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Sear's Klein; a servicing guy at the top.


Some top executives in the mortgage banking business seem to have been born with their titles. No so for Walter C. (Terry) Klein, Jr., 46-year-old chairman of Sears Mortgage. His career has been atypical for the head of a major modern mortgage company.

Klein's a 1969 liberal arts graduate from Harvard and an ex-Marine who saw duty in Vietnam. He started out to be a banker at Citicorp in New York, but early on found out business lending was not his strong suit. He wound up at Advance Mortgage, a Detroit-based mortgage banking firm acquired by Citicorp in 1973. There he made a name for himself as an operations man who could iron out the many kinks in the loan origination and servicing departments. Then, after a stint as head of servicing at Lomas & Nettleton (now Lomas Mortgage), Klein was tapped in 1986 to head Sears Mortgage--not just servicing, but the whole mortgage operation. To the fair-haired skeptics in loan production, it was like the tortoise beating the hare.

While traditionally the ranks of top management in the business have been filled by those who have risen through the ranks in loan production or secondary marketing, Klein is one of the rare exceptions who hails from servicing. The jovial, somewhat portly manager from loan administration has made it to the top and beat out the flashy, front-office boys. In the process, he helped transform Sears. There he has come to grips with the internal contradictions, and has mapped new ways toward profitability in the industry. How did it all happen?

The rise to the top has been a long and winding road for Terry Klein. He considered going back to Harvard for his MBA when he was assigned a slot as a loan officer in the unglamorous real estate and construction division at Citicorp. He told his parents after the first few days: "It's going to be a short career in banking--Harvard Business School here I come." Klein never made it back to Harvard for his MBA.

After a lackluster stint at real estate lending, Klein was suddenly pressed into service in the high stakes world of mortgage-backed securities. He helped his then Citicorp boss Kurt Kettenman put together Fannie Mae's first private line of credit--$600 million, and then went on to be a trader on the Ginnie Mae desk. It was then that Citicorp acquired Advance Mortgage and put Robert J. Mylod, Klein's first Citicorp boss, at the helm. "You're wasting your time trading Ginnie Maes," Mylod told Klein. "Come to Detroit and learn what management is all about." After turning down the offer twice, Klein was finally convinced by Syd Kaye, Advance's vice chairman and one of its former owners. Kaye was "a gentleman and a scholar" who made Klein understand what the mortgage banking business was all about, the Sears executive recalls.

Klein's rosy view of mortgage banking was soon to fade in the face of the daunting realities of running the operations side that fell into his lap. Future Citicorp Chairman John Reed, who had already made his mark in the corporation by cleaning up the operating problems in the back office at 111 Wall Street, had been promoted to head the subsidiary group, overseeing all consumer-oriented businesses, including Advance Mortgage. Not surprisingly, he ordered Mylod to clean up the back room mess at Advance in residential loan production, where shoddy work was producing shaky loans and customer service nightmares. Mylod then sent Klein his marching orders, "Fix it."

Klein's approach was comprehensive and substantive. To reduce operational headaches, he went to the source of the problem instead of trying to patch it up downstream in the mortgage pipeline. He devised a motto for Advance. "Think of customer service in advance--do it right the first time." He had 1,000 buttons printed up with that motto and gave them to employees to wear. Instead of hiring a lot of customer service representatives to calm customers down or find out if loans were properly documented, it seemed better to find out why the procedures seemed to fail so often in the first place. Klein's goal of zero defects in loan originations was nothing less than a revolution in the way the mortgage business had been run. When employees came to him to say they were already working as hard as they could, he would instead tell them to "work smarter, not harder."

Klein was already putting in 14- to 16-hour days. "I worked my brains out to organize the division," Klein recalls, revealing his deeply ingrained perfectionist bent. Kettenman, who has followed Klein's career, says "he's the sort of person who sticks to a problem until he solves it, no matter how long it takes."

Even with his almost mathematical, theoretical approach to organization, Klein says he likes to bend the organization and procedures to fit the employees rather than try to fit employees into an inflexible operating model. Klein's is a rare understanding of both the ideal and real--ideal abstract systems and zero defects along with real procedures and real human foibles. Mylod, now chairman of Michigan National Corporation in Southfield, Michigan, recalled how Klein got loan production to work. Klein "is a very gregarious, fun-loving people-person, but at the same time he's very, very bright and exceedingly well-organized. He has the courage of his convictions that allows him to make difficult decisions about bow the business is organized, but he makes decisions that are fair to the people involved," Mylod says.

But being a man of strong convictions who some describe as a workaholic, Klein stirs different emotions in different people he has worked with on his way to the top.

