In a tightening environment, it helps to know if the broker channel really is cheaper for lenders

David Olson, president and managing director, Wholesale Access

As published in Scotsman Guide's Residential Edition, February 2008.

In recent months, mortgage brokers have met much scrutiny, with politicians, regulators and others appearing to blame them for the current mortgage mess.

Cost Breakdown ___________________________ Download the author's calculations as a Microsoft Excel spreadsheet. Chart

Proposals such as the Mortgage Reform and Anti-Predatory Lending Act, for example, raise the question of whether the role of the mortgage-brokerage industry will be fundamentally altered by legislation. The rhetoric against brokers also is prominent in the press, which often relays stories of predatory practices and brokers taking advantage of borrowers. In August, Sen. Charles Schumer (D-N.Y.) painted the mortgage-brokerage industry as "unscrupulous" in the Wall Street Journal.

These sentiments, plus the fact that some major lenders have exited the wholesale-broker channel altogether, raise concerns about mortgage brokers' future in the mortgage industry as a whole. According to our data, brokers accounted for 58 percent of the total residential mortgage-origination market in 2006, slightly down from 68 percent in 2003. But given the financial stature of brokers' retail rivals -- namely banks, thrifts, credit unions, finance companies and mortgage banks -- what caused mortgage brokers to dominate mortgage finance in the first place?

We have long thought the underlying reason was lower costs, but we have neither seen nor produced any published data to support this assertion. By comparing costs between the wholesale-broker and retail channels using 14 consecutive years' cost data, collected twice annually from many of the large multichannel lenders, we see a clearer picture emerge.

Using the two methods detailed in the graph to the right, we found some evidence that large lenders gain economy-of-scale and cost advantages in the wholesale channel. Here's a look behind both methods.

Method No. 1

The first method in determining the cost difference between the retail and broker channels examined expense data for eight periods from 2000 to the first half of 2007 using average costs from the Wholesale Access production revenue and expense benchmarkings. We included data from about 15 of the largest U.S. mortgage lenders in this period; because of mergers, participants are not the same over the entire period but were chosen to be representative of the industry's larger firms.

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