentioned earlier a "master plan?" What is your goal? MK: Easy. To become the largest single originator in the U.S. and deliver considerable value to each partner, unattainable as stand-alone businesses. TMP: Sounds like you are in the right place at the right time. MK: I agree! We are most anxious to see 2003 unfold after seven years of preparation!
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