In the second quarter of 2010, I wrote an article about the future of our industry primarily as it relates to non-depository lending institutions. After spending several months on legislative issues, visiting Washington, D.C. and talking with hundreds of loan originators, I felt drawn to do a follow-up on this topic nearly a year later as the level of continued confusion surrounding our industry is unprecedented. The Federal Reserve Board’s ruling on loan originator (LO) compensation has only added to this confusion and it’s important to me that I communicate topics that I feel to be extremely important moving forward.
In my last article, I discussed the importance of awareness and concerns we should all have about industry pessimism, fear-based recruiting and/or self-promotion, excessive net branching, along with industry monopolization toward limited origination platforms which reduces competition. There is no doubt that our industry has gone through significant change, but many are making decisions too quickly or not taking the necessary time to understand the implications of their actions. I want to expand on this topic, primarily as it pertains to the recent reform in compensation. I also want to clearly state, as I did before, that I support all channels of ethical loan origination for healthy competition and accountability, which ultimately protects the consumer. Both wholesale and correspondent channels must thrive moving forward.
I have recently read opinion articles from “industry gurus” with a product to sell or self-promoting bias company managers talking about the “difficult” times ahead for the mortgage broker (don’t make me laugh again) and many don’t even originate loans themselves!
Listen, if you do not personally originate mortgage loans in the present or have not in the recent past, there is no way you can fully understand or relate with the implications of these rules, let alone how they pertain to a mortgage broker under the wholesale channel exclusively. For the purpose of this article, I am defending the abused mortgage broker and wholesale origination channel which is now completely misunderstood. The gloves are off … hands up, chin down.
To begin, the new Federal Reserve LO compensation rule needs to be put into perspective. Because every mortgage loan originator has different backgrounds and levels of involvement in our industry, the biggest challenge is with education and communication for all to understand. Some of the questions I’ve heard come up on many different conference calls (with only weeks from the rule being implemented) were simply shocking to say the least. I understand that all the interpretations and details may have been confusing, but too many generally do not understand the basics of the rule and are relying on their employer, lender or others to decipher for them.
Most of us, of course, disagree with the unintended consequences the LO compensation rule generates. We will continue to fight for what is right, but no one should have been unprepared by the April 1st implementation date. Time should have been more focused on compliance rather than complaints about the LO compensation rule, given the direction government regulation is moving. I personally don’t like the outcome to the consumer on heightened costs and will fight to make the plan a better one, but I do agree with anti-steering rules and the inability for an LO to be compensated based upon the terms of the loan.
As we know, creditors are not regulated under the rule for payments received on the sale of a closed loan on the secondary mortgage market. Only the LO is subject to the rule in the primary mortgage market, while dealing with the consumer under any origination channel. Because of the possibility that the rule favors owners and creditors over originators, it’s very important that LOs understand how this will impact their choices and compensation going forward.
For an owner, it primarily comes down to balancing overhead and profits, while not leaning too far toward greed or too far toward generosity when setting compensation plans, corresponding rate sheets and lender agreements. For LOs, it comes down to clearly understanding their options and determining a compensation plan and channel that doesn’t price them out of the market.
The primary issue I’ve seen with operating the Fed’s rule is that owners are not thinking like LOs and LOs are not thinking like owners. The other major hurdle is trying to balance all of this with the least amount of damage to the consumer. The higher your compensation plan, the higher your rate sheet. The question is on what each origination channel can provide in comparison for an LO since it’s all about basis points (BP) and the corresponding interest rates and flexibility. Keep in mind that we are in a transaction-based industry without the benefits of passive or residual revenue. This forces businesses to revise policies when volume is up or down.
How do we solve the compensation and interest rate puzzle? It really comes down to the marketplace, the employer’s overhead and how they are balancing anticipated risks with unknown profits. I predict that we’ll be in a testing phase for a good portion of 2011.
Understanding what a “Banker” and “Broker” is, pre- and post-compensation reform
I can only hope that any LO reading this understands that they are ultimately a third-party originator (TPO) to Fannie Mae, Freddie Mac and Ginnie Mae with the exception of any rare portfolio loan here and there which likely are still not owned or serviced by your employer. Drawing from a warehouse line of credit does not change your position or status. Although the futures of these agencies are unknown, there is no doubt that we are all puppets to a system that pulls the strings. It makes absolutely and entirely no difference if you are brokering or banking a loan to the consumer.
One definition for a bank is a chartered institution empowered to receive deposits, make loans, and provide checking and savings account services, all at a profit. Most correspondent lenders truly are not banks, however, the term “mortgage banker” is loosely used. I’m personally okay with that unless an individual with this title is brainwashed into thinking a warehouse line of credit is any different than or superior to brokering a loan. That is completely false in every sense of the word. If I borrowed money from my bank and then lent it to a friend temporarily whom I felt to be a low credit risk, would I then be a “banker” until I repaid that loan since the loan is in my name? You get where I’m going with this …
Those working for retail correspondent bankers/brokers or net branches have been told for years to sell “in-house” programs due to internal underwriting benefits, fast turn-times, service, “we know we’ll get it done,” etc. to justify using their credit lines for more revenue over-brokering. Add significant compensation incentives and you have the fuel to make brokering look like it’s a disease. I view this as the heavy smoke and mirrors hiding reality. Transaction performance, turn time and loan quality are all derived from the human being originator and the systems and lenders their chosen employer has in place … not the channel of origination. All of these benefits have nothing to do with banking or brokering a loan.
