NATIONAL MORTGAGE PROFESSIONAL MAGAZINE JUNE 2009 O
Securities-based lending: An alternative source of funding
Third-party originations: What the future may hold
By Adrian Skiles, GML
By David Walden
You may have heard the term “stock with a proposed interest rate. loan,” “stock-secured financing” or “secuThe terms are offered to the borrower, rities-based lending.” All of these terms and upon agreement by both parties, the refer to the type of lending program loan documents are drawn up and where the borrower’s securities (stocks, arrangements are made for the securities bonds, mutual funds or options) are to be transferred to a holding company. A pledged as collateral for a loan. These are final value is then given to the securities “non-purpose” loans and no lien is placed based on an average of the closing price of upon any asset, such as real estate or per- the collateral for three consecutive marsonal property. The securities alone stand ket days. This is called the “strike price.” as collateral for the debt. Proceeds of the The borrower then transfers the ownerloan may be used for any purpose except ship of the securities to the lender. The to purchase or carry securities. borrower still retains all beneficial interInterest rates for these programs are ests in the securities and will receive any usually between 2.5 and 4.5 percent and dividends or interest that accrues from the the loan-to-value ratios offered may be as securities during the term of the loan. high as 80 percent of the securities value. At the end of the loan term, the loan The factors that determine the rate of may be renewed, refinanced or paid off. interest and the amount of the loan are If the loan is paid in full at the agreed how actively traded and upon term, the exact numliquid the securities are on ber of shares or collateral the open market. The loan initially pledged is term is typically between returned to the borrower. three- and 10-years, with a One important point is fixed interest rate and there is a “lock-out” for the “interest-only” payments term of the loan, which due to the lender. These means the borrower may loans are offered with no not make any principal closing costs, broker or reduction payments or pay transaction fees. Funding off the loan entirely until can take place in just a the end of the agreedmatter of days. A credit upon loan term. “These loans are a report is not required, nor If, during the term of “qualifying stock is any income or employthe loan, the value of the ment verification done. securities falls below the lending agreement” Not all types of securities and therefore a nonagreed upon minimum may be used as collateral. fair market value (usually taxable event with The securities must be able 70 to 80 percent of the respect to any gain to be “free traded” without loan amount), then the or loss at the time of any restrictions and the loan would be considered the transfer of the borrower must be able to in default. The contract securities.” prove that they are not a 10 may require the borrower percent or greater holder, to contribute additional director or executive officer in the compa- cash or shares as more collateral to keep ny that is the issuer of the securities. the loan out of default. The decision to Retirement funds (401k’s, pensions, etc), move forward is solely up to the borrowdo not qualify for this type of program. er. Remember, that this type of lending is These are also “non-recourse” loans, non-recourse, so should this type of shortso if the borrower does not make the fall occur, the borrower may stop making interest payments when due or fails to the payments and simply walk away from repay the principal at the end of the loan the loan and forfeit their collateral with term, the lender’s only option is to keep no penalty or recourse from the lender. the securities that were pledged as collatWhen choosing a lender, here are a eral. Should a loan default occur, the loan few items the borrower may want to is cancelled and the borrower keeps the consider prior to entering into this type money received from the loan and the of arrangement: lender keeps all interest in the securities. The loan default is not reported to any O How long has the company been in credit bureau or placed in public record. business? The loan application process is quite O What are the backgrounds of the simple and should take just a few days principals in the company? to complete the loan process and receive O What assurances can the company the funds. To start, the borrower supgive that the full amount of collaterplies the name and number of shares al will be returned to the borrower that they wish to pledge, along with the upon completion of the loan term? loan amount and term desired. The O What is their track record of returning lender will then do a preliminary examthe pledged collateral to the borrowination of the loan request, and based er at completion of the loan term? upon an assessment of risks, they will determine the loan-to-value ratio, along continued on page 39
The views and opinions expressed in the following article do not necessarily represent the views and opinions of NMP Media Corp., its publishers and staff, the National Association of Mortgage Brokers and the National Association of Professional Mortgage Women.
