Over the past two years, I’ve traveled to over 30 cities and met with more than 60 mortgage bankers. This week, I visited a small North West retail mortgage banker that is doing around $20M per month. I was hired to perform a FOCIS study on the company.
There are 4 owners: 3 originate loans and 1 manages mortgage operations. Mortgage operations includes processing, funding and loan delivery. The company operates as a mini eagle and sells its production to several investors.
What really jumped out at me was their approach to secondary marketing. Management allows loan officers to perform the secondary marketing manager's function. All 15 loan officers have access to investor web sites to view daily pricing and lock loans directly. The company does not mark up the investor price to generate any gain-on-sale. Loan officers add their commission margin onto the investor price and deploy that execution rebate out to borrowers.
This practice runs contrary to everything we at Garrett, Watts & Co recommend to mortgage bankers. We have always believed mortgage bankers should centralize the lock desk function, mark-up an appropriate margin before deploying pricing to loan officers, and measure the delta of the expected gain to actual gain after loan settlement.
Before making any recommendation to change the current business practice, I reviewed the financial statements to see if their performance was substandard. I also reviewed several investor score cards to see if their current practices had any negative effect on loan performance, pull through, etc.
Let’s discuss:
- Although top line revenues were lower than most other mortgage bankers I’ve reviewed in the past 12 months, their pre-tax earnings were only slightly lbelow similar sized mortgage bankers who sell loans via best efforts.
- Loan officer commission splits were less than other companies I’ve reviewed. This strategy provided an incentive for loan officers to mark up the investor price to generate higher dollar commissions. This in turn provided a mechanism for the company to generate higher revenues as well.
- Expenses were lower because they didn’t have a secondary market department or underwriters. All loans were underwritten by investors.
- The company has not repurchased one loan in its 10 year history. It has also never had to enter into any investor loan indemnification agreement. The FHA Comp Ratio was below 100 and delinquencies reported by investors were lower than the average.
There’s no question this company could generate more revenues by moving to mandatory model and developing a secondary market department. However, I’m not sure the company would generate any additional revenues by centralizing the lock desk as long as it continues to sell loans under the best effort program. Their business model is simple and cost effective and does not seem to increase risk for the company by allowing loan officers to perform the secondary market function. Sometimes we need to take the position that “if it ain’t broke, don’t try to fix it.” At the exit review, I made no recommendation to change the current business practice.
