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Surviving small: here's one niche a small company has found in between the mortgage brokers and the big wholesalers.

SURVIVING SMALL Here's one niche a small company has found in between the mortgage brokers and the big wholesalers.

As we enter a new decade, many small mortgage bankers are worried that they may meet the same fate as hundreds of their peers did in the 1980s. The unfortunate combination of interest rate volatility, capacity excesses, increased competition from larger entities and narrowing spreads that prevailed then drove hundreds of firms out of the business.

One can say two things about the mortgage banking business in the 1990s without causing too many arguments. The first is that technology and the economies of scale it has created (along with the larger role of the secondary agencies) will lead to even further consolidation of the industry. The giants will be able to operate profitably on increasingly narrower spreads through volume and specialization. Given this, the small mortgage banker will have to merge or find niches his larger competitors cannot or will not exploit. In the past five years, Home Lenders, Redondo Beach, California, has evolved from a sleepy government loan shop to a full service originator offering a wide variety of products. We met the challenges of technology and declining retail demand with a clearly defined and carefully implemented business plan. As a result, we have taken the concept of servicing our customers and correspondents to the limit. We project that origination volume in this fiscal year will triple to more than $300 million, compared with the previous year's $99 million. The reason for this success is that we take our servicing commitment seriously.

Like all mortgage bankers, Home Lenders found it increasingly difficult to make money from its retail operations in the post-1986 bust. At one time, we had as many as five retail offices stretching from Los Angeles to San Diego. But we soon realized that traditional retail offices are simply too expensive to run, especially in a period of slack demand. The key to remaining in this business is cost containment. We reduced down to just two offices that account for only 20 percent of our origination volume.

We have become a conduit, helping smaller brokers and correspondents access the better pricing of large investors. The reasons this strategy has worked well for us are interesting. Also, sharing some of the keys to this success with others in the industry can shed light on the serious impediments to traditional growth patterns.

Correspondents are crucial

An important lesson of the post-1986 bust was that not only were traditional origination offices expensive in a slack period, but they were highly unlikely to make much sense during the next boom period. Spreads are just too narrow to justify if a lender is to remain price competitive. Going to a system of relying on independent brokers and correspondents makes sense. But if this makes sense for one lender, then it makes sense for all.

With that in mind, the question becomes "why should a correspondent bring his business to us?" The independents can easily spread their share of business among a wide pool of lenders. Thus, the needs of the independents had to be examined. These needs then had to be put into the larger context of the quality control needs facing us as lenders.

Home Lenders enjoys a default ratio of less than 1 percent, even though we make many loans in low-income areas many other lenders shun or ignore altogether. Clearly, this ratio could not be sacrificed in trying to increase loan volume. Rather, we decided to take a hands-on approach to training correspondents and brokers. This is essential today due to more stringent controls demanded by the agencies who fear the whole system will fall apart without tough standards. But you can't force this kind of thing upon independent originators. You must clearly demonstrate the benefits to them. Accordingly, we offer all our correspondents thorough training. We regularly schedule seminars on quality control. We don't just train people and say, "OK, we're done." We follow up with quality control audits and let them know what mistakes they are making. Our own newsletter, Quick Close, interprets all the latest agency memorandums and bulletins, as well as reports on some of the most common mistakes. We expect employees to learn and not repeat the same mistakes. In one case, we terminated the largest correspondent we ever had because we couldn't see eye-to-eye on quality control issues. In another case, we helped one operation substantially improve by personally visiting their shop and suggesting improvements.

Home Lenders assists correspondents in other ways. We overstaff in the funding and underwriting departments to ensure timely processing of loans. We compensate for this overstaffing by training all employees in every facet of the company's operations. Thus, when the funding and underwriting departments have an especially busy month, it almost always follows that the shipping and insuring departments will be overburdened the following month. Employees are then simply moved over to those departments. This enables Home Lenders to guarantee underwriting in 24 to 48 hours and consistently meet those deadlines. If a deadline is promised and the company fails to meet it, we pay the correspondent 1/4 of a point.

However, it is rare that we must pay the 1/4 point. Every day, we update correspondents and brokers as to how long it really is going to take. That way, no one gets upset and we find the brokers are happier about being told the real timeframe immediately than they are about getting the 1/4 point. Home Lenders also promises seven-day appraisal services.

While all correspondents close loans in their own name, Home Lenders will work with brokers in trying to develop FHA-VA correspondent status, something few large lenders will bother to do. With HUD-approved underwriters and appraisers on staff, Home Lenders offers its correspondents all insuring functions and the attendant follow-up that often requires adding additional positions within a small company. However, because Home Lenders has to field these personnel to run its own retail operation, little overlap is involved. In addition, our company usually finds it handles such services more efficiently than the correspondents would. As a rule, the independents want to get paid; they worry more about originating than the follow-up paperwork.

