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   ARTICLE   |   From Scotsman Guide Residential Edition   |   October 2010

The Downside of Retail Temptations

The rewards of leaving wholesale lending often aren't what they seem

It is increasingly common for mortgage brokers with years of experience to move their business to a retail mortgage bank. When this occurs, brokers often list four reasons for their decision:

  1. Yield-spread premium (YSP): They don't want to worry about the regulation of YSP.
  2. Team consistency: They're tired of working with a changing mix of underwriters and others.
  3. Net-branch opportunity: The bank plans to give them a net branch.
  4. Avoiding audits: They'll be able to sidestep U.S. Department of Housing and Urban Development (HUD) audits and specific net-worth requirements.

Although all these reasons may sound great, brokers should consider each one more closely before deciding that a change to retail banking is their best course of action.

Yield-spread premium

The Federal Reserve Board announced this past August that it will ban YSP beginning this coming April. Moreover, the financial-reform act signed into law this past July generally prohibits retail and wholesale residential mortgage originators from receiving compensation that varies based on loan terms other than the principal amount.

In response to long-standing concerns about YSP -- a fee paid to originators by lenders based upon a loan's interest rate and other terms of financing -- some retail mortgage banks created complex formulas that result in their originators being paid hourly wages rather than receiving per-unit compensation. Others renamed the accounting classification of YSP, calling it "gross gain on sale" or "accrued servicing revenue," for example.

Changing the name of YSP, however, isn't an acceptable solution, and efforts to pay originators by the hour rather than based on commission often leave originators unsatisfied and making much less money than they previously did.

Brokers, however, already switched from receiving YSP directly from lenders beginning with the new Real Estate Settlement Procedures Act requirements this past January. Presently, YSP is credited to borrowers and then captured by brokers. Complying with the new regulation is as easy as converting captured YSP to an origination finance charge. In other words, brokers could often make more money by staying on the wholesale side without having to make any material changes.

Team consistency

Although the idea of working with the same underwriter every day may seem attractive at first, the reality can get old quickly, especially if you don't get along with the underwriter. Working in a retail operation also often means you're stuck with the same appraisal-management team and other service-providers, typically with no ability to change. If you find yourself dissatisfied with how a certain department handles your loans, your only option often will be to complain to management.

As an independent broker, however, if you're unhappy with a lender or service-provider, you can make a change. This freedom allows you to conduct business with like-minded professionals.

Life at a retail bank often is completely different. If management dictates a policy change, you often must adapt or find yourself seeking another job. That's not a great position to put yourself in, particularly if you love the freedom of being your own boss.

Net-branch opportunity

For some industry professionals, net branches maintain a black mark because of how retail mortgage banks used them to circumvent regulations.

Although net branches are still acceptable to HUD, Fannie Mae and Freddie Mac, it's often easier for a mortgage bank to find an alternative way to structure an agreement that looks like a net branch but isn't quite as accommodating.

Information often hidden from prospective branch-operators includes corporate allocations, transaction fees and high-margin rate sheets. Such rate sheets deliver lenders handsome payouts based on the difference between the price they pay to originators and the price they receive when selling loans on the secondary market.

"When considering a move to a net branch, brokers should inquire about the bank's net worth."

In many cases, companies will find ways to recoup any expenses they paid to recruit new branch-operators. Often, visits by regional managers and staff dinners may come out of the branch-operators' pocket, along with other expenses related to running the branch. This can include vendor services, employer taxes and insurance benefits.

Also, branch-operators may file for unreimbursed business expenses -- something tax auditors often investigate -- rather than filing taxes under their own business entity. In other words, some branch-operators may find themselves experiencing little to no monetary benefit while losing advantages associated with self-employment.

Avoiding audits

Two of the biggest drawbacks of originating Federal Housing Administration (FHA) loans are meeting minimum net-worth requirements and going through annual audits.

For mortgage brokers, however, HUD's minimum net-worth and audit requirements for correspondent approvals will cease beginning this coming Jan. 1. Brokers no longer will need to pay for audits or be subject to net-worth standards imposed by the government. Instead, the requirements only will apply to FHA lenders. Beginning earlier this year, lenders were already able to approve their own FHA correspondents.

Further, HUD has increased the minimum net-worth requirement for FHA lenders to $1 million beginning in 2011, with additional increases set to occur by spring '13. When considering a move to a net branch, brokers should inquire about the bank's net worth. If the bank won't reveal specifics, it could be at risk of failing to meet mandated levels.

Other issues

When considering retail opportunities, remember the burden of exclusivity. As a retail loan officer, your originations would be almost exclusive to your employer. Because retail employers don't need to worry about the high level of competition that wholesale lenders deal with, they often can adjust pricing at their whim. Wholesale lenders, on the other hand, must compete with every rate sheet and on every decision.

Various industry groups compare wholesale lenders and provide live feedback on those with the best prices and service. In the retail world, no entity has the necessary information to perform such a service reliably.

Another burden of exclusivity involves compliance violations. If a retail lender fails to issue a Truth in Lending disclosure to borrowers before they pay for an appraisal, then the lender will have a noncompliant, unsalable loan. Lenders often will decline a loan because of this issue. If they don't, they will have violated the Mortgage Disclosure Improvement Act and risk consequences. In the wholesale world, on the other hand, if a lender fails to comply, then a broker can pull the loan and send it elsewhere.

Brokers considering retail lending should carefully inform themselves about its drawbacks before making any change. Although the retail world can seem enticing at first, many apparent advantages aren't always as great as they seem. Weighing your options can help you make the best decision for your business.


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