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Buyers by design.


Runaway volume taught some valuable lessons to major wholesalers earlier this year. Quality is the critical component, even if it means sacrificing new business. THE BIG ENGINES OF LOAN production these days are in the hands of the wholesalers. Two of the largest mortgage wholesalers were on a pace early in 1990 to book $7 billion and $10 billion in originations for the year, until the volume proved too much for their back offices.

In all of mortgage lending, there are only a handful of lenders that can boast yearly volume numbers like that, particularly in a year that is likely to tally up as a bit of a snoozer anyway.

How many originators, when they think back over 1990, will remember it as the year of too much volume? Not many, unless you are a Fleet or a Marine Midland.

But blazing volume is one of the big pluses that has made wholesaling one of the hot spots of the mortgage business. The huge origination volumes that the big players in wholesale pull in during an average month yield another attractive payoff. Wholesalers can literally engineer their idea of a model servicing portfolio in a fraction of the time it would take if you were doing production the old-fashioned way--with branch offices and crack loan sales crews.

The sophisticated players at the wholesale game also make the most of data generated by computers on their production and their correspondents. The data they watch and incorporate into their pricing tracks fast and slow prepayment areas and low and high delinquency regions. On top of that, they throw in a profile of the types of products they don't want (read VA loans, investor loans, some types of condo loans, and a few other assorted undesirables), which helps them arrive at a list of desired products that they will pay the most to get. And there you have it--servicing assets written to specs. That is what wholesalers have going for them. And the engineers of wholesale are taking advantage of this in a major way.

Mortgage Banking talked to three key participants in the wholesale business earlier this year to find out what their particular niches are and what is on the most wanted and unwanted list of mortgage products. We also asked them about the sophisticated tools they use to control the unique risks of this part of the production business. Mortgage Banking interviewed representatives from Fleet Mortgage Corp, Milwaukee, Marine Midland Bank, N.A., Buffalo and Dominion Bankshares Mortgage Corporation, McLean, Virginia, to get a glimpse at this growing sector of the business.

Runaway volume

Even though the basic formula of wholesaling sounds great, all is not entirely rosy in the purchased production business. Buyers of loans originated by outside producers face some unique problems in their branch of the business. When the originator is not one of your own, you lack total control over origination quality, you face pipeline fallout problems unique to wholesale, you face bulging and unpredictable volume periods that strain your back office and, finally, you are dependent on a correspondent's financial strength to enforce your buyback rights.

But the ability to design and construct your servicing portfolio to avoid the regional concentrations that became a black hole for services of government loans in the 1980s, has made wholesaling increasingly popular. Even as long ago as 1987, purchased production represented slightly more than 33 percent of total one- to four-unit origination volume, according to data collected by the Mortgage Bankers Association of America's (MBA) economics department. It was just a shade under a third of residential originations in 1988 and has grown substantially since then.

James R. Loving, vice president--correspondent lending, Fleet Mortgage Corp, Milwaukee, directs one of the largest wholesale operations in the country. Loving expects that fully two-thirds of Fleet's final origination volume for this year will come from its wholesale programs. Fleet's niche in wholesale has traditionally been as a major purchaser of government loan product--VA and FHA mortgages. But Fleet's focus has more recently turned toward conventional production. Even so, by the first quarter of this year, Fleet Mortgage Corp and its sister company, Fleet Real Estate Funding Corporation, Florence, South Carolina, were still number one and two on the list of top Ginnie Mae security issuers. Fleet Mortgage Corp alone had 10.5 percent of the market for new Ginnie Mae issues with a total of $1.7 billion.

Loving's company was on a path to do $7 billion in wholesale originations earlier this year even though they had budgeted to do only $3.9 billion. The boom in production was brought under control when Fleet decided to suspend its assignment of trade business in the spring. The mountains of loans coming in through the wholesale window had strained Fleet's loan processing and turnaround time to longer that its customers were used to waiting to get paid for their loans.

Changing gears

Loving said, at its peak, when Fleet was still doing assignment of trade business, the turnaround time was five days under the loan-by-loan purchase programs and between five and six days in the assignment of trade wholesale program. Fleet knew it had to make a change to keep customers content with doing business with one of the long-time flagships of wholesale--particularly in the wake of growing competition from new players. So, the assignment of trade business was halted. Loving says the turnaround time today is between 24 and 48 hours in the loan-by-loan purchase program. Only 25 to 30 customers were lost by dropping the program. Fleet Mortgage's wholesale operation still has a total of 526 correspondents--a number that is constantly changing as some customers are dropped or new ones added, Loving said.

