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The allure of super jumbos.

Affluent borrowers are as good as gold for savvy lenders who see the mortgage transaction as a golden opportunity to cross-sell other products. Chasing down this business will net big returns for top financial services firms.

"We see it as a very profitable stand-alone business," says J. David Officer, executive vice president of Boston Safe Deposit & Trust, Boston. U.S. Trust Company of New York views it as "the most important credit product in private banking." Richard Beebe, vice president with Bank of America in San Francisco, simply says, "It is important to our institution, but we would rather not talk about it."

So, what is it that is so important, so profitable, so strategic to these institutions that many will not even talk about it? It is the "super jumbo" mortgage, along with the fees that it generates and the access it creates to

the affluent borrower.

Only recently have U.S. financial markets and the business media begun to focus on the market for the affluent consumer. The Wall Street Journal, in a recent article titled "Private Bankers Court Merely Affluent," suggested that the affluent market currently includes 15 million households and is expected to grow by another 5 million households in the next four years. Furthermore, the Journal article projected a 20 percent growth in private banking clients during the same time frame.

Private banking is the term used in the banking business for the specialized banking services provided to certain exclusive customers with assets on deposit that range up into the millions of dollars. There are few other sectors in banking that will even approach the type of growth anticipated for this niche during the time frame noted in the article.

The affluent are an undeniably attractive customer group, due substantially to the $177 billion in fee-related revenue they annually generate for the financial community. Broken down, it represents $22 billion for the banking community, and another $155 billion in fees to mutual fund companies and brokerage firms, according to the Wall Street Journal.

These fees, which represent financial services fees generated solely by the affluent, are only a small portion of the larger fees generated by the mortgage business, which by itself is a profitable, fee-based business. Equally important, the mortgage process is one of a very few situations when borrowers not only disclose significant amounts of proprietary financial information, but also avail themselves to financial entities beyond their traditional financial services provider. Recognizing the utility of this credit product in capturing these affluent customers and their financial profiles, institutions are betting heavily on the super jumbo mortgage as a key link in their strategic plans.

What is a super jumbo mortgage? One could describe it as a $300,000 home loan in Mason City, Iowa. In Beverly Hills, it would more aptly be a $2 million loan. For the most part, super jumbos are rather informally defined, in practice, as mortgage loans with principal balances in excess $625,000.

Despite the growing awareness of this market as a distinct segment, relatively little data exists on the geographic distribution of these borrowers or the actual size of the market. Geographically, one can speculate that super jumbo originations are offered and made where the affluent live. "Most of our customers with large assets have large homes. Home financing is one of our clients largest credit needs," states Michael Johnston, chairman of Merrill Lynch Credit Corp., Tampa. Primarily, the expensive housing stock is based in the Northeast, the Mid-Atlantic, Florida, Texas, California and other pockets of affluence around the United States.

As for the size of the market, "no one breaks out this information," says Stuart Feldstein, president of SMR Research Corporation, Budd Lake, New Jersey. "It is available, but you would have to process a lot of data, and most of that |data~ is old. Most financial institutions just want to keep it secret." Paul Havemann, vice president at the mortgage information publishers HSH Associates, Butler, New Jersey, states, "Super jumbos are simply hard to track."

This lack of data is not surprising, since few governmental agencies, and mortgage information publishers have considered the super jumbo market as a distinct segment of the residential mortgage market. Even when information publishers do consider this segment, they tend to lump in the super jumbo mortgage statistics with the larger non-conforming loan market, which dilutes and hides the information on the high-end of the market.

However, Merrill Lynch estimates the dollar size of the super jumbo market to be roughly $15 billion to $20 billion in originations a year. Johnston further estimates that the total value of this super jumbo market exceeds 5 percent of the $3 trillion in outstanding home mortgage debt. For those of us without calculators, that is roughly equal to between $150 billion and $175 billion. This estimate of the size of the super jumbo market was confirmed in a survey done by the author of a representative sample of major super jumbo lenders in residential markets around the country where there is a high concentration of higher priced housing stock.

For purposes of comparison, $20 billion in originations is more than the entire combined mortgage volume in 1991 of Citicorp Mortgage, Inc., Glendale Federal and Prudential Home Mortgage Corp. Not exactly a minor amount.

Given the overall size of the affluent mortgage market and its projected household growth rates of 10 percent to 20 percent, these figures suggest that the market for super jumbos will expand from the current $15 billion to $20 billion in annual originations to a market of $20 billion to $25 billion annually in the next few years. This move upward will create numerous opportunities for properly positioned institutions and will generate an expanded foundation for the secondary market.

Who originates them

"I cannot tell you for sure, but my guess is that most super jumbos are originated by non-financial institutions and a few private banks," says Havemann. While players in this market may be hard to identify, there is definitely a group of mortgage lenders who has focused on this segment of the market, although they may not be eager to tell the world about it.

Linda Simmons, executive vice president of residential lending for First Nationwide Bank, San Francisco, states, "We are in the residential lending business, and our overall corporate strategy is to be profitable. We make loans based on agreed-upon business criteria; hence we will make jumbo loans that meet our business criteria."

