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A spartan existence.

A Spartan Existence

Lean survival methods have kept mortgage brokers going in a time of spiralling costs for most sectors of the business. Their ranks are growing, and there have been some interesting developments as wholesalers increasingly flock to the low-overhead services they provide.

Mortgage brokering sounds straightforward: loan officers can work out of small shops, keeping their overhead low and being able to react quickly to local market changes. By avoiding the costs of buildings, secondary marketing staff and corporate managers, they'll be able to make a living just from origination fees.

But a mortgage broker is also a business owner--not a field rep. Management and regulatory consideration thus add to the challenge of originating loans in a stiffly competitive marketplace.

As financial institutions and mortgage bankers have closed retail offices during the past few years, mortgage brokers have grown to dominate the market in some parts of the country. In 1984, "there were not five mortgage brokers in the state of New York," says Ralph LoVuolo, Sr., president of Deer Park, New York's LoVuolo & Company, Inc. "Now there are almost 2,000."

H.A. "Tony" Davis, past president of the Illinois Association of Mortgage Brokers and head of his own firm, Preferred Mortgage Associates, Ltd. in Lombard, says Chicago-area title companies claim brokers account for 55 percent of all Illinois loans. One reason for the trend is that Realtors have become more receptive to working with brokers, Davis adds. "The change in the real estate community over the last three to four years is like night and day."

Due to this emergence of mortgage brokers in residential lending, it's not surprising that "states are looking pretty hard at them," says Andrea Lee Negroni, an attorney in the nation's capital and author of Residential Mortgage Lending: State Regulation Manual (published by Clark Boardman Callaghan). Brokers, she adds, "have been regulated with laxity for the last five to ten years."

National Association of Mortgage Brokers (NAMB) Executive Director Michael Hoogendyk notes that most states currently have laws concerning mortgage brokers, and new legislation is being considered in numerous states. Regulations vary widely, although uniformity among state laws is one goal of the three-year-old American Association of Residential Mortgage Regulators (AARMR). In addition, AARMR serves as a clearing-house for reports of fraud, making it tougher for a bogus originator to transfer his operation to another state.

Greater market share

Wholesale lending also is booming. Countrywide Funding Corporation started its wholesale division in 1987. In fiscal year 1991--which ended last February 28--the wholesale division brought in $1.4 billion, or 31 percent of the Pasadena-based firm's total volume, according to Standard and Poor's.

By the summer of 1991, Countrywide was buying from $250 to $300 million each month in mortgage broker originations, says Jerry Baker, managing director of production and support divisions. According to Standard & Poor's, wholesale loans were making up 39 percent of Countrywide's business by September of this year.

As a result of such increases in purchased originations, particularly from mortgage brokers, Freddie Mac and Fannie Mae have begun asking if there is more risk from loans originated by a third party. Freddie Mac now buys such loans only on a negotiated basis.

Fannie Mae is asking seller/servicers to track delinquencies on brokered loans separately from retail originations, says director of loan acquisition Roy Downey. But he adds that "the majority [of brokers] are doing a very good job."

Mortgage bankers aren't the only firms making use of mortgage brokers. For instance, people who walk into branch offices of California's Western Federal Savings, based in Marina del Rey, won't find anyone who will take a home loan application. Instead, they are given a toll-free number to call and are referred to one of the thrift's approved mortgage brokers. Vice President Pat Briggs explains that "we don't want to compete with our brokers in any way."

Western Federal started relying on mortgage brokers eight years ago, after attempting to work with homebuilders and also trying retail originations. Officials say buying loans from brokers gives Western Federal cost savings and makes competition with larger thrifts easier.

Who are brokers?

The growth of mortgage brokering is reflected in NAMB's membership. In March 1988, the Phoenix-based group had 440 members. But just three years later that number had risen to 1,200. Besides lobbying governmental and regulatory bodies, the association is seeking to increase public awareness of mortgage brokers. NAMB members also are eligible to earn the professional designation of Certified Mortgage Consultant (CMC).

Despite the numbers of competing mortgage brokers, they seem to have no difficulty discovering funding sources. "Wholesalers seeks us out," LoVuolo reports. "Our fax machine goes most of the day. We look at them all." With one person working as both processor and underwriter, plus six producers, LuVuolo expects $40 million in 1991 fundings. He sells primarily to four wholesalers, but the firm is approved by at least four times as many.

Brokers don't fit into molds any more than Western Federal acts like a traditional thrift. Some mortgage brokers have staff underwriters, in-house training and marketing programs that include conducting phone surveys of clients and referral sources after every deal.

D.L. Herndon III, owner of Westlake Village, California's The Herndon Company, ran several mortgage firms and also had experience in public accounting before opening his brokerage business. Now he works mainly with self-employed borrowers. Herndon's loan packages thus often contain both personal tax returns and business cash flow statements.

