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Redefining wholesale.

It's been a wonderful ride for all who participated in the explosion of the broker-based wholesale business during the past six years. It's tough to lose in a business that has grown at an estimated compound rate of more than 35 percent.

Throw out a net and reel in the fish has been the way things have worked in this burgeoning side of mortgage banking. But the game is about to change. Precisely how it will change and who will emerge as winners will be interesting to watch over the next 24 months.

The loan brokerage business quite clearly has become established as a legitimate, and in some markets dominant, form of residential mortgage production. Brokers' share of originations has grown from approximately 15 percent in 1987 ($60 billion) to a forecasted 50 percent ($400 billion) in 1992 based upon the best National Association of Mortgage Brokers' statistics available. Fueled by the void left by the demise of many thrifts and a proliferation of available product from wholesalers, the broker ranks have swelled to more than 15,000 members affiliated with the national trade group for brokers, and probably at least as many more who are not formally affiliated.

The rush into broker wholesaling seems to be peaking in 1992 as about every wholesale competitor has been scrambling to increase capacity to meet the opportunities presented by the refinance boom.

Traditional service

In this environment, few wholesalers have had the time to reflect structurally on how the broker form of the wholesale business should be run. Some important questions that need addressing include: Are local offices necessary? What should the service standards really be? How should/can technology be applied to improve service, to improve efficiency and/or to develop deeper broker relationships? And finally, how will the winners be operating 12 to 24 months from now?

To date, broker-based wholesale mortgage banking has been a simple extension of traditional, closed-loan, wholesale business - wholesalers have merely inserted their hand into the underwriting and dosing part of the process. Once-prevalent "mega-purchase" centers - popularized by the major West Coast thrifts - have increasingly given way to smaller, more local branches as the number of brokers and wholesale competitors has multiplied.

Under either model of operation, the tasks of providing consistent service and meeting what normally should be reasonable turnaround times for underwriting and closing have proven somewhat elusive. This particularly has been true as the refinance surge has strained the fragile limits of wholesalers' operational abilities. However, to date, competitors really haven't paid much of a price for their lapses in operational capabilities, since there has been more than enough business for everyone. The major concern for most wholesalers has not been how to get more business, but how to handle the business they have.

What's interesting, and increasingly intimidating, is to look slightly beyond the current situation to when volume will return to more normal levels. By that time, some competitors will have been able finally to implement some significant improvements that are likely to greatly affect how the broker-wholesale game will be played in the future.

Refining/redefining the business

The broker-wholesale business has grown up rapidly. The next two years are likely to be pivotal in the continued evolution of this side of the business, for several reasons.

First, the entire mortgage industry probably will be facing significant overcapacity sometime in 1993-94. If the current expansion plans and volume projections of all wholesalers were added up, there probably would be enough capacity for a $2 trillion broker-wholesale production market. Yet today, most wholesalers' production is made up of between 70 percent and 80 percent refinances. Refinance business surely will decline to more normal levels sometime in the next year, if a Clinton administration doesn't scare the markets into higher rates even before this article is published. Overcapacity always brings price cutting and an intensified search for better approaches in the mortgage lending industry - in that way, we are unfortunately predictable creatures of habit.

Second, and more importantly, significant technology investments being made by most large wholesale competitors soon will begin to affect levels of service, productivity and the closeness of broker-wholesaler relationships.

Third, these enhanced technological capabilities will permit a further broadening of the broker community and a redefinition of the roles of originator and wholesaler. In particular, the recently published Real Estate Settlement Procedures Act (RESPA) final rule encourages a whole new set of originators - the real estate brokers - to join the loan brokerage community. As distasteful as this may be to some, it may in time turn out to be a logical step in the evolution of the wholesale business. The fact is that with today's available technology, we can make it relatively easy for anyone to take loan applications and electronically partner with anyone to process, underwrite, and close the loans.