Mortgage bankers have slowly expanded into this market. Chuck W. Sewright, president and CEO of Anchor Mortgage Services, Inc., Wayne, New Jersey, said that the reason why they have not entered the super jumbo market is the limited liquidity of these loans. He adds that the secondary market is not well established as a conduit for these type of loans. Nevertheless, he said that Anchor will be moving into that market in the next 10 to 16 months.

The secondary market for these mortgages has been growing. Institutions such as Boston Safe Deposit & Trust, Chase Home Mortgage, Merrill Lynch Credit Corp. and Prudential Home Mortgage are increasingly selling this product in their MBS offerings. "Loans up to $1 million are included in our mortgage-backed securities," says Doug Russbach, vice president for media relations, Prudential Home Mortgage Corporation. He adds that, for the most part, "We are not a portfolio lender, only on an exception basis will we keep a super jumbo mortgage."

There is every sign that the growth of the secondary market for super jumbos will continue. The profitability on many of these loans demands the attention of an institutional following. Additionally, as the market grows, the banks' portfolio values will increase to such a size that it will necessitate the sale of the product into the secondary market.

What exactly is it that attracts lenders to the super jumbo market? The answers are surprisingly diverse.

"Others are looking at |the super jumbo market~ primarily for an investment client," says Boston Safe Deposit & Trust's Officer. He adds, "Boston Safe, on the other hand, is looking for high-quality credit borrowers." J. Matt Jurgens, public relations counselor, with Wells Fargo Bank, San Francisco, agrees. He states, "The quality of these clients' credit is very attractive."

While it may appear easy to identify credit quality, Deane W. Hall, executive vice president, Chase Home Mortgage Corporation, Tampa, says, "You |really~ need to know what you are doing. We use a cash flow methodology that utilizes a review of the client's track record, available reserves after closing and the stability of the industry employing the borrower."

The allure of high-quality credit individuals may not be sufficient in and of itself to attract everyone. "With these loans... are higher risks," says First Nationwide's Simmons.

Sewright, of Anchor Mortgage Service, while not yet actively involved in the super jumbo market, thinks that the cost of failure in this area of the business is much higher, and there is more collateral risk--therefore, his company has shied away from this market up until now.

These fears, while certainly justifiable, have not always been borne out higher delinquency rates for super jumbo loan product. HSH Associates, a mortgage information firm that has done some tracking of delinquencies for private clients, estimates that the delinquency rate for super jumbos dramatically lower than for the rest of the mortgage market. Also, typically, the loan-to-value ratios are proportionally lower for super jumbos than for the rest of the mortgage market.

Taking steps to add an extra layer of credit protection, Chase Home Mortgage Corp. requires two appraisals on all loans where the property value is in excess of $750,000. On values more than $1.25 million, they often require three appraisals. Other lenders in this market have similar requirements.

"These borrowers are usually cash-rich," says one industry executive. The executive added, "Our institution requires that |the borrowers~ have substantial reserves available after closing. We rarely have problems." However, one industry observer pointed out that "executive turnover has created most of the delinquencies" in the super jumbo segment.

Nevertheless, "Prudential has been very satisfied |with~ the quality of these loans," says Russbach. "We have experienced little or no delinquency." Merrill Lynch's Johnston estimates that his company's delinquency rate on super jumbo mortgages has never amounted to more that one-tenth of 1 percent of the company's super jumbo portfolio. Most of the institutions interviewed noted that the delinquency rates on their super jumbo mortgages were remarkably lower than the past-due rates for the rest of their mortgage portfolio.

Lower origination costs were also frequently cited as one of the attractions of being in the super jumbo market. With mortgage origination costs ranging from $1,000 to $2,000 per loan, the larger the loan, the lower the relative production cost.

Using Boston Safe Deposit & Trust Company's average super jumbo loan amount of $950,000, the estimate of $15 billion to $20 billion in yearly super jumbo originations translates to 16,000 to 21,000 loans originated annually.

Looking at this a different way, 21,000 loans amount to: just more than one loan annually for every bank and thrift in the country; or less than one half of 1 percent of all originations numerically; or 50 percent less than the number of home loans originated by Bank of America in 1991.

HSH Associates estimates that the average first mortgage loan size in 1991 was about $80,000. At that rate, it would take more than 250,000 of such mortgages to replace the equivalent super jumbo mortgage volume. Twenty thousand of these $80,000 loans only amounts to $1.6 billion.

Establishing these points of comparison in loan amounts makes comparing production costs in these different markets considerably easier. Using the numbers average per-loan origination costs mentioned earlier, to originate 250,000 mortgage loans could cost somewhere between $250 million to $500 million. The cost to originate 20,000 super jumbo loans (even assuming a 25 percent production-cost premium to cover more costly overhead to reach these borrowers) amounts to $25 million to $50 million. This simple math yields a quick and dirty cost comparison of these two markets, which suggests that the cost of super jumbo originations could be roughly $225 million to $450 million less for the same amount of origination volume.

