Each lender received a lengthy questionnaire. Answers were analyzed to ensure each firm used the same definitions and methodology.

For the broker channel, we added the yield-spread premium (YSP) to the total expenses to represent the wholesaler's total cost per loan. For the retail channel, we added the cost of overages -- the sum of corporate and branch overages -- to total expenses. Total expenses include those associated with account executives, sales management, processing, closing, other nonsales personnel, nonsales operating management, underwriting, occupancy/office space, benefits, and other direct and indirect expenses; servicing was not included. The YSP accounted for two-thirds of the total cost of producing a loan in the broker channel.

We examined eight categories of direct expense and seven categories of indirect expense, with a total of 27 line items summed. For all eight periods, the costs were always greater in the retail channel.

The differences between the broker and retail channels ranged from a low of 16 basis points in 2006 to 65 basis points in 2000. The average difference was 35.1 basis points, $733, during the eight periods. The difference was greatest in the down-cycle years of 2000 and 2001.

These numbers suggest that in the down cycle, the cost per loan tends to increase much more quickly in retail than in the wholesale-broker channel. We think this is because it is more difficult and expensive to downsize retail than to downsize wholesale.

In addition, large lenders working the wholesale channel gain economies of scale by spreading costs such as secondary marketing across a larger production base.

Method No. 2

This method looked at the factors that accounted for the expense differences in the two channels. We believed that there were higher benefits, office-space costs and overhead in retail because on the wholesale-broker side, many brokers earn little benefits and work out of their homes or in less-expensive offices. We also believed retail banks employ more lawyers, accountants and management staff than brokers do.

With this method, we focused on benefits, office-occupancy and indirect expenses to see how similar they were to the costs in method No. 1. The cost of benefits and office occupancy totaled 20.7 basis points more on average in the retail channel than in the broker channel. Indirect costs, or overhead, were 11.7 basis points more in the retail channel than in the broker channel. The average cost difference per loan for all three factors was $675, near the $733 cost difference in method No. 1.

For lenders, one negative aspect that could emerge from the broker channel is fewer cross-selling opportunities from wholesale customers than from retail-bank customers. Other limitations might include greater quality-control and compliance costs, which sometimes appear in loan-administration expenses.

Based on this analysis, the wholesale-broker channel is the lower-cost production channel for lenders. The three main components of this lower cost are lower benefits, occupancy/office space and overhead expenses. This explains brokers' growth and success in the past decade while facing better-funded competitors.

We don't see any evidence of this cost advantage disappearing in the down-cycle years. In fact, the data suggest the cost differences will widen to further favor brokers, absent major regulatory or legislative changes. The decline in broker-channel volume in the first half of '07 likely reflects the loss of nonprime, Alt-A and jumbo-loan production, as well as the reduced refinance activity.

Once these market segments return to normal, we expect brokers to regain much of their lost production.

David Olson is president and managing director at Wholesale Access. His background includes two years at Household Finance, a decade at Commercial Credit and three years as head of market research at Freddie Mac. He founded Wholesale Access in 1991 with Tom LaMalfa. Their goal was to establish a top-flight research, publications and consulting business built around wholesale-mortgage banking. Reach him at dolson@wholesaleaccess.com.

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