In order to get a loan approved, Herndon finds that changes might be needed in a borrower's business finances. For instance, when an entrepreneur has substantial personal funds invested in his firm's inventory, Herndon might suggest the person get a business line of credit to pay for the inventory and then transfer some cash into a personal savings account.

Because many entrepreneurs must personally guarantee their corporate debts, at first glance their credit reports might cause lenders some concern. Herndon says he "knows how to position" the borrower's financial statements to give lenders a clear picture of how much cash is available to make home payments.

In addition to working with Realtors, Herndon gets referrals by keeping in touch with past clients. Community bankers also refer customers to him when they don't have a mortgage that suits one of their clients.

Big lender strategies

Some of today's large volume lenders--such as Bank of America and Norwest Mortgage Corporation--combine retail and wholesale production strategies, notes Stuart Feldstein, president of SMR Research Corporation in Budd Lake, New Jersey.

Yet other big lenders avoid certain aspects of the wholesale business, or stick with in-house originations altogether. Since last February, Columbia, South Carolina's Fleet Mortgage Group has had "no relationships with brokers," says Executive Vice President Richard Duncan. Although the firm is a major player in wholesale production, retail originations, adds Duncan, allow a lender to have "better control over employees."

One factor influencing Fleet's decision to stop using mortgage brokers was the administrative needs for processing loan packages from many different brokers. Even receiving packages in which documents are in a different order makes the task harder, Duncan notes. "To be effective, you have to have some flexibility" when dealing with brokers, he adds.

Ann Tierney, a vice president at GE Capital Mortgage Services in Cherry Hill, New Jersey, says the firm works with 270 correspondents. But because of its volume appetite, GE works with mortgage banking companies, not brokers.

"Stronger financial standing" is required of correspondents, Tierney says, because of increased risks in home lending. At the end of 1990, GE required correspondents to have net worths of at least $500,000. By the end of 1992, they will need to have $1 million in net worth and other requirements to do business with GE, according to Tierney.

Finding funds

Despite their small size and lack of sizeable net worth, mortgage brokers can have surprisingly sophisticated operations. Mark Ross, CMC, president of Tucson's Prime Capital, Inc., works with two dozen wholesalers as well as "200 private investors" he has found over the years. With these sources Prime Capital originates "|A' to |D' paper," Ross says. Lower-rated loans are "very well-secured" by collateral, and loan-to-value ratios are a maximum of 70 percent; most are at 50 to 60 percent, he adds.

Customers are found by referrals from traditional sources, as well as from recreational vehicle dealers and home improvement-related firms, such as pool and fence companies. In addition to originating residential paper, Prime Capital also does commercial property loans and second mortgages.

Ross presents private investors--such as doctors or pension funds--with the borrower's credit report and a property appraisal in order to help them decide whether or not to fund the loan. Prime Capital succeeds in a medium-sized city, although most mortgage brokers are found in urban areas that have "a lot of real estate transactions," says Hoogendyk.

How brokers work

Some brokers rely on advertising, mailings or telemarketing for business prospects. However, most find that referrals from Realtors, financial institutions and past clients are the best ways to get business, says former NAMB president C. Kent Miller, CMC, president of Gilroy, California's Monterey Mortgage.

Brokerages are managed to fit individual philosophies. For instance, Donald Henig, president of Island Mortgage Network in Islandia, New York says purchase loans make up 85 percent of his business, because he doesn't want to hire staff for refinancings that will go away when rates rise.

On the other hand, current NAMB president Diane Kelly, president of Virginia Mortgage Exchange, Inc. in Annandale, Virginia, currently is soliciting previous clients for refinancings. Now is "a marvelous time" to turn a second mortgage into a new first, she explains.

Brokers originate loans for less than do many traditional lenders by avoiding both nonproducing managers and excess capacity. "All of us have a tendency to be understaffed," says Kelly. "You work until the job's done." Kelly has six employees in her 40-year-old firm. But she adds that often, mortgage brokers are in "a mom-and-pop shop," consisting simply of an originator and a processor.

Balancing staffing to meet the volume of loans is "a very, very difficult problem," adds Henig. "It's something you have to keep your eye on every day. You want to give the best service, but you don't want overhead."

Tying compensation to results also makes brokers efficient. For instance, D.L. Herndon pays his staff on a perdeal basis. "I want everyone to care about the business as much as I do," he says, "and have the same vested interest as I do."

Some brokers pay wholesalers to process their loans, while others try sharing an office or franchising to save on overhead. Franchising is seen as a way to save on marketing costs by combining the resources of numerous offices. One mortgage brokering franchise, Amerimac Equifirst Mortgage, in San Jose, even uses "Wheel of Fortune" hostess Vanna White as its spokesperson, according to Hoogendyk. But observers note that some franchises provide limited training, which "can give neophyte [loan officers] a false sense of security."

