In the years after the mortgage crisis, regulatory requirements tended to disfavor independent mortgage originators and small mortgage companies. Everything from the Good Faith Estimate, the loan-originator compensation rule, anti-steering regulations, qualified mortgage (QM) points-and-fees limits, the home-valuation code of conduct and requirements for small businesses to maintain compliance-management systems all put pressure on independent originators.
Adding to these pressures, big banks and many lenders exited wholesale lending altogether, making it easy to understand why mortgage originators began looking for alternative business models to pursue in the aftermath of the meltdown. Driven by these factors, two business types emerged: mortgage branches and non-delegated correspondents.
As the mortgage industry adapts to uncertainty in the marketplace and the many regulatory changes that have occurred over the past 10 years, some major trends have emerged. These trends continue to evolve today. To better understand these trends and the way they impact how mortgage originators manage their business operations, we first need to take a brief look at the history of the business models that emerged post-2008.
Branches and NDCs
In some parts of the country, mortgage originators joined large lenders through branching programs and became branch operators. Hosting lenders shared their compliance-management system platforms; provided established appraisal panels; and shared human resource, marketing and information technology support.
Becoming a branch of a large lender allowed banking methodologies to be applied to disclosures and the QM points-and-fees test, giving former independent originators some parity with bankers in the marketplace. In addition, joining large lenders also shielded small-business owners from an unfriendly regulatory environment.
In exchange for these benefits and services, mortgage originators/owners forfeited some of their independence. In some cases, they also lost the ability to control their own branding, marketing, pricing, choice of wholesalers and, most importantly, their control over their processes, workflows and businesses. Although this was a bit of a shift for independent originators, large lenders generally benefited from these efficiencies.
In other parts of the country, mortgage originators took out warehouse lines of credit and restructured themselves as non-delegated correspondent lenders, or NDCs. Non-delegated simply means these lenders do not underwrite their own loans. They sell loans to investors who underwrite the loans prior to funding.
By funding loans themselves, however, NDCs become creditors. They can choose their own appraisal management companies, set their own pricing, use banking methodology for disclosures as well as the points-and-fees test and have control over their processes. Independent originators who enhanced their business models by adding the NDC channel gained all the benefits of banking, but also retained much of their independence and control over their own businesses.
Importantly, NDCs lost none of the bene-fits of being independent originators by adopting this model. Instead, they gained added benefits in exchange for taking on more risk and more responsibility.
The latest trend is the emergence of investors and fulfillment companies offering software solutions and expanded services to assist originators looking to emerge into an NDC model with less risk as a new business owner. Some boutique warehouse-lending facilities offer software solutions that feature performance feedback to emerging NDCs. Similarly, some fulfillment companies are now offering more guidance to emerging NDCs.
In addition, several investors are partnering with warehouse and fulfillment services to offer emerging NDCs well-rounded guidance and efficient processes that act to mitigate risk to NDC owners without deteriorating the integrity of their status as correspondent lenders. These NDCs must still shoulder more risk than independent originators or branch operators, but the industry is now organizing to better support these business owners.
Across the country, branch operators can now consider the NDC model as a viable platform for themselves and their teams. They can re-establish their independence as well as their control over their wholesale and investor relationships — and therefore their pricing.
In most models, branch operators are required to fund the majority of their originations with the hosting lender. In many cases, the wholesale relationships offered by the hosting lender are limited, if nonexistent. This reduces the ability of branch operators to access product and pricing comparable to either independent originators or NDCs.
Other factors that may drive branch operators to explore the NDC model include their desire to regain control over their own branding, marketing, compensation and loan processes. More importantly, branch operators can ensure that all their hard work goes to establishing equity and capital in a business they own with no ties to a larger brand. It comes down to the ability to own something that you can control, build, brand and someday have the opportunity to sell — prospects that are more limited in the branching model of yesterday.
Finally, many independent originators also are looking to the NDC channel as a smart enhancement to their existing business model. This trend is being driven by the desire to offer sales candidates and referral partners the banking-methodology perks mentioned previously, plus the added cache of being a banker.
Risk versus reward
One of the biggest considerations for any small-business owner considering these business models is the risk to the owner or owners. Every business model carries some risk, but arguably the lowest-risk mortgage business model is the branch operator, which is partly why the trend toward this model has emerged.
The hosting lenders assume most of the risk. They assume liability for compliance, human resources, information technology, marketing, fraud, misrepresentation, licensing, compliance and errors-and-omissions insurance. In addition, hosting lenders assume all the risk for the warehouse lines of credit, buy-backs, etc. Many former business owners turned to the branch-operator model because they were seeking lower risk.
Of course, all risk must be compared against reward. In exchange for the lower risk of operating a branch, these former business owners forfeited much of their independence. Additionally, they generally pay a higher premium on base pricing to compensate the hosting lender for additional costs of supplying necessary services.
The second least-risky business model would be that of the independent originator. Independent players must assume liability for fraud, misrepresentation, licensing and compliance. They maintain their complete independence, can contract with the wholesalers of their choice, set their own compensation plans and control their own branding and marketing.
The NDC business model carries additional risk beyond that of a branch operator or an independent originator. Business owners adding this enhancement to their business assume the added risk and responsibilities of carrying warehouse lines of credit, funding their own loans and acting as the lender on the transaction. In addition, there are higher capital requirements and, usually, personal guarantees to secure the lines.
Non-delegated correspondents also take on more responsibility to ensure they only fund loans they can successfully sell to one of their investors. They are acting as the lender on all transactions they “bank” and fund on their warehouse line. This means enhanced responsibilities around compliance, too.
Fortunately, many warehouse-line providers, fulfillment services and some investors catering to NDCs have developed tools to assist these independent business owners with their added responsibilities. For small-business owners who are motivated to offer their clients and loan originators the best of both worlds — and who are ready to take on the responsibilities of a lender — the NDC model may just be the best fit.
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Innovation, new technology and regulatory changes will continue to transform the mortgage industry. This means that, even though existing business models that emerged after the mortgage crisis will remain, the non-delegated correspondent structure is emerging as an attractive choice, and those who are looking to take on the risks may indeed see the rewards of the independence it offers.