effects of their shrinking net worth resulting from runoff, those lenders will need to stem the tide of rapid runoffs as quickly as possible for their stockholders. There will be limited servicing available to purchase at cost-effective prices. Therefore, it must come from production. Their own existing When offering my opinions on the subject production operations will soon prove to of the future prognosis for the mortgage be insufficiently staffed and trained to broker industry, I have only one agenda meet this demand. This industry has lost a and that is how to save the mortgage bro- lot of its trained, seasoned human ker industry. I certainly do not speak for the resources from the production side of the Mortgage Bankers Association (MBA) as a business. We will absolutely need the surtrade group spokesperson, but I am offer- viving community of mortgage brokers to ing uncensored straight talk from real expe- help generate the volume required to stem rience. I’m entering my 39th year in this the servicing portfolio runoff once this business, and until eight months ago, I co- cycle turns upward! owned a third-party wholesale operation Yet today, their very survival is being that was also a division of a federally-char- threatened by program eliminations, clostered thrift. I am a mortings of wholesale lenders, gage banker, and I mortgage insurance restricexchange knowledge and tions and new legislation. ideas almost exclusively Why? Over the past three within mortgage banking years, mortgage bankers circles from board rooms, have been perpetually anamanagement retreats, and lyzing what went wrong in lounges at industry trade each file that began failing shows, the office water our performance expectacooler, telephone, e-mails, tions, including the and inner-industry trade “what/why/who” of each publications. file. The analysis of data It is a complete mistake across the total industry “Everyone in this born of misunderstanding to indicts the broker more than business, and all believe mortgage bankers any other origination group. want to completely reIn my opinion, the allied business assume the responsibilities compensation structure of groups, are going to of meeting the total demand most mortgage brokerages be even more for mortgage originations. In hungry than today!” is the number one factor the late 1980s and early 90s, that compromises the ethmortgage bankers basically ical focus of the originagave birth to the mortgage broker industry tors. Number two is poor or non-existent of today because the business cycles of orig- supervision, and number three is the inations, coupled with almost uncontrol- absence and/or enforcement of traditionlable losses in other business units of bank- al quality control practices, both of which owned mortgage banks, forced the reduc- are prevalent at the significant number of tions of overhead associated with the mort- poorly-managed mortgage brokerages gage origination platforms. We avoided when compared to the more structured, incremental overhead (on the balance rules-based culture typical of a mortgage sheet) by using outsourced overhead (off bank. Not at the trade association level, balance sheet) thanks to the brokers. but within the individual businesses When we come out of this “meltdown” themselves. Servicing mortgage bankers there is very possibly going to be a fairly conduct the origination business for the rapid ramp-up of business demand for real servicing rights of the loans. They don’t estate financing, especially because the want to put defective business on their downside has been so protracted. Realtors books because it doesn’t perform and are tired of starving and pent up demand contaminates their portfolio or securities. from consumers previously frozen with They certainly don’t incent their originafear will give them the opportunity to get tors to break the rules and will not hesiback on the road to prosperity. The same tate to terminate production personnel holds true for homebuilders. Everyone in found to be involved in fraudulent activithis business, and all allied business ty. That includes fraud by omission or groups, are going to be even more hungry commission. They typically pay the lowthan today! There will be pressure on new est commission rates of all origination product development to assure that the platforms. If one of their originators seeks American dream will again be within reach to achieve gross earning levels comparafor most Americans who wish to own a ble to those working in other origination home. Five major banks will own in excess platforms, they must create that opportuof 65 percent of all mortgage servicing nity through higher volume. Non-servicrights and while Troubled Asset Relief Program (TARP) funds have mitigated the continued on page 38