Outside, and sometimes inside the office Klein plays a hard as he works. For instance, when he wasn't working long hours at Advance, he was back at his hotel room in Southfield, putting together an electronic digital clock from a do-it-yourself Heathkit. The clock still peels out the Westminster chimes of Big Ben every 15 minutes in Klein's executive office at Sears. It's an apt symbol. Like an organizational clockmaker, Klein set out at Advance to get all the parts of the loan production business to work in perfect concert. His management style is one of intense involvement and is probably too comprehensive and too demanding for some managers.

Before Klein could create the loan origination model for Advance, the company was hit by a regulatory bomb from Washington. In 1976, the company was sanctioned by HUD's Mortgagee Review Board for originating poor quality loans. Citicorp Chairman Walter Wriston had been an outspoken critic of government regulation. It was believed by some at the time that Advance had become a target in Washington to punish Wriston for his candor.

Under a consent order signed with HUD, Advance pledged to properly document loans, close them on time, and handle all customers' complaints. The heart of the problem, Klein discovered, was the slipshod way loans were approved and placed on the books. This required him to do battle with the free-wheeling loan officers who brought in the business for Advance from real estate companies. There he found himself cheek-to-jowl with the new head of loan production, Walter Blass, a Harvard MBA with some real estate experience. With Mylod's support and Blass as a complementary counter balance, he set out "to make Advance more professional and less entrepreneurial."

Advance's struggle to revamp its loan origination system was a descent into "Mortgage Purgatory" for the staff and the company. There was 100 percent turnover in personnel in less than two years. It pained Klein that people would leave rather than adjust. But, in retrospect, he believes the very public flogging of Advance by HUD turned out to be "the best thing that ever happened to Advance--we purged ourselves of past thinking." It gave the operations side an unusual amount of leverage over the loan production side, and it made Klein an equal partner with Blass in the business. A firm rule was set that no verification of employment or deposits could be carried by a third party. Letting Realtors perform these functions had led to fraud in Los Angeles. Blass terminated the firm's top loan officer for violating the rule. But, after two painful years, Advance emerged from its trial by fire as "a more Citicorp-like company," he recalls. Discipline had triumphed.

After the traumas of rebuilding the loan production division subsided, Klein got a second shock. Mylod called Klein into his office and told him, "Now we have to address the Augean stables in servicing." Klein was flabbergasted. "What did I screw up?" he asked Mylod. Klein was sure the new assignment was punishment for something that had gone wrong in the old assignment. Not so, Mylod recalls. Klein was the best man for the job, so he got it. And what a mess he got. Under pressure from HUD, Advance had agreed to set up a nationwide toll-free number for customer servicing complaints. Instead of helping consumers, however, the mandated solution opened a Pandora's box of underlying problems in the servicing department.

As soon as the number was connected, the phones started ringing off the hook night and day. There were 60,000 calls in June 1976 alone. Even the local telephone company complained the calls were tying up their WATS lines at peak hours. Mylod told Klein, "They're too many calls coming in--make them go away." Klein asked for more time to fix the process or more people (there were only six answering the phones), and was denied both. Klein even put himself literally on the line by taking the most irate calls. "We would buy up customers' accounts on the spot," he says.

Klein devised a system-supported solution to the problem. He put in one of the world's earliest on-line computer systems. It had terminals at the Advance origination branches so loan officers at the point-of-sale could make queries about a loan. They could also gain on-line entry into the problem tracking system to order a repair to an account. This cut the flow of calls going into Detroit. Klein also turned to the people in Advance's 15 collection branches, and asked them to perform a second function, customer service representative, especially on the sticky issue of paying local taxes. "We grew a whole generation of managers who understood the duality of those functions," says Klein. By 1978 "we had stamped out the problem." Having devised a solution to the serving problem, Klein was promoted to head the division and began to build up the servicing portfolio.

Just as everything was coming up roses, Citicorp was ordered by the Federal Reserve to divest itself of Advance under provisions in the Bank Holding Company Act of 1970. Impressed by the firm's new systems, Oppenheimer & Company snapped up Advance in 1978 in a leveraged buyout. With the firm's operational clock works rebuilt and ticking with precision, Klein was free to focus on new servicing strategies to increase profitability. Mylod told Klein to analyze the profitability of low-balance, older mortgages. Because conventional servicing typically earns 3/8 of a point and it was then costing most servicing operations between $50 and $60 a year to service a loan, mortgages with balances below $12,000 were assumed to be losing money. But Mylod believed the conventional wisdom was wrong. He believed that low-balance mortgages were actually more profitable than they appeared because they were less likely to go into delinquency and because they carried a higher proportion of escrow funds, on which Advance could earn interest income. With Klein's systems in place at Advance, the cost of mortgage servicing was somewhat lower than the competition. This made these accounts even more appealing to Advance. Mylod asked Klein for a plan to buy up the low-balance mortgages from thrifts around the country and put them into servicing packages. In 1980, Advance acquired many seasoned mortgages and pooled them into three $100 million packages that Advance could handle more efficiently, and cheaply, than the thrifts. It paid off nicely. Shortly afterward a sudden, drastic rise in interest rates, followed by a sharp recession, forced many mortgage bankers belly up. But Advance prospered from the adversity.