Loving is keenly aware of the growing number of competitors in wholesale, as were the two other executives we talked to. Loving noted, "I think if you take a look at the top 25 Ginnie Mae issuers, I would say virtually 95 percent have some type of wholesale program." But the wholesale production volume appears to continue to grow to accommodate new participants on the buy side. As mortgage banking companies continue to shift away from an overwhelming reliance on retail, many loan officers have taken to opening their own small mortgage brokerage shops that sell their loans servicing-released to the large wholesalers.

Loving observed that even after closing down their assignment of trade business, Fleet Mortgage is still on track to beat its original $3.9 billion budget target for 1990 wholesale originations. He noted that May volume figures were particularly impressive and that "the growth in the numbers has been incredible."

Another major wholesale operation that was posting runaway volume early this year was Marine Midland Bank, N.A., Buffalo. Although the year's budget called for $4.5 billion in originations from the wholesale operation, the pace in the first quarter showed that Marine was headed for a $10 billion year. April alone brought in $750 million from the wholesale side, according to Allen F. "Pete" Grum, department executive with Marine Midland Bank. Marine took some rather dramatic steps to curtail that boom in business and now expects to post volume for the year close to the original $4.5 billion target.

Marine began the year doing wholesale through a variety of different programs. They did purchases on a "flow basis" where individual loans are purchased from correspondents shortly after they are originated. Marine also did bulk purchases of loans, bulk purchases of servicing and assignment of trade business. Marine stopped their assignment of trade business at the end of June, and Grum does not expect the bank to resume that program. Now Marine has pared back its wholesale operation to only include flow purchases and what Grum called concurrent transfers of servicing. The latter incorporates an already sold loan that upon settlement of the mortgage-backed security, would assign the servicing to Marine Midland, Grum said.

To substantially slow the boom in business, Marine cut its correspondents and gave those remaining strict volume constraints. During the first quarter, Grum said, every correspondent overdelivered by roughly 150 percent. Now, the 150 remaining "active" correspondents-- down from a peak of roughly 400--are on "specific budgets as to what they can deliver," Grum said. The budgets are less than what these customers delivered in prior years, he added. What Marine did to bring volume under control runs against the grain of a typical wholesale operation. As Grum notes, the bottom line result of the action was to "send business to our competitors."

Taking care of servicing

The primary mission for a wholesaler is to line up a large stable of quality correspondents and then encourage them through pricing and top-drawer service to deliver as much quality product as they can produce that suits your product demands. But signing them up and keeping them in the fold are two different matters. What both Marine and Fleet found out earlier this year is that there is a limit to the volume you can handle without jeopardizing the critical service component of wholesaling--which is key to keeping the cream of the correspondents crop as contented customers. And with growing numbers entering the wholesale field as buyers, correspondents can say with conviction that they are taking their loans and going elsewhere.

So, to head-off potential defections among its correspondents, Marine stopped taking new customers last year and halved its roster of active correspondents to deliver the service it believed its top customers expected. Grum says, "It was a situation where the service that we were providing to our customers was not acceptable to us." The volume boom plagued Marine's back office where turnaround time began to suffer substantially starting late in 1989, Grum said. Marine Midland does only conventional loans in its wholesale program, with a specialty in jumbo loans. Marine Midland does a full underwriting review on its wholesale business, with no matrix scoring, and fields a staff of about 20 underwriters to handle the workload, Grum said.

To handle the crush of business, Marine added roughly 15 new staff in the funding and underwriting departments. As a result, turnaround time gradually improved from its 5-day pace at the worst of the crunch, to the current turnaround time of "well within 48 hours," Grum said.

Wholesale boom

What were the factors driving the boom in business early in 1990? Grum says the rush of wholesale business partly relates to the fact that overall loan production activity early in 1990 had been soft in many markets for most originators. That meant that significant origination income was not there to cover cash flow needs for some lenders. He explained that translates into a "lot of correspondent-type business. The market was somewhat softer, and what happens is that as profits dry up, people begin to sell more [to capture the value of the servicing-released premiums.]"

Also, new risk-based capital rules that banks and thrifts must live with were having an impact on many of the bank and thrift-owned correspondents that form the bulk of Fleet's and Marine's customer base. Grum said that "by January, [the dawning awareness of how the risk-based capital rules would affect individual institutions] was really a cold slap in the face." When these regulated institutions realized they could not readily find the added capital needed to meet the new standards, one answer was to sell assets to downsize the institutions to a level that met the capital requirements. The "good majority" of Marine Midland's correspondents are subsidiaries of banks and thrifts, according to Grum. And approximately 75 percent of Fleet Mortgage's wholesale customers are banks, thrifts, or subsidiaries of banks or thrifts.

One of the most important rules of the game in wholesaling is keeping the customers you want happy. But another critical rule is identifying the customers you don't want and getting rid of them quickly, before they botch up your operation with a lot of bad loans or create havoc by failing to deliver on their commitments too many times. All three wholesalers we talked to do elaborate monitoring on the performance of their sellers in a variety of different ways. But in recent times there have been other reasons for dropping correspondents, aside from high delinquency rates on their loans or excessive failure to deliver promised loans.

