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Netting wholesale opportunities.

Lenders who focus their origination strategy on wholesale lending will emerge brightly against the conforming backdrop of the 1990s.

Netting Wholesale Opportunities

The 1990s are going to be very different from the 1980s. The opportunities will be greater than ever before, but they will be shared by fewer people.

Mortgage origination attitudes and plans will move from a short-term to a long-term focus. Loan officers and mortgage brokers will be asking more of lenders, while investors and conduits will no longer view the purchase of loans as isolated business transactions.

Instead, there will be a shift to advisory relationships, loyalty and customer focus. We'll see more joint ventures and strategic partnerships, as firms uniquely prepare for a more difficult economic and regulatory environment spawned by the 1980s. The results will create a customer revolution in mortgage banking.

Your mission is to build yourself a secure spot in this future. The industry is forever changed and you'll have to be smarter about your origination strategy, think long-term and build core business relationships with pre-selected customers. Right now the industry is in a period of transition--from the uniqueness of the 1980s to the conformity of the 1990s--where all mortgage banking firms will begin to look alike.

During the "Roaring Eighties," the heyday of the savings and loans, it was possible to build loan production around a particular origination strategy. The primary strategy focused on creating a product niche. Firms could offer unique adjustable-rate mortgages (ARMs) with a slightly lower life cap or a below-market "teaser" start rate and capture market share. However, with the bulk of these investors now involuntarily merging with the RTC, the investor base has dwindled to only a few.

Another popular way to create volume in the 1980s was aggressive "portfolio underwriting." You could easily distinguish your company by offering less documentation and easy loan approval. Again, the result was to drive a wedge between you and the competition, thus establishing market share. This door, too, has been slammed shut.

Fraud, more delinquencies, massive loan losses and abusive underwriting has given way to a new era of quality control. No longer will investors be asleep at the wheel. The lone, remaining strategy to grab market share is pricing. Excellent pricing breeds quality production, in that it gives lenders more room to pick and choose which loans to underwrite. However, firms can no longer afford to stay on top of the heap in terms of pricing. Competition, as cutthroat as it is, serves to level the playing field. In a nutshell, the 1990s will serve to knock lenders into generic oblivion.

Take a look at your own company. What do your customers want? And don't tell me excellent customer service. That's a promise of the 1980s. So is quality. Quality and service will be the price of admission in the 1990s. As the transition to conformity becomes clearer, you will need to create other characteristics that will allow your firm to stand out from the rest. If you ignore this phenomenon, the only way you will prosper is through volume and economies of scale. However, if you are not the size of, for example, Pasadena-based Countrywide Funding Corporation, you will forever labor in a marketplace dictated by price and delivery. Worse still, you will face the challenge of each new player who pays the price of admission. This is sometimes called "being caught between a rock and a hard place." Not a fun place to be.

Let's assume you believe what I'm saying. If you do, then you'll have to focus on a particular strategy for the 1990s. Your method of originating loans and the cost of bringing those loans to your customers will be more important than the types of loans you bring in. This brings us to the purpose of this article--discussing the pros and cons of doing business in the 1990s strictly wholesale.

Why wholesale?

Generally speaking, wholesaling is the easiest, most accessible and least disruptive means to originate home loans. It appears effortless. Select a person, pick a market, display a sign, fax out a few rate sheets and wait for those loans to come rolling in. Your ability to limit brick-and-mortar costs, savor precious cash and access new markets, without expending vast amounts of human capital, makes wholesale mortgage banking look so simple. And I believe wholesaling is simple; it's just not easy.

First Franklin Financial Corporation, based in Westlake Village, California, entered wholesale mortgage banking in 1986, the same year home loan originations exploded to record levels exceeding $450 billion. That year it didn't really matter how you originated. Loans were there for the picking. It didn't take long for wholesale originations to exceed our retail production, but as a private company, we always justified keeping retail because of the cash flow it generated. These two organizations within our company co-existed for several years.

After the boom, however, the industry was infected with overcapacity and spiralling costs, a symbol for the excesses of the 1980s. And as new players flocked to the wholesale market to reduce infrastructure and costs, it became apparent to us that our company must specialize in wholesale in order to remain competitive in the 1990s. The strategic decision was finally made in 1989 to originate strictly wholesale.