While, obviously, it is not possible for any one institution to have a 100 percent market share of the super jumbo market, the cost analysis does illustrate how an institution can dramatically reduce its production costs, while maintaining the same origination volume, by concentrating on this market, or increasing its presence proportionally to the institution's overall volume objective.

Aside from costs to originate loans, what attracts many to this market is the profitability of this mortgage product. Chase, Chemical, Prudential and others all enforce a pricing structure that provides increases in rate, with increases in the loan amounts. Many contend that this reflects an increase in the risk of the loan.

Many institutions in the super jumbo market do not bother to focus on the pricing issue, when going after this market segment. To them, profitability and service are paramount in their decision to offer these loans. The institutions contend that a customer that needs a mortgage commitment in 5 to 10 days and to close in 20 days is not concerned with rate and points. Their only concern is delivery of service. That is not to say that these affluent borrowers are not price sensitive. It is rather a question of what is important--service or price. Many affluent borrowers resoundingly reply that it's service.

While this approach to pricing for super jumbos is accepted by many, it is not universally shared. Merrill Lynch's PrimeFirst mortgage offers pricing of prime minus 1/4 percent. Additionally, this program offers an interest-only option for the first 10 years. Furthermore, this program is not limited to purchases only, they provide it on all first mortgages; purchase money or cashout refinancing. Service is also pre-eminent under this program.

Merrill Lynch sources say they can offer this below-market rate pricing because their low delinquency rates and the shared risk nature of the PrimeFirst mortgage gives them the profitability they need from this product. They further point out that the company sells all of its PrimeFirst mortgages, however, it keeps all the servicing from these originations.

When reviewing the attributes of the super jumbo market and assessing the reasons given by mortgage executives for being in this market, my research revealed that many super jumbo lenders were in the market for reasons other than the more obvious ones noted earlier in this article.

Private bankers and a number of the huge brokerage firms have and will continue to target this market. Many correctly believe that the super jumbo mortgage introduces many affluent individuals to their services.

Johnston, of Merrill Lynch, states, "We definitely use |the super jumbo mortgage~ as a prospecting tool. Our financial consultants use it as a door opener. |Super jumbo's~ are a key to expanding a financial consultant's customer base." He adds, "To not cross-sell is crazy."

The incidence of credit clients who have been graduated to other advisory and management services has been dramatic. Merrill estimates that 30 percent of it new client growth is attributed to getting consumers in the door initially as a mortgage customer. U.S. Trust, according to it's 1991 annual report, states that mortgages have become the most important credit product in private banking. This credit product provides a way to steadily attract more corporate executives and professionals. U.S. Trust reports that increases in private banking deposits funded nearly the entire mortgage loan portfolio.

Borrowers, knowing that this marketing method is just beginning to blossom, have expressed concerns about preserving their privacy. Many of the institutions have addressed these concerns. Matt Jurgens, of Wells Fargo, states, "We use |super jumbo mortgages~ as a method of investment cross-selling, but we always respect the client's privacy."

Merrill Lynch, while processing the mortgage loan, withholds the client's specific financial information until after closing. At that point, they notify the financial consultant, responsible for the loan, of the closing. It then becomes the financial consultant's job to speak with the client. "We keep the financial information private--it is the client's choice to pass it on," says Johnston. Not surprisingly, many do want their information passed on.

Have the big guns entered this market in a serious way and begun to systematically cross-sell to these high-balance mortgage customer? Not really. Private bankers and, with limited application, brokerage houses are just beginning to become committed to the market. Additionally, institutions, such as Prudential and Citibank, are just starting to routinely cross-sell other financial products off of their super jumbo mortgage transactions.

Prudential's Doug Russbach says, "At this point, we are still trying to grow the mortgage business. We are growing so fast that we have had very little time to cross-sell. However, we are, on a very limited basis, offering homeowners insurance on properties that meet Prudential's criteria." Russbach continued with, "We are actively looking at moving into the cross-sell market."


The mortgage business is a profitable fee-based business. Equally important, the mortgage process is one of the very few situations when borrowers disclose much of their personal financial information.

Furthermore, demographically, the affluent market is about to explode. Just two quick facts will pull this market into focus: We are at the start of the baby boomers' advance from being spenders to savers; and we are at an unparalleled point in time when roughly $3 trillion in businesses and personal assets will pass from one generation to another.

Home mortgages are almost always the largest credit need that consumers require. The breadth and scope of the super jumbo market is growing. Development of the secondary market for this product also will continue to expand. The stability of these borrowers, for the most part, is better than for the rest of the market and the profitability of these loans is greater simply due to lower origination costs and higher profit margins.

Opportunities tied to this market exist beyond the mere extension of credit. The generation of fee income, combined with the affluent's dramatic increase in net worth, will attract all of the financial service sectors. Institutions that recognize the utility of this credit product in capturing the affluent market, can and will use it to expand all of their other product offerings.

Byant D. Nielson is president of Nielson & Associates, Inc., a financial consulting firm specializing in the affluent market.
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Title Annotation:mortgage loans with principal balances exceeding $625,000
Author:Nielson, Bryant D.
Publication:Mortgage Banking
Date:Aug 1, 1992
Previous Article:People investing.
Next Article:Settling up.

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