Loving said that Fleet Mortgage "lost a tremendous amount [of correspondents] because of the thrift debacle." He could not pinpoint an exact number of customers who dropped from the ranks because of the thrift insolvency crisis. But, he said, "The vast majority of ones were cut because their financials did not meet our criteria in the last year." A correspondent's financial net worth is critical to its wholesaler because that is what the buyer looks at to ensure that a correspondent has the cash to buy back a faulty loan.


Correspondents now are being eye-balled by their wholesaler's computers in every possible way. Loans are being given matrix scores based on a variety of indicators of credit risk and correspondents are routinely informed of the scores on their originations. Correspondents are given report cards showing their incidence of failure to deliver loans on time and delinquency rates on their originations. Wholesalers have built up several years of data by now and have a real handle on who their quality sellers are based on computer records.

Faith Arnold, vice president of wholesale and secondary marketing, Dominion Bankshares Mortgage Corporation, McLean, Virginia, said her company has tracked every correspondent from the start of Dominion's wholesale program. The lender now has five years' worth of data on correspondents. Dominion does an "extensive review of correspondents off of the delinquency [performance of their loans] and the way the package comes in." She adds that Dominion grades its correspondents and will discontinue the relationship with customers who do not meet investor requirements. Dominion's program currently has roughly 50 correspondents. Arnold says that if a correspondent is not measuring up to secondary market standards after six months of customer service, a decision is made whether or not to stop doing business with them. "It becomes real prohibitive to do business with people who can't deliver to you a decent package, and of the credit quality that you're looking for."

Dominion is an example of another type of player in the wholesale market. The mortgage operation is still first a retail lender, with about 14 retail branches, and is owned by a commercial bank holding company. Arnold says the bank expects to do roughly $1 billion through its purchase program this year. She describes the wholesale operation this way: "We're primarily a regional buyer. We buy in our lending markets. We favor east of the Mississippi [production]; about 80 percent of what we do is in our backyard." Dominion's backyard extends to Maryland, Virginia, Washington, D.C., and beyond that to New Jersey, Pennsylvania, Delaware and the Eastern Seaboard, according to Arnold.

Being a regional player in markets that up until now have held their value quite nicely, Dominion has been able to continue purchasing VA loans without getting hit with the high VA no-bid losses others have suffered from that product. Dominion currently does about 60 percent conventional loans and 40 percent government product under its loan purchase program. Arnold says that Dominion has a "very good delinquency rate on governments because of the way we buy--regionally."

Tracking delinquency rates on production purchased under its various programs is a critical management tool for Fleet Mortgage to help target high risks tied to particular customers and loan products. Loving says that the big wholesaler tracks the delinquency rates separately for each program. Fleet also conducts matrix reviews of around half the production it receives. This sophisticated loan scoring system is done at the time of loan purchase, and produces average scores under each type of product that Fleet can use to judge an individual correspondent's performance. For example, one of the five factors measured that will knock a loan's matrix score down is a high loan-to-value (LTV). Loving said that the average score for a VA loan with automatic approval is 26. One reason the score is lower than the average score of 48 for conventionals is the fact that VA loans are typically 100 percent LTV. The average score systemwide for FHA direct endorsement loans bought by Fleet Mortgage is 36, Loving said.

The matrix scores help Fleet kick out loans that require full-blown underwriting reviews to spot potential problem loans and to help identify correspondents tied to poor quality originations. Correspondents can submit loans that fall within tolerance levels for the average score for that product and not be called to task for it. Fleet has collected about a three-year sampling based on these matrix review scores per correspondent. Loving said Fleet looked at the correspondents' matrix scores and delinquency rates when it reviewed the premiums it was paying, and found high correlation between the two measures of originator performance.

Loving said the only time Fleet Mortgage will do a full-blown underwriting is if the loan scores less than 15. "At that point, it is pulled and given to what we call matrix underwriters," he said. They will do a complete underwriting of the loans to see if there are compensating factors that may escape the matrix scoring review. If compensating reasons exist for the low scores, the loans are removed from the "kick-out category."


Wholesale programs amount to asset engineering with a vengeance. The engineers that direct these defined servicing acquisition missions assess loan products on the basis of whether or not they will produce desirable, or more to the point, profitable servicing.

There is no question that there are some product types that have earned a spot on many wholesaler's unwanted list. And while everyone's list is not the same, everyone appears to have a list. They may not be an outright ban on buying that particular product, but there are likely to be tight limits on the amount of that product that correspondents can sell to their wholesaler.