In 1982, Oppenheimer put a profitable Advance Mortgage on the auction block. Lomas and Nettleton was able to outmaneuver other bidders to scoop up the firm. During the first two years of Lomas' ownership, Klein was the president of Advance. He ran the operation from Detroit, frequently commuting to Dallas. But, by the end of 1984, the two operations were completely merged, and Advance Mortgage became an extinct entity, as Mylod had predicted. Mylod, meanwhile, went off to become president of Fannie Mae. Klein, no longer a president, was instead one of the "key players" at Lomas, according to Jim Wooten, chairman of Lomas Mortgage. Or, put another way, he became a smaller fish in a bigger pond.

Lomas' purchase of Advance worried Klein from the earliest days. He feared he would be called in to organize Lomas' enormous servicing portfolio to the same high standards he had brought to Advance. He really didn't want to play Hercules again, but Lomas Financial's chairman Jess Hay talked Klein into moving to Dallas to run the merged operation. Klein warned, "I'll clean this sucker up once, but don't let production screw it up again." He then married the woman he had been dating since he came to Michigan in 1973, Patricia Ann Domme, and adopted her daughter Laurie Van, and they all set off for Texas.

Bringing order out of chaos at Lomas, however, was a bigger challenge than it was at Advance. He had to merge the 200,000 loans in Advance's portfolio with 400,000 at Lomas. This time, however, he didn't have a disciplinarian like Mylod or a sympathetic team player like Blass as the head of production. Klein found the various divisions at Lomas fairly independent of one another and neither Hay nor Wooten seemed to want to make them more interdependent. "I tried to meld the teams," Klein says, referring to the sales, servicing and secondary marketing sides of the business. Because the other division heads were content with things as they were, he was unable to create the right kind of balance he believed necessary to make Lomas operate like clock work. He was, however, able to merge the two servicing operations into one, efficient operation.

Then one day, seemingly out of the blue, Klein got a call from Robert E. Wood II, Sears' senior executive vice president and chief administrative officer of the Dean Witter financial services group. Wood is the grandson of Sears' legendary Robert E. Wood, who transformed Sears from a catalog company to a department store chain in the 1920s. Wood told Klein they had a mortgage company that needed its operations fixed. Who to call, then, but the industry's most famous "fixer?" They told him that Sears was strategically committed to the mortgage business and committed to customer service. They wanted him to be president. Klein was surprised and flattered, but cautious. He told Wood, "I'm an operations guy--I'm old hat." But, the changing fortunes of mortgage banking were beginning to make operations-type problem solvers and servicing "new hat." Jim Wooten, chairman of Lomas Mortgage, for one, says he was not surprised that Sears would want Klein. With loan origination costs remaining high, and competition driving many mortgage bankers to trim their profit margins, the pressure was on servicing to produce new efficiencies to regain some of the lost profitability for the business.

Klein finally said yes. He took the Sears' offer and moved to the Chicago area. (Sears Mortgage was then headquartered in Lincolnshire, a northern suburb, but moved to nearby Riverwoods in late 1988.) Although Sears Mortgage was no larger that Lomas & Nettleton, Klein sensed that he had finally made it to the "Big Time." Bob Horner, who left Sears for Citicorp in 1986, had already shaped an efficient loan production operation. With only 70 branches, Sears was originating $3 billion in mortgages. Lomas, by comparison, was originating about the same amount with 120 branches.

The view from the top, in fact, was exhilarating and inspiring for Klein. It gave him a sweeping view of the whole business and an appreciation of the intricacies of its various parts. Speaking like the organizational engineer he is, Klein says the business divides naturally into three areas--production, secondary marketing and servicing--"the eternal triangle of mortgage banking." From his view they have to be kept in balance if a company is to function properly and be profitable. Yet, their interests frequently collide. The production department wants the lowest price, while secondary marketing wants the highest price. Production wants the lowest quality underwriting, while secondary marketing and servicing want the highest quality. The production department wants fast action, is entrepreneurial and not attentive to detail, while servicing wants complete accuracy, wears green eye shades and pays attention to detail. In Klein's ideal model, the three balance their opposing needs.