Competing on service

If ever there was an aspect of mortgage banking where service could be a competitive weapon, it is the broker-wholesale business. Certain firms may buy the business on the basis of price for a time, but the capital structures and investors' required returns are too similar to permit a significant advantage on this front for any of the larger players over any significant period. However, it is true that medium-sized players can be squeezed out by larger lenders pursuing an aggressive pricing strategy. While being a low-cost producer is always desirable, the wholesale business is not a cost-intensive business to begin with; therefore, relative cost is not a likely source of meaningful advantage.

Finally, there are very few sustainable product differences in mortgage lending. Therefore, firms will compete and the business will be refined primarily around the issue of service.

The nominal standards for service in the wholesale mortgage banking business today typically require that: * Faxed price sheets be out to brokers by 9-10 a.m. local time; * Underwriting decisions be made in 48-72 hours from the time the loan package is received by the wholesaler; and * Closing documents be delivered in 48 hours from the time a faxed order is received.

Moreover, each broker tends to be treated the same with respect to underwriting flexibility and closing conditions, regardless of its performance history. Perhaps most importantly, as the process now works, brokers are expected to operate essentially blindly while their loans are at the wholesaler, without even "visiting rights" to data on the status of their loans. Obtaining good, timely information on status, decisions and/or problems can be pure hell for most brokers. Most wholesalers simply haven't matured in their thinking to the point of recognizing that these legitimate operating needs of their brokers must be met within the operational setting of the wholesaler.

The technology is certainly available for wholesalers to substantially redefine the level of service they can provide to brokers. Moreover, the technology is also available to redefine broker-wholesaler relationships for the better on both sides. It is the effective application of technology to wholesaling over the next year or two that will begin to redefine service, relationships and ultimately who stays and plays versus who exits the business.

The 1993 battleground

The first major improvements in customer service that will represent the pace-setting challenge to the competition, in terms of redefining the broker-wholesaler relationship, will occur in early 1993. Countrywide Funding Corporation, Pasadena, California, has already announced and demonstrated software that it will be providing to brokers to reduce dramatically the current communications gap between wholesalers and brokers.

The loudest pleas heard from most brokers are simply for the ability to "visit their data" and communicate with wholesalers, whenever and from wherever they want. The dual games of telephone tag and "find the file" that take place in all wholesalers' shops are the most serious impediments to responsive customer service confronting wholesalers. This problem is frustrating to brokers and (should be) embarrassing to the wholesalers.

The steps taken in 1993, by firms such as Countrywide, will define new standards for competitive service. At a minimum, the leading competitors breaking this new ground in providing better service will provide the following capabilities to their brokers, through easily used PC software: * Automated access to the status of loan files; * Loan approval information; * Daily pricing; * Ability to lock-in loans that are already registered with the wholesaler at any time; and * Electronic mail between wholesaler and broker that becomes part of the loan file record.

Collectively, these capabilities will reduce most of the communications shortfall that now exists. They also will enable the wholesaler's staff to stay current and better informed on the status of loans, given the fact that they too will have access to the same status information on loans produced by individual brokers. In addition, these capabilities will alleviate much of the daily pressure within the wholesale branch by reducing phone calls and the seemingly endless search for files.

The impact on the broker and his or her ability to provide service to borrowers is perhaps even more profound. These software capabilities will enable brokers to respond instantly to borrowers'/Realtors' inquiries regarding loan status, to provide on-the-spot pricing information, and even to lock-in a loan while discussing rate movements with a borrower. The broker simply appears in complete control, and this control translates into greater customer comfort.

From the perspective of technology, each of these capabilities is relatively easy to develop, provided the wholesale lender has its internal systems capabilities in reasonable shape. However, it is unfortunately the case that most wholesalers can't even provide most of these capabilities internally, so extending them to outside brokers must wait until internal development catches up. This means that those few wholesalers who are prepared internally to offer these services can seize a meaningful advantage in 1993, if they commit to the developmental effort.

Perhaps most importantly, putting effective wholesaler-broker communications capability in place sets the necessary base for further and more aggressively redefining the wholesaler-broker business relationship.

Stage 2

The communications software addresses the broker-wholesaler communications problem, but it doesn't address underwriting/closing turnaround time or reduce the underwriting consistency problem - two very significant aspects of the service gap. However, directly on the heels of the communications software development will come two additional technology-based capabilities that do attack these issues head-on. They are: * Artificial intelligence (AI)-based underwriting; and * Remote dosing document printing.

