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A balancing act.

Wholesale lending's stunning growth has allowed mortgage companies to rapidly increase their volume and even restructure servicing portfolios. For instance, Riverside, California's Directors Mortgage Loan Corporation began wholesale lending a little more than two years ago. Today it accounts for half of the firm's production.

Source One Mortgage Services Corporation, Farmington Hills, Michigan, got into wholesale lending in 1984. "Our size and appetite means it makes sense to do both," explains CEO Jim Conrad. Last year a little more than half of Source One's $4.2 billion in volume was originated through wholesale. "I don't believe we could grow our production quick enough with just retail," Conrad says.

Yet, wholesale lending has not replaced traditional retail activities. Many large lenders see the two origination strategies as augmenting each other. "We can run both wholesale and retail businesses successfully," says Peter Wissinger, senior vice president at Norwest Mortgage, Inc. in Des Moines, Iowa. Wissinger heads the retail division, which accounted for more than half of Norwest's $13.2 billion in 1991 originations.

After the collapse of the 1986 to 1987 refi boom, mortgage lenders discovered that having people on staff who could produce didn't guarantee that a company would flourish. In fact, volatile interest rates can make yesterday's top office tomorrow's expense headache.

Management now is paramount, because having a strategy and then implementing it is the linchpin to success in today's mortgage business. Although traditional selling skills and contacts are as important as ever, businesses no longer can grow simply by hiring loan reps with natural sales talent and providing them cursory training.

The emergence of new types of loans has taken some of the simplicity out of mortgage lending. Demands made by the secondary markets and regulatory bodies, as well as the need for investment in new technologies, have increased the cost of doing business. In addition, the industry has become more competitive and profit margins have shrunk.

Today, there is not one approach - rather, there are choices made according to a company's existing financial and operational structure. Strategies differ between companies, depending on, among other factors, a company's access to capital and its management's willingness to set its own course.

Portfolio restructuring

Colonial Mortgage Company in Montgomery, Alabama has moved from being primarily a retail lender to a wholesale firm during the past few years, says Colonial President Ronnie J. Wynn. One reason for the switch was because management "wanted to change the servicing portfolio mix from Ginnie Mae pools to Fannie Mae conventional servicing."

The continuing liability for government loans plus the favorable accounting treatment of loans acquired through wholesale made Colonial's move from retail FHA and VA originations to wholesale conventional purchases an attractive one, Wynn explains.

Many larger companies view wholesale lending more as a means of increasing total volume rather than as an attempt to capture a certain type of business. However, that can cause problems when retail originators perceive wholesale prices - including those offered by their own firm - as being more attractive than what they can provide.

"Production is production to us," explains Richard Duncan, executive vice president at Columbia, South Carolina's Fleet Real Estate Funding Corporation. "It's important for the retail people to understand that," he adds, noting that a recent company-wide meeting brought all of Fleet's production units together.

Duncan told retail originators that wholesale prices might be better than retail rates because an originator can pass on to a borrower a portion of Fleet's servicing-released premium. But, he adds, the wholesale division is not competing against the retail staff, because it is seeking loans that otherwise would go to another wholesale lender.

Almost $8 billion of Fleet's $11.4 billion in 1991 volume came from wholesale lending. However, management hopes to bring retail production up to half the total origination volume. Duncan says that "Fleet is fairly conservative. We don't want to put all our eggs in one basket."

Staying balanced

"Growing a retail network fast is hard unless you take on a lot of risk," Duncan adds. Steps to building a retail network include finding the right market area, staff and location. You might end up on the wrong side of town, he explains, if you make a poor location decision for your branch.

Duncan says a lender must get the company's name established. "If you're really lucky, you might do $25 [million] to $40 million the first year," depending on the resources committed to the new office.

"You can grow wholesale faster," Duncan adds, because a lender can "establish a relationship with a correspondent who has already [gotten] established in the market." Fleet requires that its correspondents have a net worth of at least $500,000, have HUD or agency approval, have at least two years' experience and "enough volume to stay current on our procedures," according to Duncan.

But he notes that there is "a lot of competition" for the banks, thrifts and mortgage banker correspondents meeting those criteria. Duncan explains that because correspondents have limited warehouse funding, they need reliable funding sources. So although wholesalers can leave markets without much cost, their reputations might be tarnished if they ever choose to call on those originators again.

Those markets that rely on mortgage brokers provide the best opportunity for wholesaling, says David Frank, president of Margaretten & Company, Inc., an independent mortgage company based in Perth Amboy, New Jersey, that up until 1990, was a traditional retail originator. "It's tough to compete against brokers in retail," he notes.