We are all mortgage professionals
The terms “banker” and “broker” mean nothing more than the channel used in the primary market to provide consumers access to residential real estate financing. These terms do not provide credentials or leverage in the non-depository lending world. The Federal Reserve LO compensation rule will continue to commoditize our product. It’s time we get rid of titles and focus on filtering the problems with this crazy lending climate from our consumers as best we can with a smile on our faces and a focus on protecting their interests for continued referrals. If you are an LO working by referral, self-branding is always better than channel branding.
Understanding steering, pre- and post-compensation reform
The Federal Reserve’s anti-steering rule has people concerned when they should not be. While the safe harbor disclosure is optional, an LO’s presentation should have always had this type of comparison done prior to rate lock. Sure, showing the very lowest rate and highest discount points available makes no financial sense and the details need to be relevant, but not providing this disclosure or not offering your borrower multiple rate and fee structure choices within reason is a disadvantage to any LO. Most are not using this form unless brokering, but full disclosure is an advantage and not a disadvantage.
I highly suggest that a mortgage broker, or anyone brokering loans, sets the same lender-paid margin with each investor. I know that many are not doing this, but it is my personal opinion that you may have an uphill battle should an audit expose favor to the higher-paying lenders. I will be interested to see what future changes occur as it pertains to how employers and wholesalers are allowing the originating party to control the rate sheets for compensation. Depending on the details, this could potentially be a violation of the rule, even if compensation is fixed for a period of time.
On the topic of steering, I want to make something very clear that everyone seems to disregard … if you have the ability to save your client on rate or costs for an identical product and program, but choose not to do so for your own financial gain (such as using a warehouse line over-brokering), this is steering. If you don’t agree with that, clearly discuss it with your borrowers and see how they feel about it. I just witnessed (after getting involved and creating competition) a re-issued Good Faith Estimate (GFE) within days from initial GFE by an originator going from using a warehouse line to brokering with no changes in the market or their borrower’s credit profile. The different was $6,000 out of pocket for the same rate and program due to exposing the credit in Block 2 rather than a cost with hidden service release premium (SRP). Keep in mind, he was still making a significantly fair compensation when brokering. This steering has gone on for way too long under both channels, but change is here.
Competition can avoid and expose this behavior, but this type of steering will be very difficult going forward as the Fed intended. The LO employed by the creditor will have an extremely difficult time brokering in general if at all given their compensation agreement cannot increase or decrease. When brokering, the creditor is an originator under the rule. In order for outside lenders not to compete with their warehouse lines on price, they will need to price them out by setting high lender-paid margins or cutting them off entirely. If the company falls short on the required reserves needed to offer Federal Housing Administration (FHA) loans, however, they will be forced to broker which makes things extremely difficult. These factors can be a disadvantage to the LO employed by a creditor. To help alleviate these issues, the creditor must get as many “niche” products as possible under their banking channels while also staying competitively priced.
Lender-paid vs. consumer-paid
The issue on consumer-paid options when commissioning an employee came up early on in the process of deciphering the new compensation rules. It sat quiet for a while, and then was reintroduced weeks before the rule went live and concerns were confirmed by the Federal Reserve Board. The good news is that mortgage brokers don’t need the consumer-paid option. Say what? I repeat, the mortgage broker can thrive without the consumer-paid option. Yes, it’s still available to the broker owner, but it’s truly not a necessary option if you’ve set up your systems properly and understand how this thing works.
There are challenges and issues with the compensation rule under all channels, but nothing we cannot adapt to as we have with all other recent regulation. In this case, things have been blown way out of proportion. With the exception of the inability to provide broker credits to the consumer at closing, lender-paid is an excellent option. It provides more consumer-friendly rate sheets with the ability to offer no-cost loans, as well as an optional discount buy down. Call it origination points or discount points, if the borrower chooses to take on these costs you get the same net interest rate. It makes no difference at all, and I personally prefer this method over consumer-paid any day of the week. It’s consistent, it’s clean and it simply works.
I have found that the benefits of YSPs to cover origination services for the borrower (directly or indirectly with lender paid) are significant after pricing and locking several loans under this model. Paying any kind of points typically makes no financial sense in most cases under the wholesale pricing model. Lender-paid simplifies this by taking care of the brokers’ agreed compensation and starting each loan at a “0 points” PAR interest rate to the consumer. They still have full flexibility and a wide array of products and pricing to choose from, giving an advantage to both parties if the margin is set fair and if it’s clearly understood. I’m not saying there are no kinks that need to be ironed out, but I am saying that those questioning the new broker model are misinformed. The biggest challenge will be to those setting their margins too high or those who have a difficult platform and/or higher overhead to operate their channel competitively and effectively under the rule.