All correspondents are paid within 48 hours of recording, another plus that helps retain their loyalty. Many lenders postpone payment, but we have found that having the check ready at recording keeps correspondents loyal. Conversely, the profits made by delaying payment are usually insignificant in the long run.

Currently, there is probably more volume than most companies are prepared to deal with and as a consequence, some warehouse lenders and investors are engaging in questionable practices. Small mortgage bankers must examine their policies extremely carefully or risk harmful consequences. So many mortgage bankers have simply disappeared from the scene that the volume can't really be handled, at least in Southern California. Quite often, the honest warehouse lender now tells you he does not want more correspondents and to call back in a year. Some investors will buy a package of loans, cherry pick the most desirable and then reject the rest. Some are even abusive enough to charge a penalty on loans they send back.

For this reason, Home Lenders carefully nurtures its relationships with warehouse lenders and investors. We make a point of acquiring all guide-lines in advance and meeting people on a one-on-one basis. When dealing with new investors, we first test the waters by sending them only a small volume. Small companies like Home Lenders can head for disaster quickly if an investor ties up a product for three or four months without making a disposition. With the interest rate inversion curve, what you pay your warehouse lender and the amount the borrower is paying can really tie up your warehouse credit lines.

Establishing strong relationships with your warehouse lenders is of prime importance. Open the lines of communication long before you have a problem that they recognize. We work very closely with our warehouse lenders and inform them immediately of any problems. This way, when problems do arise, we don't have to reduce our volume by a significant percentage. These lenders give you special dispensation if you have gained their respect.

We made some loans we did not want to sell at a big discount and managed to sell them at par after three years without detracting from our credit line. This result is possible only if you gain a warehouse lender's trust in your firm's integrity. Also, the favorable pricing we can offer is a direct result of actively communicating with warehouse lenders.

To succeed as a correspondent loan originator, a firm must remain sensitive to the needs of its investors, customers and independent brokers and correspondents. Problems must be attacked when they are small and still manageable. At the first sign of trouble, discuss the situation and try to arrive at creative, mutually satisfying solutions. This is all the more important as investors continue to tighten their belts and look for higher net worths and better representations and warranties.

When HUD performed the underwriting function for the company, the default ratio was more than 13 percent. Now, close contact is offered with investors to assure the quality of the loan files shipped. This, in turn, facilitates rapid purchases and a minimum of post-closing problems. So while origination volume is up threefold, it has not come at the expense of quality control or underwriting standards.

Home Lenders began as a small government loan operation, but has since dramatically expanded its product mix. We recently introduced a jumbo loan program with a target volume of $3 million per month. We also have a full slate of conventional products, but not everything. A cluttered rate sheet does not result in high quality originations. Restricting the product mix improves job performance and understanding, we've found.

Recently, the company opened its first "efficiency office" on California's eastern border or "Inland Empire." Management sees this efficiency office idea as a trend not only for the company but for much of the industry. Run by a HUD-approved underwriter and appraiser, it is basically a one-man shop that could be closed in a week if business does not justify keeping it open. This one person can make daily rounds to all the brokers in the geographic area, a decided advantage over larger lenders who may send a package out once every six months. Should the first such office work well, Home Lenders will open a whole string of them, particularly in the Inland Empire region - the fastest growing in the state.

Each office would have its own computer and messenger who doubles as a receptionist. All paperwork will be sent back to the firm's home office in Redondo Beach, south of Los Angeles. Initial projections show such a network of offices could eventually produce the same amount of volume the company currently underwrites at a savings of up to $1 million per year in overhead and salary expenses.

Another resource available to all mortgage bankers is participation in industry conferences and conventions. It's an overused term, but by networking, a small company can gain name recognition with a variety of industry leaders and may find many doors opening. We call a lot of the people we meet at such events and the results have been extremely gratifying. Home Lenders has its roots in inner city, low-income areas of Los Angeles. Our founder, Earl Castle, is Afro-American and at least half of the employees - including senior level management - come from minority groups. This background has helped us develop business relationships with several Los Angeles area developers on affordable housing projects. Home Lenders was instrumental in handling the wholesale end of providing mortgages for buyers in one recent project, and the company is likely to gain from this involvement on the retail side.

Whatever business we derive from such a project is of secondary importance - the real satisfaction comes in putting something back into the community. This experience further illustrates the positive power of networking. Paradoxically, we have found that the tried and true, old-fashioned values such as honesty, frugality and hard work remain crucial to success in any business, even in our high-tech age.
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Copyright 1990 Gale, Cengage Learning. All rights reserved.

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Author:Chelimsky, David M.
Publication:Mortgage Banking
Date:Apr 1, 1990
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