An open letter to U.S. President Barack Obama
JUNE 2009 O
NATIONAL MORTGAGE PROFESSIONAL MAGAZINE
By Thomas J. Murphy, CMA, CLA, CMPS
Dear Mr. President: environment of severely restricted lendMy compliments to you, on the steps that ing/borrowing opportunities. you have taken so far, in addressing the Now is the time to dust off this negchallenges that we are currently experienc- lected loan program, bring it up-to-date ing in the mortgage and real estate market- with current standards, implement the place. I believe that your actions are a good proper management and supervisory start; now, we need to take the next step. controls, and offer the financing to the One of the most significant issues we thousands of individual, grassroots are faced with is the distressed, aban- investors around the country who would doned and foreclosed housing stocks love to take an active role in real estate located throughout the country; espe- investing and rehabbing—and watch as cially in the blighted neighborhoods of private enterprise floods into the dynamour cities. We are dealing with millions ic American marketplace and takes over of homes that are negatively impacting the job from governmental efforts of the values in their neighborhoods. We reinvigorating our neighborhoods. have thousands of foreclosed properThe ancillary benefits to this proties continuing to flood onto the mar- gram are of no small consequence. An ket; the sooner we work through these increase in construction jobs/employhousing stocks, the sooner we will ment, an increase in commerce for the return to a normal real building trades/supply estate market. industries, increased payYou have a very potent, roll revenue and taxes, yet unused, weapon in the return of more housyour arsenal. The Federal es to the tax base of the Housing Administration municipalities, improved (FHA) has an excellent business prospects for housing rehabilitation thousands of realtors, loan; the 203(k) program. mortgage bankers and This loan program is curregular old, “mom & pop rently offered on an investors” … seems like a owner-occupied basis; win/win proposition. however, in the past, it Americans are industri“We don’t want has been offered as an ous, motivated and entrebailouts, we want investor loan program as preneurial by nature … all well. Real estate investors you need to do is provide opportunity and were allowed to particius with sufficient, effective hope!” pate in the program until funding mechanisms and October 1996. At that point, the investor we will solve the problems of the country part of the loan program was placed the old fashioned way, with hard work, under a moratorium, due to poor quali- motivated by capitalism and a desire to ty control issues, resulting in a number improve our own situation, as well as the of high-profile mortgage fraud cases. situation of our own neighborhoods. We It is self-defeating to take a success- don’t want bailouts, we want opportuniful, viable loan program and place it ty and hope! under a moratorium because some I encourage you to redeploy the people abused it. Instead, let’s figure 203(k) program for Investors. You don’t out how to make it better. It’s kind of have to reinvent the wheel, it already like, “This isn’t working the way I want, exists. The current economic conditions so I’m taking my marbles and going have created a strategic opportunity for home.” Everything is difficult before it this type of financing; you should direct is easy. It is certainly not the American the U.S. Department of Housing and way to quit, we don’t just give up. We Urban Development (HUD) to remove figure out how to make it work the right the current moratorium, institute way. The American genius is that we viable support, managerial and superconstantly re-invent ourselves. If you visory systems, and turn loose the are looking for a methodology to draw American entrepreneurial spirit. private equity off the sidelines and get To paraphrase Victor Hugo: “Nothing people working and investing again, is as powerful as an idea, whose time you have it at your fingertips. has come.” The FHA 203(k) loan program is an Thank you for your time and considexcellent vehicle for neighborhood re- eration. vitalization and increases homeownership opportunities for many low-to- Thomas J. Murphy, CMA, CLA, CMPS may moderate income families by offering a be reached by phone at (540) 786-2646 government guarantee, flexible under- or e-mail firstname.lastname@example.org. writing guidelines, a low downpayment and the opportunity to finance the actuFor more information on al home improvements with the origiauthor Thomas J. Murphy, nal mortgage … the very attributes that visit his Web site at investors find so attractive in today’s www.tjmurphy.com.