The top quality of our loan originations is a direct result of our commitment and dedication to the wholesale-mortgage broker relationship. We have been able to build and maintain a dependable customer base, while delivering investment-quality loans to our investors. The foundation of our loan quality is the mortgage broker. By concentrating solely on wholesale for the last few years, we've worked closely with our originators to understand their wants and needs. As a result, we originate nearly $2 billion annually with little or no quality control problems through our Select Advisor program.

Profit: a myth in mortgage originations

The fundamental goal in American business is to earn a profit. At best, this is only wishful thinking in mortgage banking. It's generally known in the industry that for decades, mortgage bankers have lost money on originations and have been determined to make up their losses with volume. In fact, most mortgage banking firms attempt to increase volume as their primary avenue to profitability. This is a myth--and separating myths from reality is critical in the mortgage banking business. Wholesaling enables mortgage bankers to predict revenues, control costs and become more bottom-line oriented. Profitability is achieved and the myth about volume is destroyed.

Since turning to wholesale exclusively in 1989, we've been able to focus on cost controls, productivity, team building and our wholesale customer--the mortgage broker. The results have been incredible at First Franklin. We've doubled our net worth two years in a row, reduced costs in all areas of the business, added $2 billion in servicing and created unheard-of productivity. Our 225 people will produce approximately a total of $2 billion in home loans in 1991. Overall, our gross (all-in) cost to produce a loan is less than 25 basis points, down 125 basis points from our retail days. The point is this: controlling costs can produce the same result as increasing loan volume, and specializing in wholesale can give you the best of all worlds, at least in our experience.

A strictly wholesale focus

Wholesaling is a method of production. Rather than originating loans, through the efforts of an in-house (retail) staff, whole loans are purchased or funded concurrently from correspondents and mortgage brokers. These loans are purchased servicing released and are an attractive way to build a servicing portfolio without enormous costs. There are several obvious financial and business reasons why wholesaling is attractive:

* lower fixed costs; * economies of scale and size; * more favorable accounting

treatment (purchased loans only); * efficiency in building servicing; * recent and pending regulatory and

legislative developments; * centralized risk management; * improved quality control; * consolidation in the mortgage


It follows that smaller staffs, fewer salaries and lower rents equate to better control of service and greater efficiency. At First Franklin, we believe these are the keys to survival and prosperity in the 1990s. Unfortunately for us, so does every other mortgage banker in the United States.

In wholesale lending, customers are mortgage brokers, other lenders and correspondents. Capturing the hearts and minds of these customers requires execution of business fundamentals in the most single-minded and dedicated way. We believe that only those lenders who specialize in wholesale will be able to execute these fundamentals. To be the "number one" lender in their eyes requires: timely resolution of problems; negotiation flexibility; consistency in pricing; a coherent, predictable underwriting philosophy; a wide range of loan products; and access to the decision maker.

The crucial element in wholesale lies in giving authority and responsibility to employees and managers closest to the customer. In retail lending, this isn't possible because loan officers, paid on production, are closest to the customer and are not treated as part of the team. Accordingly, timeliness in decision making, the cornerstone to building lasting business relationships, flourishes in wholesale and flounders in retail. By narrowing the focus to wholesale, lenders are able to release authority to front-line personnel, which allows them to respond to customer needs faster, and simultaneously builds a strong team inside. This can only be a win-win situation.

Team building

The age-old war between administration and production continues to rage in organizations that don't specialize in wholesale. And if failure to earn a profit doesn't kill you, disloyalty, disrespect and distrust certainly will. Our industry has proven, year-in and year-out, its inability to earn a profit in retail. The real nemesis, however, isn't the 50 basis points we pay loan officers, it's the fact that organizations become overwhelmed by a "production-only" mentality. People simply don't get along inside. Loan officers don't trust management. Branch management is wary of corporate management. Processors perform all the work for one-third the pay, while underwriters make all the rules and try to navigate the ship. If the customer game is ultimately won or lost on the front lines--where the customer comes in contact with the firm--then loyal, well-trained, customer-obsessed players are a necessity.