Margaretten entered the wholesale business during the third quarter of 1990. In 1991, $600 million out of $4.4 billion in total originations came from wholesale purchases by Margaretten. Frank expects the wholesale arm to provide servicing portfolio growth. Margaretten's wholesale branch operates mainly out of the West Coast and Texas, while the firm's 58 retail offices are in other markets.

Although Margaretten managers say they might run wholesale and retail operations in the same market areas in the future, other lenders already are successfully doing that.

Managing for profits

Norwest was the nation's largest home mortgage originator in 1991. But retail manager Wissinger says his company's low market share - compared to total industry originations - "makes it difficult for me to argue against wholesale."

Wholesale, retail and servicing divisions all are run as separate profit centers by Norwest. However, both retail and wholesale loans come together at the national operations center, where they are pooled and shipped.

Managers of Norwest's 350 retail offices must balance their gross income and a value given the servicing rights they produce against their expenses and an allocation for corporate overhead. Because of this profit-oriented outlook, "No one in our company, except loan officers, gets paid off volume results," says Wissinger.

Norwest's branch expenses usually are less than 50 basis points per loan, and the home office allocation is 15 to 24 basis points, according to Wissinger. "We empower our managers to make a lot of decisions," adds Wissinger, who describes the company as "management-driven." Local managers can subsidize their pricing in order to attract business, for instance. However, they also are charged for cancelled loans.

Economics of lending

Different approaches to mortgage lending call for varying analyses of wholesale and retail business. Norwest, for example, wants to balance its source of profits between its retail, wholesale and servicing divisions.

"Profits per loan" are figured separately for the origination arms, according to Wissinger. Yet servicing also must be profitable, and at times Norwest will sell part of its portfolio to ensure servicing profitability.

Other lenders focus mainly on servicing portfolio growth, while some see origination and servicing as hedges against each other. For instance, Source One's Conrad says that in a slow market, servicing income makes up for reduced origination fees. He adds that in today's market, strong production is a hedge against prepayments. Source One currently has $42 billion in servicing, according to Conrad.

Knowing the profit in both wholesale and retail originations and "how fast you can grow each" helps corporate planning, adds Conrad. For instance, with that information the firm can figure how many new loans are needed to meet profit goals.

Source One has annual and five-year plans to meet financial goals, explains Conrad. "If we fall short of our needs with retail, we know what we have to do in wholesale."

Wholesale mortgage banking is driven to a certain extent by accounting rules that allow purchased servicing rights to be capitalized and amortized. The cost of loan servicing is written off over a mortgage's life - thus the expense of acquiring the servicing and the income from it tend to match.

Under FASB-65, only purchased assets can be amortized - thus all others must be considered as immediate income expenses. Most lenders acquire loans at a loss, which they expect to recover through future servicing income. However, the loss on current retail production goes directly to a firm's bottom line.

Retail originations are cheaper after netting all income and expenses, according to Fleet's Duncan. He says wholesale lending can, "on paper, make money," due to the favorable accounting treatment. "It takes two to three years to make money with a retail loan," he adds.

Currently, Fleet has retail offices in 35 states, covering the major metropolitan markets. Future expansion will be within those markets, adds Duncan. For instance, another branch might be added in an area of Los Angeles that isn't currently covered.

Fleet's wholesale purchases are done in 48 states, with operations centers in Milwaukee and Columbia, South Carolina. Four sales managers work out of those offices - but Fleet's wholesale operation "has no regional sites and no field people," Duncan explains.

Larger correspondents might use Fleet's "delegated program," which has a repurchase provision. A percentage of the loans will be screened for underwriting after purchase, says Duncan. Less experienced or smaller lenders usually choose "prior approval," which involves submitting the file to contract underwriters from GE Capital Mortgage Insurance and MGIC. Upon approval by the underwriters, it is shipped to Fleet as a close loan.

Opportunity management

In today's market it is difficult to reduce mortgage lending to a formula. Salesmanship, being in the right market, the use of technology, processing quality and many other factors play a role. While some companies discover a formula that works and clone their operations around the country, others allow each office to combine the elements in its own way.

Directors Mortgage edges toward the latter approach. "Opportunities present themselves and we look at all of them," explains Senior Vice President Norman Anderson. Expansion in both retail and wholesale has always been based on people - not an area."

Rapid growth has occurred as Directors expanded into wholesale lending through its Courtesy Funding division and also through acquired branch offices of troubled firms. Last year, Directors bought the West Coast branches of Old Stone Mortgage Corporation, as well as some branches of CenTrust Mortgage Corporation.

Expansion has helped Directors - the largest government lender in California for the past eight years - to diversify. Thus, production of both conventional and nonconforming loans is up dramatically.

Yet it hasn't necessarily happened by design. Offices "are built around people," says one executive at the firm. When acquiring branches, Directors "looks at cost and production and people, rather than picking a market it wants to be in," he continues. Other lenders agree. Fleet's Duncan notes that mortgage lending "is still very much a people business. Transactions are done one-on-one."

