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A veteran perspective.

A Veteran Perspectie

JESS HAY HAS BEEN chief executive officer of Lomas Financial Corporation since September 1965. This native Texan has directed the fortunes of a major mortgage banking company for longer than many others have been in the business altogether.

Hay graduated magna cum laude from Southern Methodist University law school in 1955 and is a member of more corporate, university and charitable boards than there are oil rigs in Texas.

His company, the parent of Lomas Mortgage USA, hit serious troubled waters when the Texas real estate market crashed with the fall of the oil business in the mid-1980s. Lomas Financial Corporation and its real estate-related subsidiaries filed for Chapter 11 bankruptcy protection in September 1989.

Although a recent squabble with the Official Committee of Equity Security Holders raised some small media headlines, a Lomas spokesman says the bankruptcy proceedings are going according to plan. The committee sought to file its own plan of reorganization for Lomas in lieu of one designed exclusively by Lomas management. Hay, in a statement, dismissed the committee's proposed plan, saying it "is based on implied enterprise value that Lomas believes is substantially inflated and, therefore, misleading." He criticized the committee, which issued a press release announcing its move, for trying to "negotiate a plan of reorganization in the media."

Lomas Mortgage has been actively buying servicing and making headline deals with the Resolution Trust Corporation (RTC). On April 10, 1990, the mortgage banking firm bought a $3.4 billion mortgage servicing portfolio and related assets from Bright Mortgage Company. The purchase added 90,000 loans to its portfolio. On May 30, 1990, Lomas Mortgage bought another $600 million portfolio from Ameriway Mortgage Corporation of Houston. This deal added roughly 10,000 more loans to the portfolio. Another small purchase from Carterett in January of this year brought the servicing portfolio to an all-time high of roughly 610,000, or $24.4 billion.

Just how close is this company from getting out of bankruptcy and what can we expect from the new Lomas are some of the questions we posed to Jess Hay, chairman and CEO of Lomas Financial.

Q: When do you expect Lomas Financial to emerge from Chapter 11 bankruptcy? What developments must still happen before that can occur?

A: It's impossible to say with precision; there are so many different constituencies involved with the process. The discussions with all the parties involved are going very well. It's fair to say that a reasonable target for completion of the process is sometime in the third quarter of 1991. The steps that need to be taken include an agreement on a plan for the business going forward. Then that leads to a definition of the aggregate enterprise value. We are very far along in the process of planning the business strategy of the enterprise going forward. And we are close to a definition of the value of the whole enterprise. But then you get into the more difficult part of the process and that is the division of value to the various parties. By mid-calendar year 1991, I expect the presentation of the formal plan for approval by all parties. But the process seems to have its own rhythm. The process has been very civil so far. I expect the talks to continue in that fashion. That has contributed to the stability of our operations during this period. I think the discussions are on a favorable plane at the moment. Assuming they continue this way, I expect Lomas to emerge from Chapter 11 as a strong operation no later than by the end of the year.

Q: What were the reasons that Lomas decided to exit the retail origination business, and are there any plans to get back into that side of the business?

A: We will not be in retail in the immediate future. When we exited in the Spring of 1987, we indicated we were going to maintain our capacity to re-enter that market when we perceived circumstances had changed in a way to make that an attractive business to be in. At some point in time in the future, we in fact probably will re-enter the production end of the business. In the meantime, the focus of our strategy is on continuing the growth of our servicing business. This is consistent with the pattern in the industry favoring a move toward smaller originators and the tendency toward consolidation of servicers so you can have the economies of scale and the tendency for greater productivity. One thing we know for certain is that the one constant in this business is change. We will be alert to the possibility of circumstances changing, and we will reconsider the production side of the business when it appears an appropriate and potentially profitable thing to do.

Q: How has the mortgage banking business changed since the early days?

A: Going back before GNMA, the basic mortgage banking function involved a relationship for moving capital from those that were capital rich to those that were capital poor. It was a paternalistic relationship between an investor and a mortgage banker as a local intermediary of the other. That has been in the process of radical change. By the mid-1960s, that particular aspect was a thing of the past, with a rare exception. Mortgage banking has tended toward consolidation and geographic diversification. Change is intrinsic to the mortgage banking business itself. Capital markets have changed, too. A key factor has been the advances and the broad acceptance of mortgage-backed securities. That has broadened mortgage bankers' access to the capital markets. Plus, there has been a whole myriad of complexities coming into the business in the last 20 to 30 years in terms of legislation and regulations. It now really requires a much higher degree of sophistication to conduct the basic business of servicing and originating loans. There are greater burdens and greater challenges for the business today.

Q: What are the key factors that have depressed the value of GNMA servicing currently?