Most large wholesalers and all private mortgage insurance firms, as well as Fannie Mae and Freddie Mac, are well into the development of AI-based underwriting. It's rapidly becoming an accepted future fact of mortgage banking, although only a very few firms are actively and effectively using these systems currently. In 1993, this is likely to change, however, as the developmental work gives way to practical use.

In the broker-wholesale world, even the first steps in this arena will improve broker service significantly. Instead of two- to three-day underwriting turn-around (in, say, 40 percent to 50 percent of the cases), brokers will get same-day turnaround from the receipt of the file. In all cases, brokers will begin to receive more predictable underwriting evaluations, particularly with respect to conditions that might be placed on loan approval. For those brokers already possessing communications software, the availability of underwriting decisions and conditions notification will literally be minutes away from the time the file is received by the wholesaler. In fact, in areas where courier service delivers the loan files early in the morning, prior to the start of most business days, wholesalers can rearrange their work schedules to process the files and have underwriting decisions available to brokers when their business day begins.

While such fast turnaround time may not always be needed, in the face of similar pricing offered by most wholesalers, brokers likely will lean toward those wholesalers who make their job easiest. And needless to say, speed simplifies the broker's world significantly.

The other broker-wholesaler integration step that will be part of stage 2, is simply to provide for the remote printing of closing documents. Assuming that the wholesaler has an internal system for printing all the closing documents in the right order, it's a very simple extension to be able to dial up a remote network and print the documents wherever the broker designates. This reduces the printing turnaround cycle of closing documents from the current 24- to 48-hour standard to literally minutes. By the time the loan is ready for closing, a good wholesaler should require no more than five minutes to verify and input the final closing data and then direct the printing to a designated printer. Again, multiple-day turnaround service gets redefined into minutes with such a change.

What's the long-term vision?

Certainly there is no single correct long-term vision for the broker-wholesale business to follow. But there is clearly a logical evolution of the broker-wholesaler relationship, which brokers would subscribe to, if not champion.

From talking to many brokers in the business, the view commonly expressed is that, far from wanting to retain their total independence and deal with numerous wholesalers available to them, most brokers want and need a very close working relationship with a few wholesalers. The analogy that applies is that of the independent insurance agent, who has close ties to a select number of insurance companies, even to the point of using the insurance companies' technology, accounting, marketing and benefits programs.

The loan broker's fundamental marketing challenge is to appear to the Realtor (in a non-refinance market) as much like a direct lender as possible. The major barrier to the mortgage brokers' increasing penetration of the mortgage purchase business is acceptance by Realtors as being able to deliver a committed loan, to get the loan done as well as a direct lender is perceived as able to do.

Today, most mortgage brokers do well even in the purchase market because they generally tend to be exceptionally good marketers. In the future, as direct lenders wake up to the possibility of greatly enhanced speed of approval through technology, an advantage in superior marketing skills by mortgage brokers may not be enough to hold market share. Mortgage brokers also will have to contend with the overall issue of loan-approval speed, which increases the motivation for very close wholesaler-broker working relationships - in fact, strategic partnerships.

Whether these strategic relationships take the form of franchises, or what are called "net branches" or merely preferred broker status, it is relatively clear that as soon as wholesalers are prepared technologically and organizationally, the broker community is ready to pursue such relationships.

The relationship is likely to be organized around and directed by technological capabilities in order for brokers to truly appear as seamless extensions of wholesalers. These strategic relationships will feature brokers with direct electronic linkage to the wholesaler and having the wholesaler's AI underwriting module available to them on their own origination software. This would enable brokers to provide "at the table" responses to borrowers on credit underwriting questions and/or transmit the underwriting data to the wholesaler for a real-time evaluation.

In a "net branch" or franchise situation, the broker actually would have the wholesaler's whole processing system and be able to provide the same level of speed and responsiveness as a direct lender.

