Many executives today who occupy the “C” Suite are pondering questions related to the future of the wholesale production channel. They are asking themselves and their fellow “C” level executives questions like:
◄ What on earth has happened to wholesale?
◄ What forces are working against wholesale?
◄ Who’s left?
◄ Is wholesale going to survive?
◄ What is the future of wholesale?
◄ As a wholesale C-level executive, how best should I position my company’s business strategy to not just survive but prosper on these changes?
The later question is the primary focus of this article, but we first need to understand the problems currently facing the wholesale channel.
It doesn’t matter which side of the wholesale channel you are on … the originating broker or the mortgage banker funding the loans … these questions are in the forefront of everyone’s mind of anyone remotely associated with wholesale. This is especially the case if you are one of the many who have been (or were) regularly checking the now infamous Web site, the Implode-O-Meter (http://ml-implode.com). For the last two plus years, this site has chronicled the demise, one-by-one, of the multiple hundreds of wholesalers who have either exited the wholesale channel or completely gone out of business. Never in the history of the industry have we witnessed such a mass exodus (or implosion) of participants from such vibrant sectors of our industry.
Forces working against wholesale
And it isn’t like the forces working against the wholesale business channel have abated at all. There are credible reports of literally thousands of bills working their way through the legislatures of almost every state in the union that have will have a significantly negative and onerous affect on our industry. There is a determination behind each of these bills to bring under control what is perceived as a greedy out-of-control mortgage industry. For those who feel that regulation is the end-all-be-all “cure” for what has “ailed” our supposedly “sick” industry, they are brewing up a concoction of “medicine” that will do more to kill than to heal what is wrong with our industry.
Well-intentioned regulators who do not understand our industry, nor the complexities or the problems we faced in this last business cycle, are the most ill-equipped body of individuals to be crafting a “fix” to a system that admittedly has flaws. The real problem here is that we, as an industry, have lacked the will or desire to self-regulate, and now, whether we like it or not, are going to face an onslaught of regulation like we have never seen before. And interestingly enough, it will have the greatest negative impact on the wholesale origination channel. Is there a better example of a misguided, albeit well-intended, regulation than the Home Valuation Code of Conduct (HVCC)? I cannot think of one single piece of regulation that has done more to kill a greater number of real estate transactions than the HVCC. And it comes at a time when our economy desperately needs every real estate transaction possible to fund in order to help rekindle an otherwise stalled real estate economy and world economy. Unless we speak out with a loud voice, more of the same is on its way … and once again, the greatest impact will be on the wholesale channel. But, your voice can make a difference as we have witnessed by HR 3044, which if passed, will put an 18-month moratorium on the HVCC until it can be reconstructed to better accomplish what it set out to achieve. Beyond the regulatory conundrum we face as an industry, there are internal forces further eroding the number of wholesale participants. We have witnessed an increasingly uneven “playing field” between the “haves” and the “have not’s.” By that, I mean those mortgage banking companies that have sufficient net worth and liquidity to be able to sell loans on a “mandatory basis” have a significant pricing advantage over those more thinly capitalized smaller companies that are forced to sell loans on the “best efforts” basis.
Those selling on a “mandatory basis” are realizing anywhere from a full point to a point and three-quarters bottom line gain over those selling on just a “best effort” basis. When a group of companies, in this case the better-capitalized companies, are able to realize the pre-tax difference of a full point or more over their more thinly capitalized counterparts, the better capitalized companies are going to be able to offer better pricing, while at the same time, maintain greater profitability. And when this happens in the almost-always-competitive “dog-eat-dog” wholesale market, only the strongest (better capitalized) companies will survive, thus causing a further thinning of the wholesale ranks.
Several years ago, very few knew what a warehouse line of credit was. It was only those who owned their own independent mortgage banking company or those who wanted to become a mortgage banker knew and understood the importance of a warehouse line. In fact, in this last business cycle there was such a seemingly endless abundance of credit and warehouse line providers that we, as an industry, took for granted this critical segment of our industry. Few understood that warehouse-lines of credit were the very “heart pump” of the independent mortgage banking industry … that is until we as an industry experienced a life-threatening cardiac arrest. This brings me to the last couple of major forces working against the wholesale channel: an ever shrinking number of warehouse lenders for the whole industry, and even greater shortage of warehouse lenders willing to fund loans for independent wholesale mortgage bankers. If warehouse lenders are willing to do so, they are frequently requiring much higher capitalization to offset the perceived risk. This is compounded by a decreasing number of investors willing to buy third-party-originated (TPO) product … another name for wholesale lending. The days of thinly-capitalized independent mortgage bankers doing TPO business are pretty much over … at least for this next business cycle.
So, on the surface, it looks bleak for the wholesale originations. Gone are many large and small wholesalers that serviced tens of thousands of mortgage brokers across the country. Gone are thousands upon thousands of independent mortgage brokerage companies. Gone are thousands of folks from our industry.
So, what is going on in the heads of the C-level executives?
As a result of all these changes, we are seeing two ‘camps’ forming …
Group #1: Those that only see gloom and doom.
But, there’s another group …
Group #2: Those that see an amazing abundant number of opportunities as a result of all the calamity and carnage that has taken place in the marketplace.
In spite of all the obstacles, challenges, shortages of credit, etc, those in the second group also see a huge “void of capacity” in our industry and know that someone, somehow, someway are going to figure it out and have unprecedented opportunity in this next market cycle.
As a regular guest on TV being interviewed about these issues related to our industry, and as the result of having my own radio program and being a business consultant, I am being continually asked all the questions I am discussing in this article. Having taken my fair share of sales training classes, I always try to answer every question with a question. I ask everyone these three very basic (rhetorical) questions:
◄ Do you believe that the American dream of homeownership is alive and well today?
