E*TRADE's new ventures: this young mortgage company has found success with correspondent lending, and now will try its hand at wholesale and warehouse lending.

SUPER BOWLS ARE KNOWN FOR their creative advertisements, and one of the more memorable spots in recent years came from E*TRADE FINANCIAL Corporation, the New York-based financial services firm. The so-called "monkey flop" ad starts out with a chimpanzee dressed in top hat and tails and cavorting around on stage with a chorus line of beautiful showgirls. Fred Astaire he's not. Then it switches to the following day, with a glum-looking chimp slouched at a conference table across from former E*TRADE Chairman and Chief Executive Officer Christos Cotsakos, who's admonishing the poor ape. "A musical?" says an incredulous Cotsakos. "What were you thinking? That doesn't fit our new image at all."

If anyone flopped, it was Cotsakos--E*TRADE's brilliant-but-abrasive founder, who resigned nearly two years ago after a falling-out with the company's board over declining revenues and his outsized pay package.

One of the firm's brightest stars turned out to be its mortgage business--including its corresponding lending division--which benefited greatly from a robust refinancing market. When a slumping stock market cut into E*TRADE's profitability, the mortgage operation helped it ride out the storm.

Matt J. Snowling, an equities analyst at Arlington, Virginia-based Friedman, Billings, Ramsey & Co. Inc., says that E*TRADE's mortgage operation accounted for 30 percent of the company's earnings per share last year. "For the whole [mortgage] refinancing boom, they were at the right place at the right time," he says. "And that helped offset a big dip in the retail brokerage business."

In 2003, the company generated $14 billion in direct and indirect mortgages--$8.8 billion through its direct online channel and $5.2 billion through its correspondent mortgage division. E*TRADE's production through the first six months of this year reflects a cooling off of the red-hot refinancing market. It wrote $4.8 billion in home mortgages, with production evenly split between both channels. Those numbers might be small bananas to an 800-pound gorilla like San Francisco-based Well Fargo & Co., one of the country's biggest mortgage lenders, but it's an important business for E*TRADE.

And soon mortgages are going to take on an even larger role in the future of the company. E*TRADE announced in October that it intends to enter both the warehouse lending and wholesale mortgage markets by early 2005.

The company wants to build on a reputation for excellent customer service that it has already earned in the correspondent marketplace, and it's not the least bit deterred by an anticipated decline in mortgage origination volume as interest rates continue to climb.

"We think as the markets get a little bit more difficult, people are going to be a little more discerning, and they're going to say, 'Who are my financial partners and who aren't?,'" says Dennis Webb, an executive vice president who runs all of E*TRADE's institutional business lines. "Some of our [mortgage] competitors are going to be called out for some of their deficiencies, and we see that as a great opportunity to step up and grab some market share."

The present-day E*TRADE has organized itself into two primary businesses--securities brokerage and banking--and serves customers in the retail, institutional and corporate sectors. A true pioneer, it began offering electronic investing services in 1992 and Internet services in 1996. Today, the brokerage business includes its online securities broker-dealer operation, which caters to the needs of so-called self-directed investors and is probably the activity that still defines E*TRADE in the minds of most people. But in recent years the brokerage side of the house has expanded to include several other subsidiaries that serve both institutional and corporate clients in the securities market.

E*TRADE didn't expand into banking until its acquisition of Arlington, Virginia-based Telebanc Financial Corporation in January 2000. Today the company offers a variety of consumer banking products through its $25-billion-asset E*TRADE Bank subsidiary, as the old Telebanc operation has been renamed. And it generates a variety of consumer loans through two other subsidiaries, including E*TRADE Mortgage Corporation.

The company's mortgage business has grown significantly in just a few short years. At the time of its acquisition, Telebanc--which started out gathering retail deposits over the telephone and later migrated to the Internet--had assets of approximately $5 billion. Savings institutions are required to hold 65 percent of their loan portfolio in housing-related assets in order to retain their charter and qualify for membership in the Federal Home Loan Bank System, so Telebanc already had an appetite for mortgage loans. But the online thrift had no way of originating loans for itself, so it purchased large mortgage portfolios from other institutions, which were kept on the balance sheet for investment purposes.

But in January 2001, it acquired Huntington Beach, California-based LoansDirect--an online mortgage originator--which gave it a retail channel. And around the same time, it started to generate loan volume through a correspondent division that focused exclusively on mortgage bankers, providing it with a second origination channel. Even though E*TRADE's core business is built around individual consumers, there was a compelling reason to target institutional customers as well.