A: I think GNMA servicing and all servicing has been victimized, to some extent, by the classic rules of supply and demand. The upheaval in the S&L industry introduced to the market, for the first time in the history of the industry, the prospect of an incredible supply of servicing in bulk for purchase. That supply exceeds, to some extent, the available demand and that has tended to depress market prices generally. But GNMA servicing prices also have been affected by the costs associated with VA no-bids and by the high costs associated with foreclosures and bankruptcies. The VA no-bid practice become fairly significant for us in the spring of 1986. That added a new and unprecedented risk to the business of servicing GNMA pools to the extent they included VA loans. The unprecedented level of foreclosures and bankruptcies also added materially to the cost of servicing. That affected GNMA servicing because the delinquency rates are higher on those loans. So, to the extent there has been a distinction drawn between conventional servicing and GNMA servicing prices, it is due to those primary factors.

Q: How do you combat the servicing runoff risk of being a large servicer without an in-house origination operation to replace the servicing that is prepaying? What particular challenges do you face as a servicer without a retail origination arm?

A: We are originating mortgages on a wholesale basis at a net cost to us of less than what our net cost had been when we were originating in the last few years [through retail production]. In the current environment, we are able to grow our servicing portfolio through our wholesale operation on the basis that it makes economically more sense to us than building it through retail production. How do we protect ourselves from refinances? We are prepared to and do offer refinancing opportunities to our own portfolio. We are prepared to move forward aggressively on that front if there is a truly strong drop in interest rates. Lomas' average coupon rate is between 10 and 10.5 percent, so rates would have to move 200 basis points below that for our portfolio to really be in jeopardy. We washed out a lot of high-rate stuff with the last big refinancing surge.

Our wholesale business in fiscal year 1991 will total approximately $3 to 3.5 billion. In addition to that, we will add bulk purchases, of servicing. We don't have any hard and fast target for bulk purchases but we will respond to opportunities in the market. As far as RTC purchases, we have been very happy with our acquisitions from the RTC and we plan to do more. We hope to get a reasonable share of the servicing they will sell.

Q: If you were building a mortgage company from the ground up in today's market, what would it look like?

A: I think the direction of the business has been pretty clear for a while now. If you were building a business from scratch, I am not sure you could alter the direction of the industry or whether you ought to try. I think you should be looking for geographic diversity and you should be looking to be large in size, and that is particularly true if you include in your new business, mortgage servicing as a component of your activity. There will continue to be room for smaller, geographically concentrated producers of single-family loans, where they produce with a view toward selling the loans and the servicing. I think that will be a profitable business on a stand-alone basis. But a major player would have to aim at size and have a reasonable base of capital strength in order to be competitive. It has become a complex business, and it takes capital to accommodate the various requirements for servicing and securitizing. I think it's a great business to be in. We enjoy it.

Q: Do you think that being an independent, publicly owned, mortgage banking company is the best corporate structure for operating a mortgage company?

A: I don't think it makes a lot of difference operationally if you're public or private. I don't think it makes a lot of difference if you're free-standing or attached to a large parent. The important thing is that the owner or the purchaser is a strong parent. The important thing is that the owner be committed to the business and understands that the business has its ups and downs. They need to just be willing to stay the course. That type of commitment is more likely to come from private capital that focuses entirely on the business, or from public shareholders, than from a corporate parent who has much broader interests.

Q: Fannie Mae is talking about approving a new type of seller/servicer that would be an investor rather than a hands-on direct servicer of loans. What impact do you see this having on the subservicing business?

A: I personally think those new sources of capital would increase the potential for subservicing business. What is being discussed is investing on a non-operational basis and that usually means you need an organization to handle the liability side. That fits right in with our arrangement as a subservicer. I think it would be an opportunity.

Q: How much excess capacity does Lomas have in terms of servicing? How many additional loans would you estimate that your servicing system could take on currently?

A: We think we have excess capacity, but we have not tried to find out exactly what our excess capacity is. We know we have a lot of capacity from a management point of view, and from a systems and space perspective, to handle very substantial growth in our servicing portfolio. Obviously, we would not try to deplete totally our servicing capacity with subservicing. But as long as we have excess capacity, we feel we can do subservicing. I don't have a particular mix in mind in terms of how much of our system we would like to use for subservicing. Strategically, we wouldn't want to jeopardize our capacity to grow our primary ownership of servicing, but we are a long way from being in that position.

Q: What is the target for additions to Lomas' servicing portfolio in 1991?

A: We hope to end the year with a portfolio totaling $26 to 27 billion. We are at [in mid-March] roughly $25 billion. We are looking to acquire more servicing, and we have not eliminated any product type [in terms of what we would buy]. We are moving away from what used to be a very strong government mix. The trend is toward increasing the share of conventional business in the portfolio and a declining percentage of government. But government is still a major stake.

Q: Do you think conventional servicing is overvalued in today's market?

