We have several bank clients that either operate a mortgage banking division or own a mortgage banking subsidiary. Operating within a regulated environment requires a respect and sometimes a fear of bank regulators.
When a bank regulator makes a visit, they focus on various types of risk associated with operating a mortgage bank. They are interested in steps management has taken to control and mitigate those risks. They are not focused on whether you are originating a bunch of loans or whether you are earning a profit. They are focused on risk.
One of my recent engagements was a bank that operates a mortgage division. They wanted me to review specific areas of the operation in preparation for an OTS audit. The division is originating loans through mortgage brokers nationwide and is highly profitable. The Board of Directors wanted to find out if there were any weaknesses in how management was addressing three areas of risk: TPO (broker originated business), interest rate risk management and consumer compliance.
Let’s review what we found:
TPO Management: This Company third party originates through mortgage broker in 35 states. They have approximately 750 approved customers. A TPO channel is considered high risk today and bank regulators are very interested in understanding how management approves and monitors mortgage brokers. We found that management has put an extensive approval process in place and monitors loan quality of each broker. Here are some key procedures they use:
- Account managers are required to visit each broker and complete a comprehensive write up on the key characteristics of the prospect. In addition to an application and signed agreement, there are numerous documents and information required before the prospect is passed along to management for review
- Extensive due diligence is performed on the prospect including various third party reports, reference checks and review of financials
- Three layers of management review the application and the Chief Credit Officer has the final say on the approval
- Ongoing performance review of broker customers such as pull through percentages, loan quality and total revenue generated
Interest Rate Risk Management: Regulators are especially sensitive to how interest rate risk is managed, monitored and measured. The Company uses one of the top hedging consultants / advisors to help manage its interest rate risk. The vendor provides analytics and trading support to the secondary market department. Management has implemented an internal audit process to validate the hedging consultant’s performance and hedge effectiveness. The VP of Secondary Market measures the expected gain-on-sale marked by the hedging consultant at lock with the actual gain-on-sale when the loan is purchased. Over the past several months, the variance has been less than 4 basis point. No regulator will be critical of the audit process and results.
Consumer Compliance: Consumer compliance is another key area bank regulators are focused on today. The new RESPA regulations are especially a key focus. In order to ensure all employees are knowledgeable about mortgage compliance and the new changes, management has developed extensive internal compliance training. Each employee is required to attend various training each quarter and must pass a written test. In interviewing several employees, I found all to be very knowledgeable about mortgage compliance and all had a clear understanding of the new RESPA changes.
Though this company has spent a fair amount of money and resources on audit and control processes to mitigate risk, the financial results are very impressive. This Company generates in excess of 90 basis points of pre-tax profits. They are one of the better performing clients of Garrett, Watts & Co.