Webb points out that online banks traditionally have had to find different ways of raising deposits and making loans since they lack a branch network, and many consumers still prefer to deal with their financial intermediary face-to-face. "Assets have always been the harder of the two to raise [for online banks], and that's the reason for the correspondent channel," he explains. "There's a need out there for someone that will cater to the type of customers that we cater to."

The correspondent division, which is run out of E*TRADE Bank's headquarters in Arlington, employs approximately 40 people and has more than 150 mortgage banking customers. The unit's managers decided early on to make high-level customer service one of its core strategies.

"We provide more assistance, more hand-holding and a higher level of working with a customer than a lot of other correspondent people in the industry today," says C.K. (Rick) Pishalski, vice president and business manager of the correspondent channel. This did not occur by accident. Pishalski and several members of his team came out of the capital markets, and when they were putting together a strategy a few years ago for growing the business, they decided to consciously avoid doing the things that used to tick them off when they were selling loans to buyers like E*TRADE.

"How could we structure this type of model to take that into consideration?" says Pishalski. "So [our correspondent business model] was customer-designed, and it has paid off because we've been able to grow the business substantially and maintain our buying levels pretty consistently."

The correspondent group has tried to keep this customer perspective in mind by listening closely to what customers have to say. "We have a customer advisory board, and we take suggestions from them," says Pishalski. "We look for opportunities that perhaps other people have missed."

Pishalski also tries to be flexible when working with E*TRADE's correspondents. It used to bother him when he ran into mortgage underwriters who seemingly couldn't think outside their tiny little box--"underwriting requirements that really were just monkey-see, monkey-do," he complains. "You know, the book says 'ABC,' and just because the book says that, you have an underwriter who would follow the book without applying common sense to the situation."

E*TRADE has its own underwriting criteria, of course, and Pishalski claims the correspondent group has been pleased with how well the quality of its mortgage loans has held up. "Our delinquencies are significantly less than what we believe our peer industry group is," he says. But E*TRADE is also willing to buy loans written to the correspondent customer's underwriting standards rather than its own if Pishalski and his team have developed a comfort level with the customer's approach. "We're not buying what we feel is unacceptable risk, but we are providing that extra level of customer service where our customer doesn't have to change something within their process just to do business with us," Pishalski says.

This emphasis on flexibility has forced E*TRADE to recruit a different type of underwriter than many other correspondent lenders might normally hire. Pishalski says he asked his head underwriter once why she kept interviewing people but wouldn't hire any of them. "And she said, 'Rick, what I'm looking for is the type of underwriter that can take a rather complex loan file of personal tax returns or business tax returns and figure the true risk of that deal and restructure it if necessary,'" he says.

"Within the correspondent channel we try to delegate down the decision level as low as we can, and empower the people to make decisions that are prudent and appropriate," he adds.

The correspondent group also has a flat organizational structure, which Pishalski believes greatly shortens its response time to customer requests. "Instead of a slow 'maybe,' we'll give you a quick answer," he says--although that answer won't always be yes. "It doesn't take a committee of 18 people to decide whether we can make this contract change or grant that variance. I think that gives us a leg up on some of the larger organizations that take six months to come back with an answer," he says.

The group is closely integrated with portfolio managers at E*TRADE Global Asset Management Inc., an in-house investment adviser that manages asset portfolios for the company's various businesses in the brokerage and banking sectors--including the $5.7 billion in real estate loans that it carries on its balance sheet. It reports up to Webb, as does the correspondent group. "We're a correspondent, but we're also an investor," Webb says. "We know how things perform. We know the attributes that cause losses and those that don't." Webb adds, "Rick has direct access to me and the portfolio manager, and there's an exchange of information going back and forth. It's a handful of people that make these decisions. We execute and move on."

Webb, who joined E*TRADE in 2000 from a commercial bank, says this attitude reflects the culture of the entire company. "You come into a meeting, you close the door, you say your piece, you make a decision, you execute, you move on," he says. "And that culture is refreshing to those of us who have been on the other side, where you come in, you debate, you do the PowerPoint presentation and two weeks later you do another PowerPoint presentation."

Two E*TRADE customers affirm many of the things that Pishalski and Webb say about their business. George Bain, president of mortgage bank First City Financial, a subsidiary of Denver-based Megastar Financial Corporation, has maintained a correspondent relationship with E*TRADE for approximately six months. He cites the "ease of transaction" when doing business with the company.

