Correspondent And Wholesale Lenders Hope To Increase Subprime Volume | in Residential Origination > Subprime Lending |  |
Secondary Marketing Executive, May 2004.
Correspondent and wholesale lenders expect subprime business to increase this year as interest rates rise and originators turn their attention from refinances and search for new volume sources.
“In a market where rates were extremely low the last few years, loan brokers didn’t give subprime borrowers the time of day,” says Layne Sapp, CEO of Mortgage Investment Lending Associates (MILA), a wholesale lender based in Mountlake Terrace, Wash. “Conforming loan officers would pass on subprime borrowers to take easier loans.”
Recent economic hard times have increased subprime mortgage demand, he says. Subprime borrowers generally experience higher job turnover and rack up debt more quickly, prompting a need to refinance and consolidate debt more often. “We’re finding that the marketplace just continues to grow,” Sapp says.
“We remain positive in either a declining or increasing rate environment,” says Tony Gotschall, president of Long Beach Mortgage Company (LBMC), Orange, Calif. “With one of the highest percentages in purchase transactions and programs in the industry, we are confident we will grow in any market cycle.”
The company, a subsidiary of Washington Mutual, intends to increase volume this year by doing more business with existing relationships and expanding its approved list of customers in markets where it sees growth opportunities, he says. It will also be looking to augment its offerings in the correspondent space and to add mid-sized mortgage banking customers to its approved sellers list.
“We are seeing a more competitive approach from many traditional lenders,” Gotschall says, “but we are confident that there will continue to be only a handful of companies that will commit the expertise and resources required to be a dominant player in this segment. It is a much tighter group of lenders that control more than 60 percent of the existing share than the traditional lending market, and we see that trend continuing.”
The company focuses on speed to close, he says. It has a major project underway to re-engineer its existing processes and automate the process from beginning to end. “We are researching what our customers want from us and will drive our changes from that perspective,” he says.
“As the A-paper originations dwindle, we believe that more lenders will take the time to learn and offer alternative products, such as nonprime loans,” says Maxine Matteo, head of Deutsche Bank’s Correspondent Whole Loan Lending Division.
Deutsche Bank hired employees of First Franklin Financial Corp.’s correspondent lending division when that company left the correspondent business. The bank buys bulk subprime and Alt-A whole loans from large originators, but also wants to buy flow and mini-bulk production from smaller originators, notes Matteo, former head of First Franklin’s correspondent lending group.
A-paper lenders can enter subprime originations by using Deutsche Bank’s automated underwriting and delivery system that allows them to close the loans without creating a separate subprime division.
The national accounts division of Irvine, Calif.-based Option One Corp. also provides A-paper lenders a subprime outlet, notes Faith Schwartz, senior vice president, housing, industry and trade relations. Through that division, the wholesale lender can purchase closed loans from lenders, or finance loans directly, allowing banks to act as brokers.
The division allows lenders to complete subprime deals without creating a new department and provides a subprime outlet that conventional lenders may lack, she points out, adding that the division has seen increasing demand.
“This is a great market to be in,” she says, saying there’s plenty of room for additional players, which would help make the market more efficient. “We’re pretty well-positioned in the market. We’ve enjoyed good growth the past year.”
Aggressively expanding
Lime Financial Services, a subprime wholesale lender based in Lake Oswego, Ore., is aggressively expanding, says Zan Hamilton, CEO. “We’re building a subprime franchise. We’re in 11 states now. We’re aggressive on the West Coast and are expanding east.”
While conventional lending volume hits the peaks and valleys of refinancing rates, subprime remains consistently strong. When refinance volume slows, new players typically enter subprime, seeking a sector that’s more profitable and stable.
Subprime veterans are used to seeing a renewed emphasis on subprime in rising-rate environments. A-paper lenders will attempt to tap the subprime bonanza, but few are likely to maintain successful staying power, predict many industry players.
Typically, those new entrants, lacking experience, end up leaving the sector, Hamilton says. They find that subprime and conventional are two very different animals – too different to be done effectively in one shop.