Take the case of VA loans. Fleet Mortgage--the predominant player in the government purchase market--now limits the percentage of VA product they will buy from any one customer to "no more than 20 percent of the overall product" purchased from any one of its correspondents." Loving says that if a correspondent says they typically run about 10 percent of their overall originations in VA home loans, then Fleet "will put 10 percent as far as our contract" with the customer. Loving said the bottom line is this: "We are trying to discourage as much VA as possible because of the no-bid issue."

To further curtail the amount of no downpayment VA loans coming in through the wholesale program, Loving said that when Congress raised the loan amount limits on VA loans, his company decided they would only purchase VA loans over the old limits if the borrower put down 10 percent. This policy was pursued under the wholesale and retail program.

While Dominion Bankshares also limits its VA loan purchases, Arnold said the limit per correspondent is closer to 20 percent. Arnold noted that "44 basis points is a good servicing fee on good performance." She added that Dominion's experience has been good with VA loans in her market, thus justifying that percentage of VA product. Fleet's Loving noted that "no-bids eat up 44 basis points real quick."

Loving said that his wholesale program will not purchase any investor loans and limits the amount of condominium loans it will purchase per correspondent. The condominium loans cannot exceed approximately 15 percent/conventional and 10 percent/government of any correspondent's volume. A volume limit is placed on the number of buydowns and graduated payment mortgages per customer as well.

But as far as regional quotas, Fleet Mortgage wants to diversify its purchases, so it "does not really discourage any regional area" in terms of purchased production, Loving said. A few exceptions exist, however. Fleet will not buy loans from Alaska and only a very limited amount of conventional product from Hawaii, he said.

Marine Midland's Grum said his wholesale program has never done government loans. Initially, that was so because when the program was started the "government area was too expensive." He said his bank has no "hard and fast limits on any type of product from an individual correspondent." He said they will take investor loans and condominium loans on a flow basis.

But Marine has its own servicing acquisition agenda that is tied to prepayment speeds. Grum said Marine prefers production from areas linked with slow prepayment speeds. Marine analyzes its own servicing portfolio on a quarterly basis to detect regional prepayment speeds. He said "about 51 percent of our servicing portfolio is in the 10 slowest prepayment states." That is an accomplishment borne of-design. The wholesale program helps build in that slower prepayment component by offering better pricing to sellers with product from regions with slower prepayment speeds.

Marine's portfolio shows that currently, the slowest prepayment performance is coming from mortgages based in New York, New Jersey, Pennsylvania and Massachusetts, among other regions. Grum says the tradeoff is that usually slower prepay areas are associated with slightly higher delinquencies.

Loving says Fleet also factors in desirable prepayment speeds and delinquency trends into its pricing models.

While being a large wholesaler allows you to construct a servicing portfolio tailored to your preferences, it also has its downside. Pipeline fallout was a sore point for the wholesalers we talked to. Grum said that when Marine first launched its wholesale operation, under some of its programs, the pipeline fallout would jump to 50 percent. But now its become stabilized at around 25-30 percent fallout, he adds. The way the bank achieved that was to monitor every correspondent and wave a red flag when the originator's fallout percentage got too high. Grum says correspondents continue to be kicked out of the program for excessive fallout rates.

Fleet, too, watches this area closely and will cut off offenders from the program. Monthly reports are sent to customers showing the dollar amount of loans locked in by each correspondent for the most recent four months. The report breaks out the percentage delivered on time. When a customer falls below a certain number, they are called and told to improve their delivery performance. Fleet sends monthly reports to its larger customers on a loan-by-loan basis that shows fallout rates and matrix scores and every loan that was locked in.

Even with problems like higher fallout percentages, the wholesale business appears to have attracted some committed participants. The one major issue on the horizon that wholesalers say threatens the continued growth in wholesale is a proposed regulation from the Federal Deposit Insurance Corporation (FDIC) that limits the amount of purchased servicing that banks can count toward their core capital. Grum of Marine Midland said the regulation is "going to have the effect of putting [regulated financial institutions] on an unfair playing field with industrial companies and private mortgage bankers" who want to become larger players in the purchased servicing market.

As far as the key issues of the 1990s for wholesalers, our group said to watch: renewed efforts to achieve cost controls, the risk-based capital restrictions along with the limits on purchased servicing and quality control.

Janet Reilley Hewitt is editor in chief of Mortgage Banking magazine and Real Estate Finance Today.
COPYRIGHT 1990 Mortgage Bankers Association of America
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Title Annotation:mortgage wholesalers
Author:Hewitt, Janet Reilley
Publication:Mortgage Banking
Article Type:Cover Story
Date:Aug 1, 1990
Previous Article:Boardroom view.
Next Article:Wholesale competition: how important is it to be the preferred buyer for a correspondent? It may be more critical than you think, a new survey shows.

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