Regulatory blues

Because brokers work with consumers, their activities are coming under greater scrutiny--particularly at the state level. Regulatory practices range in severity from no oversight in Mississippi to requirements of a $25,000 net worth and annual fees costing thousands more in Illinois.

Having minimal capital requirements to enter the business or to participate in table funding programs are points of contention for mortgage brokers, who often are thinly capitalized. Attorney Negroni notes that "you can't always tell who the good guys are based on how much capital they have."

Florida brokers take 24 hours of classes on mortgage finance before being licensed and must disclose the fees they receive. Only New Jersey and Arizona also require mortgage brokers to pass a test, says Negroni. But she advocates that feature, which "regulates competency, not solvency."

Licensing requirements

Different states use various regulatory bodies to watch over mortgage brokers. For instance, the state banking commission regulates brokers in Florida, while the department of real estate does so in California, which requires just a real estate brokerage license to get into the business.

In Illinois, brokers are licensed annually and examined every other year, says Commissioner of Savings and Residential Finance Jack Seymour. Loans also are spot-checked, bonding is required to establish a third-party review of brokers, and a $25,000 minimum net worth is necessary. Seymour says this reserve isn't meant to provide funds for buying back bad loans, but instead is an indicator of overall economic health. "People do desperate things when they run out of money," he explains.

It's not uncommon for mortgage brokers to see most regulatory action as threatening. "Regulations from the state level are running rampant," contend Henig. "More regulations are coming every week," adds the former NAMB president. "Every one of them is scary." Yet despite increasing governmental oversight, mortgage brokers will not be regulated out of business, Negroni says.

Because the mortgage brokerage industry is fairly new, some observers claim that regulators aren't always familiar enough with mortgage brokering to adequately oversee it. Negroni charges that regulators in certain areas "are not well-versed in mortgage banking."

James Brodsky, an attorney with the Washington, D.C. law firm Weiner, McCaffrey, Brodsky, Kaplan, & Levin, notes that varying state regulations will make it more difficult for a national lender to manage a large retail network. Wholesaling thus should increase, he adds, but brokers will start being held increasingly accountable for the quality of loans they originate.

To give an overview of how legislators are thinking, Brodsky cites the following trends in state law requirements covering mortgage brokers:

* net worth and broker

bonding requirements; * fee limits; * written agreements with

customers; * increased disclosure to

borrowers and investors; * identification of lenders

used; * licensing as a lender before table

funding is allowed.

Although similarities are apparent, Brodsky says, "states move in non-uniform ways. They deal with abuses or problems they see." Randall Holland notes that as director of the Florida banking department's finance division, he is working for a political appointee. When constituents make complaints about originators, both his field examiners and the state's legislators tend to act.

Other states see similar patterns. For instance, calls for protection both from wholesalers and consumers helped usher in Illinois' stringent mortgage broker licensing requirements. Seymour estimates that brokers spend $4,000 to $6,000 annually to pay for license fees, annual audit fees, examinations and state spot-checking of loans. Broker Davis says the figure is actually as high as $8,000.

When the law passed in 1987, mortgage brokers and out-of-state servicers who were affected by the Illinois Mortgage Banking Act were outraged. Seymour notes that the industry had not been regulated before then in the state. So it was a shock when licensing fees jumped overnight from $500 a year to around 10 times that amount.

Yet, Illinois is home to just 300 mortgage brokers, says Davis, while LoVuolo says the situation is different in New York where "there are just too many people in the business." He notes that New York requires only a $500 fee and does no testing of mortgage brokers. Thus, competition increases with easier entry into brokering.

But while Illinois has no education or experience requirements for mortgage brokers, Arizona licensees must have three years of real estate lending background, take a required course, pass two exams and post a $10,000 bond.

Yet that doesn't bother Tucson broker Mark Ross. "Cosmetologists go to school," he notes. And because "instances of fraud get big press," Ross would like to find ways of discouraging these practices.

At the federal level, Brodsky explains that officials at HUD, Freddie Mac and Fannie Mae are stressing net worth, quality control and internal audit of mortgage brokers.

Bad apples

The incidence of mortgage origination fraud in Illinois is "very small," says Commissioner Seymour. But since such activity puts a firm at risk, "you don't engage in mortgage fraud on a one- or two-case basis." He recalls one Chicago mortgage firm "which had been around for years" that had double-sold hundreds of loans.

"We want the crooks out of here just as bad as anybody else," says the NAMB's Hoogendyk. But he contends that when lenders don't underwrite all the loans they buy, they leave the window open for certain unsavory characters who will become brokers and sell fraudulent loans.