“The difference is like between baseball and softball. They’re different skill sets,” he says. Subprime loans, he continues, are “story book loans. They’re not all black and white FICO-driven. There are nuances to subprime, including all the variations of credit overlays. You can’t be too risky. You have to able to quantify risks.”
Brokers or mortgage bankers considering entering the sector should work with an experienced subprime wholesale or correspondent investor prepared to tutor them and walk them thorough the process, he advises. “It’s all about training.”
Although Lime Financial is a relatively new company, its executives are veterans in the sector, having lead nonprime units at other firms, Hamilton points out.
While many subprime lenders focus on debt consolidation, Lime Financial generates much of its business, 60% to 70%, from purchases. It can finance high LTVs and high debt-to-income ratios, which is appealing for purchase money deals, says Mike Baldwin, president and chief operating officer.
Automated underwriting (AU) systems help, but underwriters must still examine most applications because of their many stipulations and exceptions. The automated systems may work for a small percentage of the easier loans, but most need human examination, Baldwin notes.
Automating subprime
Unlike other subprime lenders, MILA is emphasizing automated underwriting. Automation, according to Sapp, brings underwriting consistency and measurable performance, and when lenders want to change their risk tolerance they need only to tweak their model instead of reteaching their entire staff of underwriters.
To succeed in the subprime arena, lenders must use AU systems that produce accurate decisions, he stresses. “Your model has to ask enough questions so you don’t redo the decision. If you can perfect the application, you can perfect the decision. If the decision is clean, the lender will have the upper hand.”
For instance, AU should let brokers dispute credit reports they believe are misreported. Mistakes can be removed from applications – just as they can with manual underwriting, but online.
What many lenders call automated underwriting is really credit approval. It may ask 10 questions, but that is not enough. Lenders must build intelligence into the model to make its ability on par with manual underwriting.
Lenders must also anticipate the needs of borrowers and brokers. If a broker or customer calls with a question, the lender has failed to anticipate questions.
“You have to be consistent through every step of your process,” he stresses, saying lenders must do what they say they will without changing decisions.
While automated underwriting will become more sophisticated, lender underwriting guidelines, now disparate due to a lack of government-sponsored enterprise standards, will gradually become more uniform.
“Once that process jells over the next five years, subprime will be similar to conforming,” Sapp predicts. “That trend will compress the marketplace. We don’t believe there will be a subprime market 10 years from now. There will be different levels of lending.”
“In the next two years, we will validate everything from the customer with no conditions,” he says, explaining that brokers will not supply borrower financial information, which will reduce the “touches” on the loan application. Since MILA confirms brokers’ input, resending it through the model if information is correct, requiring brokers to document borrower financial information may be redundant.
In that scenario, the lender will confirm property values and validate income and credit, while brokers will focus on accepting applications and locking loans. “If we make brokers more efficient, we’re going to get more loans.”
Meeting obstacles
Office of the Comptroller of the Currency restrictions against bank lending as well as the challenge of securing a warehouse line without a track record present obstacles to A-paper lenders considering subprime, points out Kirk Smith, president of SouthStar Funding, a correspondent and wholesale lender in Atlanta. Those obstacles prevent conforming lenders from flooding into subprime, but those in the sector tend be well capitalized, he observes.
Originators trying to enter the field should pick investors carefully. Pick someone who is well established and has strong relationships skills. Lenders must also make sure they have strong control, he warns. “Fraud is certainly running rampant in our industry and is a big problem,” Smith says. “The QC process is absolutely critical if you’re going to be in subprime.”
His company uses AVMs, field reviews, and software to check social security numbers and addresses, verifies employment, and has extensive training on spotting fraud for underwriters.
Underwriting remains a mostly manual process, he says. Because investors have different guidelines, if a lender makes a mistake, there’s no guarantee that another investor will buy the loan.
That fragmented secondary market means underwriting and secondary marketing experience is critical, Smith says. “You really need to find experienced people or have a strong training program.” |
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