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August 31, 2011

Mortgage Banker View: BofA Cuts Off Mortgage Bankers

August 31, 2011

Mortgage Banker View: BofA Cuts Off Mortgage Bankers

The WSJ reported last night that Bank of America is exiting their correspondent mortgage lending business which buys loans from mortgage banks. WSJ and Inside Mortgage Finance said BofA had 24.3% market share in correspondent lending, second to Wells Fargo, and BofA’s correspondent channel made up 47% ($27.4b) of the bank’s 1Q2011 mortgage originations.

So yes, it’s a big deal. If a mortgage bank wasn’t planning for this and/or relying too heavily on BofA as an investor, they’ll feel it indeed. Below is more on what this means for consumers, mortgage banks, and mortgage brokers trying to transform themselves into mortgage banks. Full disclosure: this is my take as a mortgage banker whose firm has enjoyed a long relationship with BofA as an investor. My opinions are my own.

First you have to understand that consumer mortgages are originated through three main sources:

(1) Retail banks which make loans to consumers, then sell the underlying loans to investment firms, Fannie Mae, or Freddie Mac who bundle the loans into mortgage bonds (aka mortgage backed securities or MBS). But they usually keep servicing rights so the consumer gets their monthly statement from the retail bank.

(2) Mortgage banks which make loans to consumers, then sell the underlying loans to retail banks, investment firms, Fannie Mae, or Freddie Mac who bundle the loans into MBS. Larger mortgage banks may keep servicing rights so the consumer gets their monthly statement from the mortgage bank, and smaller ones sell servicing rights along with the loans.

(3) Mortgage brokers which get loans for consumers through retail banks or mortgage banks. The loan is funded and usually also serviced by that retail or mortgage bank.

These three channels are referred to as retail, correspondent and wholesale, respectively.

During the crisis years from late-2007 through 2009 many big firms, including Bank of America, exited wholesale/broker channel. The rationale was that most of the junk came from brokers. True or not, cutting off wholesale was an easy case for a bank to make because they don’t control salesforces of broker firms.

Retail was first priority and correspondent/mortgage bank was a close second, and for good reason. The BofA stat above showing their corespondent business accounted for nearly half of their Q1 production this year speaks for itself. As the case goes, quality is easier to control through correspondents (mortgage banks) because they have their own underwriting and retain tighter control of their salesforces. Plus if a big bank doesn’t like a loan a mortgage bank originated, they don’t have to buy it.

I don’t know why BofA is exiting correspondent, other than: they have bigger problems. But as noted above, many mortgage firms will be hit hard by this. Here’s why: as wholesale options have constricted, many broker firms have tried to morph into mortgage bankers by building correspondent relationships. This is easier said than done in a broker culture.

Broker culture says to the consumer: we shop around for the best deals for you and we have lots of bank relationships to do so. This is decades-long mantra, and many top loan agents live and die by it. They want options for their client. Trouble is that too many options means more wholesale lenders to please.

And if you’re also trying to build a correspondent division to move your broker firm away from reliance on wholesale, you’ve also got those new correspondent relationships to please too.

You have to show them volume and loyalty: high funding ratios on locked loans. If you don’t do this in wholesale, you risk losing preferred pricing with that lender. If you don’t do it in correspondent, you’re dead in the water.

I’ve seen broker-at-the-core firms try to ramp their correspondent divisions in recent years, and they stumble for a couple reasons: (1) they can’t get enough correspondent/bank volume because they can’t break their wholesale/broker culture, and this leads to (2) too much reliance on a couple investors.

This is where the mortgage banks relying too much on BofA are going to be scrambling, especially if they’re brokers who are new to the correspondent game. (And as an important aside: mortgage banks also rely on correspondent relationships for warehouse lines of credit to fund loans, so if BofA was a firm’s only funding source, they’re scrambling even more).

The BofA move is disappointing for me personally. They’ve been a good investor for us and I’m intimately familiar with all their underwriting nuance. But we’ve got many other deep correspondent relationships, our own service-retained products, and A-paper correspondent stats/reputation that’s been 20 years in the making.

So as headlines all focus on BofA’s troubles, the reality in correspondent trenches is that this market share opportunity for BofA’s competitors—large and emerging players. But the best options go to those who’ve committed to the correspondent model, not the dabblers.

The lesson for consumers in all of this is learning who you’re dealing with: a retail banker, a mortgage banker, or a broker. Hopefully the above descriptions help with that. If I can sum up pros and cons in one sentence for each, it’s as follows:

Pros of retail banks are they they’re a big brand and might have some other non-mortgage services you like, and cons are that retail banks processes and follow through are unreliable because loan agents have no control of the big machine they’re part of.

Pros of mortgage banks are that your loan agent is using the many investors they sell to to one-stop-rate-shop for you and they still control the whole process from start to finish, and cons are that you may not recognize the brand name or might not be able to get other financial services from them.

Pros of mortgage brokers are their ability to rate shop and the experience level of the last brokers standing (if they’ve not yet converted to mortgage banks) is high, and cons are that they have no control over the loan approval and funding process.

More on BofA:
-Bank of America Exits Correspondent Channel (WSJ)