◄ Do you believe that it will take a housing recovery to lead this nation out of this recession?
◄ Do you believe that Americans are coming to a place where they are no longer going to need mortgage loans to finance their American dream?
Granted, “The Dream” of homeownership may have had some recent nightmares, but “The Dream” is still very much alive! Without question, housing is critical to our economy and particularly will assist in a recovery from this recession. And there’s little doubt that Americans are in more need of mortgage financing than ever before.
So if you are one of those that gravitate to Group #2 that is good. But, before you start charging off to exploit the many opportunities that are undoubtedly out there, I would merely offer you this word of advice … If you go about your business in this new business cycle according to what worked in the last business cycle, you too will fail. However, if you are wise and get the right counsel, you will have one of the most amazing opportunities this market has ever presented any group of professionals.
I have said this before and will say it again: I predict more wealth will be created more quickly in this next business cycle than at anytime in history. Without trying to sound like some late night TV infomercial pushing some get-rich-quick scheme, I can assure you that there are more opportunities today than ever before.
Brokers who will survive
There’s little question that many brokers and loan originators have left the industry or have been forced to take jobs with banks, bigger companies or net branches, but they are still out there and they haven’t lost their desire to operate independently. Even those who left the industry want to come back. Why? Because there’s something infectious about this business! There’s something so rewarding about helping someone as a loan originator to achieve the American dream and make a decent living along the way. This is a relationship-driven business. Yes, pricing and programs are important, but at the end of the day, it’s all about relationships. Have you ever wondered why in the last business cycle, 68 percent of all originations were captured by the mortgage brokerage community? It’s because mortgage brokers did an excellent job of establishing relationships with consumers and providing them options that other big companies could not provide. So, the answer to the question, “Will the broker survive?” … the answer is “yes,” in a way. But the “how?” and “in what form?” is the bigger question. Therein resides one of the bigger opportunities. Successfully connecting (or reconnecting) with these displaced groups of originators will be the key. It’s probably a foregone conclusion that in this next business cycle, there are going to be far fewer mortgage brokers in business functioning as originators. It is near as I can determine, regrettably, only about 15 percent of the original population of mortgage brokers will survive. But that’s not to say that there is no future for the independent originators and that again is where the opportunity is. There isn’t sufficient amount of space in this article to further expound upon this point … maybe in future articles. Write me and let me know.
The brokers who do survive will have to learn to live in an increasingly more regulated environment with real penalties and will have to learn to operate earning lower fees. As the old saying goes, “What we lose in fee income, we’ll make it up in volume.” We have a client in midtown Manhattan who makes a very good living operating on one percent origination fees and minimum yield spread premiums (YSPs). This individual has always operated as a low cost originator and has discovered ways to make a very good income by doing a higher volume of loans.
Wholesalers that will survive
Those wholesalers that will survive moving forward are going to have to be adaptable. Here’s what I mean. They are going to have to adapt to numerous new regulations coming forth. They cannot be ignored or you will be put out of business. Another way a successful wholesaler is going to survive is to become adaptable in ways in which they sell loans into the secondary markets. For example, they must adapt to selling loans on a “mandatory” basis. Without question, it is going to be very difficult for anyone to successfully operate a wholesale business if they are selling loans into the secondary markets on the “best efforts” basis … at least as long as there exists the significant spreads between "mandatory” and “best efforts” pricing. Those selling on a “mandatory” basis will have such a significant pricing advantage over those don’t to the point that it will be nearly impossible to compete. The only exception will be if a wholesaler is able to achieve some unique product or market niche and provide over-the-top service.
Another key factor necessary for the independent mortgage banker to survive as a wholesaler is the ability to sell directly to Fannie Mae, Freddie Mac and Ginnie Mae. With the new higher capital requirements, wholesalers are going to have to raise additional capital to compete.
Warehouse lines of credit will remain an issue for the foreseeable future, and that the key to funding more volume will be the rate at which a mortgage banker can turn their warehouse line. However, we are seeing growing signs that warehousing will be more available in the future. With credit facilities currently being considered by Fannie Mae, Freddie Mac and Ginnie Mae, there is hope that the current warehousing shortage will be addressed. I’m encouraged by recent reports that the U.S. Treasury and the Obama Administration are aware of the problem and they are taking action.
Alternatives to both
Again, it is my opinion that there will always be a place for some number of wholesalers and mortgage brokers. However, if market conditions are requiring you to look at other alternatives, might I suggest the following:
◄ For originators, find a legitimate HUD-compliant net branch operation and become part of it.
◄ For wholesalers, consider starting an emerging broker-to-banker program whereby you convert your current wholesale business relationships to make correspondents. There’s a way of doing this to create a substantial capital base.
◄ Consider raising the necessary capital to become a well-capitalized mortgage banking company … it is possible.
◄ Do not accept the lie that there’s no capital willing to invest in your business. Forbes has estimated that there are billions of dollars in cash looking for a good investment. Find someone who can help you develop a well-thought out business plan, including a solid financial forecast, and then you can pursue your dreams of financing the American dream.
David Lykken is president, mortgage strategies and managing partner with Mortgage Banking Solutions. David has more than 34 years of industry experience and has garnered a national reputation. David has become a frequent guest on FOX Business News with Neil Cavuto, Stuart Varney, Liz Claman and Dave Asman with additional guest appearances on the CBS Evening News, Bloomberg TV and radio. He may be reached by phone at (512) 977-9900, ext. 101.