A: You are always dealing with supply and demand. I think the total mortgage business is moving in the direction of an increasing share of originations being conventional. We are talking about a huge market. The price for good conforming conventional product is higher because of fundamental economic reasons - it is more valuable.

Q: Is it hard to believe that even with a servicing portfolio of more than $24 billion, Lomas is still less than half the size of the largest mortgage servicer?

A: Not really. It's always been clear to me that if Citicorp really ever exercised their announced strategy that they would have the capital necessary to quickly become the largest servicer [Citicorp's December 1990 servicing volume totaled $66.1 billion, according to Inside Mortgage Finance, an industry newsletter.] We will be right behind them. I'm not preoccupied with [rankings]. The trend in the industry has been entirely clear to me since the 1960s. We probably were the first to articulate the notion that the trends required geographically diversified and large portfolios. And we began moving in that direction in the sixties. We didn't invent that strategy, but technology enabled the growth of a huge portfolio at a central location. Technology and communication systems allowed growth beyond anything possible in the sixties. That made it possible for an operation that used to have to be localized for compelling reasons to be done from one central location. That industry direction has been in process since the mid-1960s, at which time the largest servicer in the country had a portfolio of $1.4 billion. Lomas bought that company and remained the largest servicer until 1984, when Citicorp and GMAC made their move. There will be others, and we will continue to grow as well.

Q: What impact on the mortgage banking business will the serious decline in housing starts have in both the short and long term?

A: A big percentage of origination volume in a strong housing environment is measured by housing starts - probably 30 percent of originations come from new homes with 70 percent coming from resales. I think a more fundamental development is that we are in a period of time when housing formations are declining, and that may last for another 10 to 15 years. The aggregate volume of mortgage business measured in units, not dollars, should be flat and declining, but the market nevertheless will still be huge. Those in the business as it has been restructured will do pretty well. During this time, there will be a continuation of the trend of having specialists in the industry. There will be some whose focus will be on the production side, and others whose focus will be on servicing. The impact on servicers of this [household formations decline] will not be discernible. But if you have a slowdown in family formations you are going to have a slowdown in appreciation. We have had it now for a good while. Already we have had some depreciation. Perhaps it was inevitable, and we may have a little more. Once the excesses are washed out of the system, then I think we will get back to flat or slow appreciation. But the notion of automatic appreciation from an investment in a home is probably not going to be part of the real world for several years. It probably never should have been figured in as part of the equation. If we are not already doing so, the market will be moving away from viewing a home purchase as an investment.

Q: In your view, is there validity to the notion of economies of scale aiding the very largest servicing operations to be more profitable? Are there steps that occur in connection with benefiting from those scale economies, where you have to get to the next level of size before a new set of economies is triggered?

A: There is some validity. We are just in the process of completing and converting to a significantly enhanced data processing system for our mortgage servicing operation. It enhances our capacity and has brought significantly increased productivity to our operation. We are already enjoying some of the benefits of that. The indicators of efficiency of our operation demonstrably validate that [theory]. That is just taking place, and as you grow, you do have challenges always. A principal driver in defining the evolution in the mortgage servicing industry has been the evolution of technology and the computer implications for servicing. You have to stay on top of that end of it to keep your capacity for growth on track. We are through that cycle and that is why we believe we have very significant capacity.

Q: What did the oil patch recession during the eighties teach you about the risks of the mortgage banking business? How would you manage your company differently if you had that period in front of you to go through once again, knowing what you know now?

A: I'm not sure what mortgage bankers can do to prepare for a major decline, for example, in the steel industry concentrated in the Rust Belt, or to prepare for a precipitous decline in the petroleum industry. I don't know anything that the mortgage banking business can do to prepare for those kinds of major financial shifts. As I look back, we were too heavily invested in real estate and too heavily concentrated in investments in the state of Texas. That was not planned, but it happened, and there would be ways to avoid that. But [severe financial declines] are not a mortgage banking problem but a problem for the whole economy. That's just risk, and unless you want to get into a really conservative mode, I don't think you can really protect against the kind of delinquency rates that occurred, for example, in Houston at that time, if you were going to have been in the Houston market from 1973 to 1982 when it was the hottest market in America. Even if you were smart enough to get out in 1981, when most people weren't thinking about doing that, even if you had, you would still have a heavy concentration of loans from Houston in 1986 when the bottom fell out. You were going to have some exposure.

Janet Reilly Hewitt in chief of Mortgage Banking magazine and Real State Finance Today.
COPYRIGHT 1991 Mortgage Bankers Association of America
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Copyright 1991 Gale, Cengage Learning. All rights reserved.

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Title Annotation:an interview with Jess Hay and Gene Bishop of Lomas Financial Corporation
Author:Hewitt, Janet Reilley
Publication:Mortgage Banking
Article Type:interview
Date:Jun 1, 1991
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