third-party originations ing mortgage bankers often pay a slightly more generous commission rate than servicing mortgage banks because their profit and loss (P&Ls) margins are totally fee income-driven, yet still discourage the origination of defective products. They too will terminate any production employee found to be practicing unethical origination tactics of any kind because they are obligated under strictly enforced correspondent lending contracts to repurchase loans determined to be defective, in addition to first pay and early pay default liabilities. Mortgage brokers typically pay the highest per unit commission rate of all origination platforms. They too are totally fee-driven, with commission rates that have ranged from 60 to 90 percent of total fee revenue, including yield spread premiums (YSPs). This is often rationalized due to the lack of benefits offered by the employer and the “harder sell” scenario created by discriminating disclosure requirements that limit those originators from achieving the unit volume enjoyed by servicing and non-servicing mortgage banks, banks and credit unions. If the originator is a valuable contributor to the bottom line of the brokerage, there is a predictable reluctance to take decisive action against the guilty originators by the owner/broker. The wholesale agreements with the lenders have been too weakly worded or passively enforced, and those who were enforced were ignored by the brokers or they simply closed up and re-opened under another name. This author is definitely not for limiting or capping origination income for loan officers. However, I am not an advocate for low volume/high commission incentive programs. But what about the sub-prime and Alta programs? Let’s be clear about this. It is not so much the liberal terms of programs and/or underwriting that caused the majority of the losses driving the meltdown. It is the misuse of those programs and the documentation trickery and counterfeiting that drives a majority of the losses. The analysis also demonstrated that, by early 2008, approximately 60 percent of mortgage fraud was “fraud for shelter,” but only represented approximately five percent of the losses. That’s right … liberal programs only represent five cents of the dollars lost in the meltdown! The explosion of foreclosures skews that figure after the beginning of 2008 due to short sales and rapidly deteriorating property values. But the meltdown was seeded way in advance of 2008! On the other hand, approximately 40 percent of mortgage fraud was “fraud for profit” and represented approximately 95 percent of the losses. That indicates it is not the programs themselves but the abuse of the programs that are the root of the real problem, as well as this disagreement of where we are! Arguably nine out of 10 of the fraudulent loans were broker-originated! Mortgage
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bankers know it. Banks know it. And equally as important, the regulators know it. That’s why modifications of business and risk models used by lenders and insurers are not the principal threat to the survival of the brokers, but rather the eliminations, delivery channel closings, mortgage insurance restrictions and new legislation, much of it directed against brokers who are the principal threat. The fix to this problem is both simple and complicated. First, modify the compensation structure to more closely resemble that of mortgage bankers. Paying a higher rate to offset the lack of a benefits program is fair, but it should be kept at a reasonable level. Reallocating some of the excessive commission rates to payroll to strengthen supervision and quality control systems would improve the business model significantly, and would go a long way to meeting the next objective. Next, push to change some of the laws requiring brokers to disclose their earnings in a manner other origination platforms are not required to do. In other words, level the playing field so brokers can better focus their efforts on unit volume, rather than income per unit. It’s in the mortgage banker’s interest to do whatever it takes to preserve the mortgage broker business. They will need the production, and wholesale platforms are typically less expensive to operate and maintain than retail platforms, especially in stagnant or down cycles. In addition, and at least as important as any other step, mortgage brokers must defeat the reputation that is creating so much fear that the lenders to whom brokers were their best customers are turning their backs on the third-party originator industry? At the trade association level all the way down to the individual broker level, they must become more active and visible in their efforts to clean up their own backyard. They must stop prioritizing fear of litigation over the survival of the more intense threat to your business and industry. They know who the bad guys are. Their own loan officers tell them daily when they report that another broker got a loan approved and closed … that experience tells the honest and prudent broker would absolutely not qualify within the stated and intended terms of any known program. We, as third-party lenders, need the brokers to rebound and survive, but they must take the lead to make that happen from this point on. David Walden is a 39-year veteran of the mortgage banking industry, specializing in the mortgage production management of retail, wholesale, correspondent and affiliate branch origination strategies, and currently owns Production Solutions, outsourced production management and staffing. In addition, David also owns Risk & Recovery Solutions, conducting mortgage fraud detection, investigation, prosecution and asset recovery. He may be reached by e-mail at email@example.com.