"Underwriting time is good," he says. "Document verification time is good. Pricing is good. And they have a little bit of common sense." Bain cites the example of a mortgage loan where the borrower has one 30-day late payment on his credit history. That may not conform to E*TRADE's underwriting standards, but the company is willing to overlook it if there is a good explanation. Another correspondent lender might not be so flexible.

"It's pretty obvious that they're in the business of providing good customer service, and in my business that's really important to me," he says.

Another mortgage banker--Steven Trowern, principal and chief financial officer at Dynamic Capital Mortgage Inc., Brookline, Massachusetts--has been doing business with E*TRADE for about a year and a half. Trowern says there's a good "fit" between the two organizations because "we essentially have the same principles with our customers."

He likes the fact that E*TRADE tries to be a pricing leader, and says its underwriters do an excellent job of interpreting economic data, which may reflect the fact that Pishalski's team has been integrated into the company's portfolio management process. "They price ahead of the curve," Trowern explains. "We try to price to what tomorrow's market will be, not today's market." And he, too, appreciates the fact that E*TRADE tries to work with its correspondents on loans that have run into trouble. "They understand what you're trying to do if you restructure something," he says. "If there's a word that describes E*TRADE, it's 'smart.'"

However, Trowern sees one area where there could be some improvement. He feels E*TRADE takes too long to bring new products to market, which he believes is a reflection of the company's cautious nature. "They can be late to market with product," he says. "They know the criticism. They've heard this from other correspondents."

Using the same customer-service blueprint, E*TRADE now hopes to take its success in the correspondent channel and duplicate that in both warehouse lending and the wholesale lending markets. Webb and Pishalski recently got approval from E*TRADE's board of directors to take the plunge, which would have been more difficult during the refi boom, when everyone was focused on keeping up with record transaction volume.

"This is great news for us," says Pishalski. "This is something we've wanted to do for some time."

Warehouse lending is a natural addition to its correspondent channel, since those correspondent lenders need access to institutional funding to operate. "Mortgage bankers could not be mortgage bankers without warehouse lenders," says Pishalski. E*TRADE expects to offer this facility to its existing correspondents in a bid to deepen that relationship even further. Pishalski sees it as an extension of the company's customer-service philosophy.

The company also will move into the wholesale market, a move that holds the potential to greatly expand its production volume over time. Brokers control approximately 50 percent of the mortgage origination market--which in effect means that E*TRADE has been running a one-legged race.

Terry Rowland, national sales manager for the company's institutional mortgage business, believes that wholesale lending is another natural extension of its correspondent channel, since it's a market where customer service is equally important.

"The broker is handing his client over to you, and if you don't have the same commitment to customer service, you can actually damage that relationship," Rowland says. "If that [transaction] doesn't go well, you could have a broker tell you that you've cost him a client for life."

The job of finding customers for E*TRADE's new warehouse and wholesale lending effort largely falls to Rowland and his sales team, which is now being expanded from five people to upward of eight or nine. He'll be a regular attendee on the mortgage industry's annual conference circuit as he gets the word out about the company's expanded capabilities. Rowland and Pishalski are both veterans of the mortgage business and they'll also rely on a deep roster of personal contacts to build the business, just as Pishalski helped build the correspondent channel.

These may seem like unusual business lines for E*TRADE, given its preoccupation with individual consumers, particularly in the securities market. But they serve an important strategic purpose--or so thinks Friedman, Billings, Ramsey & Co.'s Snowling. As the stock market has steadied itself through much of this year, he believes that E*TRADE is generating lots of retail deposits through its brokerage accounts. "They've got all this excess capital and they've got to put it to work," he says. "It may be the only quick and easy way to bring in some good asset growth."

Of course, E*TRADE is still originating mortgages through its online retail channel, but production there has slowed as the market changes from one dominated by refis to one where more emphasis is placed on home purchase loans. And the purchase mortgage market traditionally has been a tougher one for online lenders to crack. E*TRADE also has made progress in building online origination volume in other consumer categories like auto and recreational vehicle loans.

But a fully developed institutional mortgage capability will have a big appetite for funds, and should be able to take whatever the retail brokerage can send it. And that's no monkey business.

Jack Milligan is a freelance writer based in Charlottesville, Virginia, and the former editor-in-chief of U.S. Banker He can be reached at [e-mail].