When he arrived at Sears, Klein found the parts of the mortgage banking operation working at odds with one another. Primary marketing had its own mission. Servicing was happy to be left alone. The consumer direct operation was competing with branch production. The secondary marketing operation had a super trading room and a strong sense of direction. Klein's first assignment was to create more interdependence by fostering a team approach to running the business.

Klein's efforts to build a team spirit at Sears faced an unexpected obstacle, a rapidly deteriorating mortgage market. The business went into a tailspin in late 1987 and early 1988 as interest rates began to rise again. With considerable excess capacity, the downturn lead to a painful industry shakeout. The market was swinging wildly from ARMs to fixed-rates and back. Sears had to change and change quickly if it was to keep pace. At Sears, the turmoil lead to some staff turnover in key positions, as Klein pushed to impose discipline and build teamwork. He replaced some top people at Sears.

Klein found the need for discipline greatest on the front end of the operation--in the origination of new loans. In spite of all the problems of high commissions and the cost of retail branches, Sears decided to stay with the traditional way of bringing in mortgages--commissioned salesmen in branch offices. Klein believes that Sears has found a national branch loan officer strategy that brings more technology to bear and is committed to bringing a high level of customer service that will be difficult to match on a national scale. Loan officers are still commissioned and "pretty independent," Klein admits, but now they follow some strict rules and pay more attention to details as part of a team. Lomas' Wooten says Klein's handling of Sears' loan production shows he has made the difficult transition from operations manager to entrepreneur. Sears, in fact, bought 19 Lomas offices last year, as Lomas was rushing to get out of loan production.

The whole process of team building at Sears has been helped by a nationwide network of voice and data lines, electronic mail and on-line access to loan origination and servicing by the local branches. This communications, operations and records network began before Klein's arrival. Horner had a front-end system designed with the needs of secondary marketing in mind. Under the system, the progress of loans through the pipeline is monitored by the trading room as loan applications are made, approved, pooled and sold into the secondary market. With its own brokerage business at Dean Witter, it was no surprise that Sears developed a top-flight secondary marketing division before Klein came aboard.

Two years after Klein arrived, Sears reorganized its mortgage operations, taking them from the Dean Witter financial services group and moving them to Coldwell Banker real estate group. The strategic move was made because it was believed that mortgage banking could be more successful with the real estate group, according to Clarke Smith, Sears Mortgage's chief financial officer.

Not long after the transfer to Coldwell Banker, Klein began to focus on another of his concerns, re-orienting Sears Mortgage away from its focus on short-term profitability. Sears' continuing poor retail performance had for some time made it important for the financial services group to show a profit. Sears Mortgage was expected to do its part, too. The goal was 15 percent return on equity every year. This often meant selling servicing to pump up quarterly or annual earnings, or even curtailing the production of new loans. Thus, throughout the industry's recent turmoil Sears has remained either number one or number two in profitability in the industry, according to Stuart A. Feldstein at SMR Research Corporation, Budd Lake, New Jersey.

Klein contends it is a mistake to sell the servicing of a mortgage just after you've weathered the early problem years of a loan and are ready to settle into many years of steady income. This short-term strategy ultimately harms the company, he told Arthur J. Hill, his boss and chairman of Coldwell Banker Real Estate Group. The matter came up when Hill and Klein began a systematic review of Sears' Mortgage's business strategy. The review led them to a common conclusion. Sears Mortgage should develop and firmly support a long-term mortgage banking strategy. And, if Sears Mortgage was to be in mortgage banking to stay, it would have to begin investing in its future by increasing loan production. It would have to stop disinvesting by selling off servicing to increase quarterly earnings.

Hill and Klein presented their new strategy to Sears Chairman Edward A. Brennan. They warned that while this could lead to substantially lower short-term profits, in the long run Sears Mortgage's profits would be higher. Brennan not only listened but also approved and supported the Hill/Klein strategy. A pleased Klein says, "Now we're in mortgage banking for real." As a result, Sears ended 1989 with $3.7 billion in originations, compared to $2.9 billion in 1988, according to Smith. The investment is continuing in 1990, as many servicing portfolios come into the market at bargain rates.

At Sears, Klein may have at long last found "Mortgage Banking Heaven," and not just Herculean challenges. He's as surprised as anyone to find himself where he is and doing what he wants to do. "I didn't set out to become chairman of a mortgage company," he says. His organizational skills, strong work ethic, faith in traditional business virtues and keen understanding of mortgage banking all paved the way for his rise to the top.

Robert England is a Washington D.C.-based financial writer.
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Title Annotation:Walter C. Klein of Sears Mortgage
Author:England, Robert Stowe
Publication:Mortgage Banking
Date:Mar 1, 1990
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