But what if these strategic alignments meant that brokers would lose their ability to select alternative wholesalers to deliver loans to? Wouldn't the technology tie-in with a particular wholesaler prohibit this? Not necessarily. By definition, an independent broker community wants to retain its independence - to a degree. Electronic tie-ins do not mean that a broker must deliver all his or her product to the wholesaler whose technology is being used, but as a practical matter, the broker will select the easiest path of doing business, and the wholesaler with whom the broker is electronically linked will be able to provide greater service and ease of use in the working relationship.

In order to compensate the wholesaler for what is effectively service bureau-type use of the wholesaler's technology in the cases where the broker delivers his loans elsewhere, the wholesaler could merely charge a processing fee for use of the system. However, odds are, if pricing, product features and underwriting standards are consistently reasonable, most brokers will settle into one dominant relationship, rather than spread their business around. The best brokers will tell you that they prefer a simple, reliable set of wholesaler relationships, rather than loan-to-loan "price hustling" to maximize profits.

What about CLOs?

Wait a minute. Won't someone come along and provide a utility system for mortgage brokers that permits them to find any wholesaler, thereby negating the need for specific broker-wholesaler electronic tie-ins? Clearly some entrepreneurs will and are trying to do this. Some may actually achieve some success. At this point, it's difficult to see the compelling reasons for brokers to sponsor and gravitate toward such a system. Most mortgage brokers already have straightforward origination software. To encourage switching to a prospective utility's software, the system would have to offer accepted AI underwriting and appraiser linkages, in order to take the brokers to the next level of sophistication and benefit. To provide this capability, the utility would have to get Fannie Mae and Freddie Mac's certification of its AI software, as well as build joint ventures with the national appraisal firms. Not impossible, but surely a daunting task. Therefore, while utility-service bureau solutions are not impossible, they do not appear to be the likeliest solution.

Implications for wholesalers

The first and second stages of technology-based redefinition of the broker-wholesale business are relatively straightforward extensions of the capabilities that the better firms are already developing. They do require some changes in the wholesalers' skill sets and management processes, but not a major shift.

Developing technology-based strategic partnerships with brokers, however, implies fundamental changes in the wholesaler's operations, in both technology management and organizational culture.

Providing tens or hundreds of brokers with the wholesaler's origination software also means accepting the responsibility for maintaining the software and supporting the users day to day. Few firms are able yet to provide high-quality support internally. Developing the technical and managerial skills to provide quality support to hundreds of brokers is a challenge that probably no wholesaler is yet ready to meet. But it can be done. There are software vendors that have demonstrated this capability. How difficult it will be to develop such an operating system within a non-technology-oriented mortgage banking company is the question that industry leaders, such as Countrywide, will soon find out.

The organizational culture

Even if the technological equation is solved, however, there remains perhaps as tough a challenge in reorienting the wholesaler's culture from that of a hierarchical, boss/subordinate-type organization to one where brokers are treated as true partners - where each side brings something critical to the relationship. Mortgage companies are used to selling and processing, not developing symbiotic relationships with partners. It requires a mind-set and behavioral changes that may prove even more difficult to master than the technology challenge.

One thing is for certain: the still-nascent broker-wholesale market is here to stay, and it will experience some major leaps in the way business is conducted over the next year or two. The next major advances will come in early 1993, with escalating intensity, as more of the large firms get focused and organize their technology investments and strategic plans. Changing the basic ground rules for competing effectively in the wholesale market, as volume declines and price competition escalates. will be interesting to watch. Will the innovative wholesalers who already have taken major steps to bring their business into an electronically linked environment build an insurmountable lead, with low cost, usable technology, and a national distribution system? Or will others be able to play catch-up ball effectively? We shouldn't have to wait too long for the answer.
COPYRIGHT 1992 Mortgage Bankers Association of America
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1992 Gale, Cengage Learning. All rights reserved.

Article Details
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Title Annotation:wholesale mortgage banking
Author:Portner, Fred
Publication:Mortgage Banking
Article Type:Cover Story
Date:Dec 1, 1992
Previous Article:A growing appetite for table funding.
Next Article:Another December surprise.

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