Directors' offices are designed around the talent in them, and staffs can range from two to forty people. A similar philosophy is followed when approving correspondent lenders. References are more important than a high net worth or a strong financial statement, managers say. Directors primarily wants to be certain that the firm is dedicated to being in the lending business long term. Correspondents range from mortgage brokers working out of their homes to large lenders.

Fast expansion

Similarly, Margaretten entered wholesale lending by bringing on board the manager of the wholesale office of San Ramon, California-based Home Owners Federal soon after the Boston-based savings bank was taken over by the RTC. Margaretten's wholesale division president, Ann Papanek, formerly of Home Owners Federal, says Margaretten's relatively quick move into wholesaling required "learning on both sides." Margaretten's President Frank remarks that "wholesale and retail have a different feel."

But Papanek adds that the members of Margaretten's management team "made up their minds they wanted to do it, and did their homework" to make the new enterprise work. Now, she works with "very experienced mortgage brokers." "Sometimes relationships don't fit," she adds, and Margaretten then no longer will accept business from a particular originator.

Papanek says the mortgage brokers she works with have anywhere from one to fifteen loan officers in their operation. Altogether, Margaretten has 350 approved brokers, one-fourth of whom use the firm regularly. "We don't want one or two loans a month, unless it's from a one-person shop," says Papanek. She finds that if a mortgage broker doesn't use Margaretten on a regular basis as a wholesale outlet, "they don't stay on top of packaging requirements."

While some wholesalers specialize in working with mortgage brokers, others prefer to do business with originators having higher net worths. Norwest correspondents, for example, have an average net worth of $750,000 and a minimum of $500,000, says Executive Vice President Jay Bender, who heads up Norwest's wholesale operation. "We're very selective about with whom we do business. We monitor the performance of their loans, as well as their financial condition."

Bender says the aim is to acquire "a very stable base of business partners" by checking prospective correspondents for good regulatory compliance and credit ratings, adequate warehouse funding lines and earnings and a strong delivery record and reputation. Norwest retail branches at times are called upon to get references for potential correspondents.

About one-third of the Norwest correspondents are banks and 15 percent are thrifts, according to Bender. The remainder are mortgage bankers - although half of those are bank subsidiaries. Norwest, says Bender, wants to work with "people who have something to protect."

Quality control measures

Although their overall operations are similar, wholesale and retail loan managers have somewhat different emphases. For instance, a retail manager must focus on the efficiency of the unit's processors as one primary concern, while his or her wholesale counterpart is thinking about quality control on third-party originations. Because the two origination approaches have different central concerns, most lenders separate their wholesale and retail divisions.

Usually wholesale does more pre-funding quality control by reunderwriting the loan, or at least reverifying credit, employment and savings information. Margaretten works with mortgage brokerage shops and reunderwrites every loan. On the other hand, Norwest works mainly with larger lenders and doesn't reunderwrite every file.

Fleet uses a matrix scoring system as "an early warning device" for quality control, says Duncan. Points are assigned to loans according to their characteristics. For instance, a 95-percent loan-to-value (LTV) mortgage might get "two points," while a 90-percent LTV loan would score "three." A self-employed borrower could earn "one point," while someone who has worked for the same company for seven years would get "three points."

Duncan explains that more traditional quality control measures catch problems later in the origination process. But matrix scoring has proven over the years to correlate with loan performance: the lower the scores, the higher the subsequent delinquency rates, according to Duncan. Correspondents who regularly score poorly will be talked with, says Duncan. Scoring is done "right after funding," he adds.

Some observers say they expect Freddie Mac to come out with more definite guidelines for wholesalers this year. Ronnie Wynn says Fannie Mae has "broad guidelines concerning third-party originations," while third-party originations to be sold to Freddie Mac require an individualized, negotiated commitment with the wholesaler.

Local focus

Striving to be "national in scope - local in focus," says Margaretten's Frank, is a common goal among wholesalers. Large lenders enjoy considerable economies of scale on the secondary market, which translates into good pricing. Additionally, they can afford large investments in technology for the back office. Yet, often mortgage brokers say that regional wholesalers provide better service, because they know the market better and are more likely to have a local office for faster turnaround.

Margaretten is attempting to speed up the loan process through its three wholesale offices by decentralizing quality control and post-closing. Having more functions in the field can increase costs, although that can save time by allowing documents to flow more quickly from originators to the wholesaler.

The question of how much to decentralize a wholesale business is important in the eyes of lenders. Norwest operations are centralized in Minneapolis, for instance, although six sales offices are used to make calls on clients, according to Bender. With more than 400 active correspondents, Norwest maintains 60 to 70 accounts per region, according to Bender.