Competition for the wholesale customer

As more and more lenders enter wholesaling in the 1990s, competition for mortgage brokers' business will intensify. In the 1980s, wholesale lenders met their business objectives simply by lining up as many correspondents as possible. But with "conformity" the new industry buzzword for the 1990s, this will no longer be possible.

Understanding mortgage brokers is the key to success in wholesaling. Mortgage brokers are tremendous salespeople and entrepreneurs of the finest calling. And they love to be sold with service. Mortgage brokers also have a tendency to feel discriminated against and hindered because of that. One broker told me mortgage brokers were the "redheaded stepchildren" of the industry. This is changing rapidly. In California, for example, the emergence of the California Association of Mortgage Brokers (CAMB) has created a dialogue and kinship between wholesalers and member brokers. The organization boasts a membership of almost 1,200 and expects to grow to 5,000 by 1992, according to Jerry Becker, CAMB president. The CAMB serves to direct its membership base to do business with lenders who support the organization and who are committed firmly to wholesale.

Mortgage banking firms who originate through both retail and wholesale operations might have a tendency to refer the leads they get from soliciting their portfolios for refinancings to their retail staff rather than their wholesale customers. With a company exclusively devoted to wholesale, those leads naturally flow through to correspondents, thus serving the business interests of the originators that support the wholesale operation.

At First Franklin, we developed a Referral Partnership Program (RPP). This program is designed to arrange leads for our customer base, while ensuring those leads are funneled back to First Franklin for funding. We use our Corporate Loan Service (CLS) division to facilitate this program. The response has been overwhelming. After all, what do mortgage brokers need most? Leads for home loans, right? By the way, we only refer leads to our Select Advisors (our top customers).

Select Advisor program

If you're not a broker's primary wholesale outlet, you run the risk of becoming just a place to lock rates for a fee or becoming a garbage dump for rejected loans. It's imperative to realize that, based on our experience, mortgage brokers maintain relationships with only two to six wholesalers. Our experience notes that mortgage brokers will sell two to three times the volume to the wholesaler who functions as their primary relationship than they will to the number two firm. Wholesale firms who fill the number three through six positions in terms of preferred sales outlets receive the broker's rejects or hard-to-approve loans. Mortgage brokers also categorize wholesalers according to certain business characteristics. Wholesalers are divided into several types and develop a reputation as being known for:

* Price--leaders or out of the market: * Lock--long or short; * Underwriting--loose or tight; * Rebates--buy servicing or high

coupons; * Service--poor or good

communication and turnaround.

The mortgage wholesaler chosen as the most preferred funding source generally blurs the distinction between price and service and is two and one-half to three times more likely to receive 25 to 50 percent of the broker's production than is the next competitor, according to industry studies. Recognizing the need to isolate good correspondents and become their primary loan source, First Financial embarked on its Select Advisor program. The strategy was to gather a coalition of "business advisors" comprised of our best mortgage broker customers and have them provide input as to how our company was doing, according to our strategy. These advisors gave us feedback in the areas that we call the "Ps" of our business: pricing; performance; predictability; product; personality; and profit.

First Franklin's Select Advisor program features 11 Select Advisors and 50 Mortgage Professionals who Service Each Loan and Enhance Communication Turnaround (SELECT).

At the heart of this alliance is the ability to maintain our Common Sense Quality underwriting standards. Together with our originators, we recognize that the essence of quality is helping mortgage brokers originate loans that perform well. This protects everyone, and in today's frail economy, striving for quality loan origination is the best way for wholesalers to protect the integrity of the finance industry.

Trust your customer

The most compelling reason to concentrate on wholesale is that it enables you to originate with your customer base. And in wholesale, your customers either make or break you. You don't try wholesale mortgage banking, it tries you.

Wholesale is a double-edged sword, it can be either a blessing or a curse. Originating loans via a wholesale network enables a firm to strengthen production and servicing by adding volume without the high costs of an origination network. That's the blessing. The curse, however, is that wholesalers rarely completely trust the broker supplying the product. The result is, that without empathy and training for these customers, wholesalers could be the dumping ground for every fraudulent loan in every new market we attempt to access. The challenge of wholesale thus becomes: Help mortgage brokers to become trusted originators.