Most fraud occurs with a new mortgage broker or in a geographic area that is new to San Jose's First Franklin Financial Corporation, says CEO Bill Dallas. By not spending enough time researching brokers' backgrounds, Dallas notes that fraud "is almost always our fault." In addition, First Franklin tries to "make brokers responsible" for their loans by letting them know what percentage become delinquent, Dallas says.

But at GN Mortgage in Canoga Park, California, president William Jacobs has begun filing criminal reports and prosecuting mortgage brokers who practice fraud in an effort to get them out of the business.

Negroni says that "distressed borrowers" facing foreclosure or falling property values are the most likely victims of fraud. She suggests mandating a "|change-your-mind period' of 48 to 72 hours" after an application is taken, and also letting mortgage brokers collect fees only if an application is approved.

Wholesaler perspective

To guard against fraud and related problems, Countrywide looks at the experience of each mortgage broker and his or her employees, says Executive Vice President Rick Cossano. References are checked and physical inspections of the broker's offices are done before approval, he adds. Although Countrywide doesn't keep a list of brokers to avoid, the firm does "share informally with other wholesalers" the names of brokers that aren't approved to do business with them, Cossano notes.

Working out of 17 regional offices, Countrywide's wholesale underwriters were rejecting about one-third of all broker applications as of September 1991, according to Standard & Poor's. Countrywide has approved 3,000 mortgage brokers nationally, says Cossano, who adds that three-quarters of the firm's wholesale business comes from one-fourth of those brokers.

Most wholesalers work only regionally, although at times these smaller lenders then sell broker-originated mortgages to national wholesalers. Using mortgage brokers allows a smaller firm to quickly access a large sales force. As borrowers began showing a preference for fixed-rate loans early this year, Western Federal decided to offer mortgage brokers its firstever, fixed-rate mortgage product. Six weeks after being unveiled, it accounted for about one-third of Western Fed's home loan volume.

Lender-broker relationships

"The longer you work with someone, the more you know how they work," says Preferred Mortgage's Davis. "Trust develops." Attempting to "make my client a real person" in the eyes of the wholesaler "helps make a deal go," adds LoVuolo. To do so, he often will visit wholesalers to discuss a loan even before sending in the application.

Brokers claim there's no conflict in being paid by a borrower, while following a wholesaler's guidelines. "We work for the customer," explains Davis, "and represent the wholesaler." He adds that 40 percent of all loans need additional "explanations to substantiate why they should qualify."

Many mortgage brokers expect to see closer business ties with wholesalers emerging in the future. Even small favors can help, they note. One broker says that often wholesalers will fax rate sheets first to their top producers. When rates are falling, getting new prices 15 minutes before the competition can help a broker get a loan he's been working for.

Brokers and wholesalers agree rates are important in determining where the business goes. If a wholesaler is off the market by more than 25 basis points, he won't get many loans. But even great rates can't guarantee a wholesaler return business. For instance, Ross describes his relationship with wholesalers as "love-hate." Although he needs the funds, inconsistent requirements and underwriting standards are "frustrating."

Most mortgage brokers today complain that wholesalers are asking for more documents than in the past, taking more time reviewing them--and then asking for some more documents. One broker complains of loans that "are processed to death."

Repeated requests for more information can irk a mortgage broker, who often has an anxious real estate agent or homebuyer on the other line. It's not surprising that each side of the business doesn't always understand the other. But generally, mortgage brokers and wholesalers think well of each other and describe their relationship in positive terms.

But that doesn't stop mortgage brokers from wanting to see more perks from wholesalers. In addition to marketing and training support, more financial incentives are expected to be offered by wholesalers in the future.

Miller adds that co-op advertising is an anticipated benefit. A wholesaler would pay part of the cost of advertisements that a mortgage broker uses to promote the wholesaler's product.

Today, some wholesalers provide incentives, such as better rates, in return for reaching certain volume levels. In addition, faster underwriting, documents and funding, as well as daily pipeline reports, are benefits some wholesalers give preferred customers.

One mortgage broker sees the practice of offering rebates giving way in the future to providing mortgage brokers with a share of servicing value and income. Doing so would provide an incentive to the broker to originate quality loans and guarantee him or her some cash flow to cover overhead during lean times. Although wholesalers generally don't talk about such matters, the mortgage broker says "some wholesale lenders are making those kinds of things available for a select few, based on volume."

Consumers benefit from a healthy partnership between wholesale lenders and mortgage brokers. Wholesalers bring operations efficiency to home lending, while brokers are the human side of the business. "We go to our closings," says Davis. "It's nice to see people move into homes."

Howard Schneider is a freelance financial writer based in Ojai, California.
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Title Annotation:increased demand for mortgage brokers' services
Author:Schneider, Howard
Publication:Mortgage Banking
Article Type:Cover Story
Date:Dec 1, 1991
Previous Article:Wholesale giants.
Next Article:Netting wholesale opportunities.

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