Norwest's franchise approach to its internal management also applies to its regional wholesale managers, who are responsible for maintaining client relationships and negotiating sales agreements with them. However, correspondent approval and monitoring is done by the main office's credit management group.

Being a national wholesale lender since 1984 has required that Norwest be a reliable presence in all of its markets. "We've never been hot or cold," Bender explains. "We've never failed to honor a commitment." In fact, during the Oil Patch recession, Norwest expanded its operations in Texas, Oklahoma and Colorado, notes Bender.

Lending standards became more restrictive at that time due to underwriting requirements established by mortgage insurance companies for high-LTV loans. Delinquencies and foreclosures in the Oil Patch areas have been low for Norwest Bender adds.

Although the firm's wholesale and retail originations tend to be about equal in volume, "we don't set expectations for one business based on another," Bender notes. Each line looks at opportunities available to it and measures its own performance, he explains. "We're not always marching ahead at the same pace."

Retail benefits

Because of a retail office's fixed costs, volume fluctuations make the cost per loan vary. For that reason, Source One's Conrad looks at production and branch expenses every month. "Wholesale has very little downside," he adds, "since excess capacity isn't a problem. But in a normal cycle, retail is more profitable than wholesale."

Conrad explains that a retail operation has the ability to control its costs and set its price more so than a wholesale division, which must "price at the market." Wholesale quality control comes from "inspecting before purchasing," he adds.

Correspondents with net worths of $500,000 or greater can sell closed loans to Source One. Most other originators send a file to the wholesale division after processing for verifications. Rather than using a field sales force for calling on wholesale accounts, Source One relies on "almost daily phone contact," adds Conrad.

About eight or nine employees are required in retail for every one wholesale staffperson, in order to generate the same volume, he notes. Loan quality comes from building the right sales procedures into a retail division, Conrad says. "Checks and balances are required to ensure quality." Underwriting for Source One's 65 retail offices in 14 states around the country is spread regionally. Source One reunderwrites 10 percent of all loans coming in and performs the same back-end quality control measures on both retail and wholesale mortgages.

Increasing wholesale

"It's hard to expand" as a wholesale lender, says Colonial's Wynn. "More and more companies are in the business." Colonial started its wholesale operation four years ago, although Wynn says he "got serious" about it two years ago.

Colonial still does some retail originations, by working with a bank and does some government loans through this limited retail production. But moving increasingly to conventional loans through his wholesale division has helped Wynn decrease problem mortgages. With fewer than 25 delinquent loans out of 9,000 wholesale transactions, it is "much better than my retail delinquencies," he notes.

Having some retail production to sell servicing-released "provides the cash to fund wholesale," says Wynn. "We place just as much importance [on] each origination method," he adds. "They are very much complementary." Wynn expects production of more than $1 billion this year and keeps a ratio of 90 percent wholesale production to 10 percent retail.

"Long-term profit is greater in wholesale," he explains, because Colonial's loans will stay in the servicing portfolio 10 to 15 years, whereas his retail production is sold for a one-time gain.

With so much wholesale competition, Wynn is finding that "it is beginning to be a niche business." Colonial's niche is making table funding purchases from mortgage brokers who don't have warehouse credit lines. Loans are closed in the correspondent's name, then servicing rights are purchased by Colonial.

By providing a special service, Colonial can afford to have "very high underwriting standards," notes Wynn. He adds, "I spend more money on quality control than most of my competitors." Colonial offices approve about two-thirds of all submissions, which Wynn notes is in line with his retail closing figures.

New services

Although Norwest's wholesale division "tries to be very competitive all the time," Bender says, "we don't react to the competition." Whenever lenders are pricing well below the market, Norwest doesn't follow them, knowing that "they can't do it for long."

By pricing for constant wholesale earnings, Norwest can budget funds to increase its ability to compete in the future. Technology and new product development are two priorities for the wholesale division, says Bender.

Norwest is seeking ways to add value to the wholesale lending operation without getting into price competition. For instance, warehouse credit lines are being offered to correspondents, and the company expects to make that available to other lenders by the third quarter of this year.

Other technology-based services are expected to be added this year, Bender says. He notes they will "make it easier to communicate and do business with us."

As lenders find new ways to attract production while keeping costs to a minimum, one thing is for certain - those companies looking to maximize volume will take advantage of opportunity in both retail and wholesale mortgage banking.
COPYRIGHT 1992 Mortgage Bankers Association of America
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Copyright 1992 Gale, Cengage Learning. All rights reserved.

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Title Annotation:mortgage companies combine wholesale lending with retail lending
Author:Schneider, Howard
Publication:Mortgage Banking
Article Type:Cover Story
Date:Jun 1, 1992
Previous Article:Boardroom view.
Next Article:In search of real mortgage bankers.

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