The secret is focus. With competition heating up in every market, mortgage firms are forced to promise the moon to obtain a loan, especially the first loan. Right?

Wrong. With the explosion of competitors--many of them new and without track records in wholesale--reliability, rather than aggressive pricing or underwriting, is the most valuable strategic edge. While getting volume fast is imperative to wholesale, living up to customer commitments is what builds partnership for the mid-to-long haul.

The paradox: Mortgage banking hybrids--companies with both retail and wholesale operations--produce an insurmountable paradox by creating a competitive system within a system. This allows retail to exist side-by-side with wholesale, placing the internal production staff in direct competition with wholesale brokers, sometimes in the same market.

For this reason, I believe you should choose one or the other, retail or wholesale. An in-between mutation distorts the vision of who the customer is. The challenge of the 1990s is to view every element of every operation through the customer's lens, to constantly attempt to literally redefine each element of the business in terms of your customers' perceptions. Consider these observations:

* Retail loan officers view brokers as

direct competitors. How can

management support both? * If internal pricing is better than

wholesale, how can brokers believe

you're committed to wholesale? * If managing costs are tantamount,

how can management reconcile

retail production which is constantly

loosing money? * Loan officers always want higher

commission splits, management

wants to lower them. Aren't loan

officers best suited to be brokers

anyway? * Could loan quality actually be better

in an arm's-length transaction with a

mortgage broker, rather than being

held hostage by your in-house loan

representative? * Is fraud an element of wholesale, or

a byproduct of aggressive

underwriting guidelines that are

unleashed on unsupervised, poorly

trained customers? * Can mortgage companies creat a

loyal environment that


administration and production? * Can mortgage

brokers be trusted? Are

they simply yield

hounds? * How can wholesalers

defend portfolio

runoff without an internal

origination staff? * What happens if mortgage brokers

are legislated out of business? Can

our origination focus risk being

built around one outside source of

originations.? * In a quality environment, how can

firms trust outsiders? * Can wholesalers survive without fee

income? * If your vision of the future

ultimately links lenders directly with

consumers via technology, can anyone

afford to be just wholesale?

Don't get stuck in the middle

As market fragmentation accelerates, mortgage bankers must strive more valiantly than ever to achieve uniqueness as an organization in the customer's mind. Standing out from the growing crowd of competitors with special products and services is essential for survival. Such uniqueness must be understood and lived by everyone in the organization--production administration, management or ownership. On the other hand, an "in-between" or "stuck-in-the-middle" strategy is disastrous.

You may be afraid that wholesaling will limit your opportunities. If that's how you think, then test the approach in preselected markets. In any case, keep the companies separate (name, culture and management) until your direction has been clearly established. If you chose retail as you focus, then become obsessed with making your loan agents your "number-one" customer. Be the finest lender your loan officer will ever use. Don't take them for granted. Routinely examine the smallest nuance of the tiniest program through their eyes. "Over-invest" in total dollars, numbers of people in frontline sales and support at the branch level. Make all sales people company heros by training them excessively, providing them with outstanding tools and giving them the opportunity to be part of the team.

Either way, retail or wholesale, the business equation is simple: Long-term profit = revenue from continuously happy customer relationships minus cost.

Along those lines, I recently read an interview of Wayne Gretzky. The journalist asked Gretzky why he was the greatest hockey player ever to play the game. "You're not the biggest, you're not the strongest and you're not the quickest skater, yet everybody concedes you are the greatest," the interviewer said. Gretzky's paraphrased reply was, "Im a little a surprised that you don't know. To me it's quite obvious. When I get on the ice and play begins, everyone else on the ice skates to where the puck is. Me? I skate where the puck is going to be."

In the 1990s, the puck is the customer and you are Wayne Gretzky. Direct all your resources toward knowing what your customer wants, knowing who the customer is and where the customer is going to be. Then slap the puck into the net.

William D. Dallas is co-founder, president and chief executive of First Franklin Financial Corporation, Westlake Village, California.
COPYRIGHT 1991 Mortgage Bankers Association of America
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Copyright 1991 Gale, Cengage Learning. All rights reserved.

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Author:Dallas, William D.
Publication:Mortgage Banking
Article Type:Cover Story
Date:Dec 1, 1991
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