Interest rates and pricing
As indicated earlier, the interest rates you offer your client will be dictated by your compensation plan and your employer’s overhead. Some will be greedier than others and some will be more generous than others. It’s truly a matter of finding balance and it’s not an easy task for the employer or broker-owner or the LO working under them. It will take some periods of testing and fluctuations to determine where most will find this balance. It’s important to keep an eye on the marketplace, as well as the big retail banks to make sure they don’t try to buy the market when volume goes down since they’re paying their employees less and have the ability to do so.
I anticipate we’ll see many employers again start working with and training originators on selling higher rates after these rate sheet adjustments. While rate is not everything, it can be if lost premiums equate to others offering significantly lower adjusted origination charges with equal or higher levels of service, organization and experience. Keep in mind, these performance traits are required to succeed in our now volume-based industry. Since we all carry the same programs, I feel that fair pricing and terms certainly do matter, along with the expected performance. The importance lies on consumer education and the understanding of loan disclosures. Ultimately, the consumer will dictate the balance between service and pricing and who they choose and refer as a service provider.
Lenders exiting the wholesale marketplace
It’s amusing when you see everyone freak out and the mass media that follows when a lender exits the wholesale lending business. Why? Because fear is good press during these times of change and many times special interests are at play. Listen, these lenders are leaving wholesale either through greed with now-controlled retail compensation and revenue potential or poor operational and pricing systems that simply did not make them a competitive entity in wholesale. These lenders would have left wholesale regardless of these rules at some point or another which I am sure we’ll continue to see when volume drops as with any channel. Change is not new to us in the wholesale lending channel and we are a resilient group of people.
As noted before, the wholesale lending channel is the most cost-effective and efficient way for a creditor to bring products to market. When it comes to concerns on compliance, it’s irrelevant in our existing lending climate and the loans currently produced and quality control (QC) measures in place on both ends. It’s very easy for a lender to expose and weed out bad mortgage brokers or bad loans. Regarding loan quality, if the number two wholesale lender is at approximately $27 billion funded in 2010 with more than 90 percent brokered business with just over a two percent default rate doesn’t tell people something about broker quality, I’m not sure what will. The Federal Reserve rule on compensation is no different than reforming the Real Estate Settlement Procedures Act (RESPA) in the eyes of a wholesale lender … this will soon just be another change we’ll look back on.
Non-depository lenders and brokers working together
These new rules will all take time to operate efficiently just as all the other changes we’ve recently faced as an industry. Attention now should be placed on compliance, but also on the future of our industry. The Consumer Financial Protection Bureau (CFPB) takes over on July 21st of this year. I am personally optimistic for the bureau and the potential for a better understanding of our industry at the street level to the consumer as it pertains to non-depository lending. As the first federal non-depository regulatory agency, we can expect to be getting more attention. I truly feel, from my experiences with them, that their intention is to regulate fairly as well as protect competition for the benefit of the consumer.
As a successful LO and exclusive mortgage broker working under the wholesale channel, I can personally tell you that these compensation changes do not put us at a competitive disadvantage. If anything, I feel that it continues to put us at a competitive advantage with greater flexibility and pricing. There are pros and cons to every lending channel and LOs just need to understand, without influence, what is best for them. Again, unless someone is exclusively brokering loans or has in the last two years or less, it’s nearly impossible to know how these rules truly affect the mortgage broker. Our channel will once again grow when awareness spreads.
I support all non-depositories that run a good business … banker or broker. I have great friends and colleagues who work in the correspondent channels and this in no way is a poke to that model which is a good model. This is, however, a poke to those that question or clearly do not understand exclusive wholesale originations. Non-depository mortgage lending must be protected at all costs for competition and accountability to the big banks and it should be a required option for the consumer with all the increases in costs and regulation. I personally rely on the man upstairs to expose good and evil, but my unrelenting passion for our industry and those who do right by their clients cannot be denied. For those who feel the mortgage broker or wholesale lending channel is not a continued force in the industry and deny what or who we are, I’m waiting in the cage of debate and the gloves are off.
►The final definition of a qualified residential mortgage (QRM) and details on exemptions as it pertains to five percent retention. Agencies allegedly will be exempt, but if this is not confirmed down to the primary market creditor than this is a huge game-changer.
►New disclosures and structure under the CFPB.
►The future of Fannie Mae and Freddie Mac. How can the private sector grow under all of these regulations? How can the government slowly dissolve these agencies in our current housing market? When are these risk-based price adjustments going to get under control and actually apply to the risks?
►With all of the unknowns and much more … get ready for a wild ride!
I believe there is more opportunity for a mortgage professional right now than there has ever been to thrive in their career. I also believe that there is a significant opportunity in the wholesale origination channel for any LO. We are beginning to see new lenders entering or re-entering the wholesale channel to also take advantage of these new opportunities. Be aware, be positive and be driven by the things in life that actually matter.
Andy W. Harris, CRMS is president and owner of Lake Oswego, Ore.-based Vantage Mortgage Group Inc. and 2010-2011 president of the Oregon Association of Mortgage Professionals. He may be reached by phone at (877) 496-0431 or e-mail [email protected]
or visit AndyHarrisMortgage.com.