Wednesday, October 8, 2014

Mortgage Loans

Mortgage Banking Regulatory Compliance - you can't afford not to!

Mortgage Banking has evolved, as life seems to, and change demands change.  There was a time when Mortgage Bankers served a vital link between borrower and access to credit that large banks did not serve and Mortgage Brokers could not provide.

Mortgage Bankers set up a Sales Department to reach out to borrowers, a Risk Management Department to set interest rates and sell the loans to secondary, an Accounting Department to settle out the financial transactions, a Processing and Underwriting Department to process, underwrite and approve the loans, and of course a Closing Department to work with title companies to close and fund the loans.

In 2008, as the sub prime market imploded there was a tremendous shift to mainstream mortgage bankers from sub prime lenders who no longer could access credit on Wall Street.  This intense volume that was also under pressure by borrowers seeking to refinance at lower interest rates, as those begin to tumble downward. 

In 2009, main stream mortgage bankers and Banks began to realize that the unsavory types had crept into the mortgage world previously occupied by the professional lenders.  All the Tom, Dick's and Sally's who put a shingle out and were fleecing borrowers with 120% LTV loans, Neg Amort loans and other predatory types of loans - came running to Bankers and Banks because they could not deal with "change" as they found their mortgage brokers closing in response to Wall Street's inability to purchase those previously hot loans that came with great rates for investors.

As a result of that and the economy, which saw unemployment well above 8% and people were losing jobs everywhere, mortgages began to default left and right.   All of a sudden a lender with a .80% 2-year default or a 1.02% default were seeing defaults rise to 3% and higher.  This caused panic in the mainstream lending environment.

No one knew if it was fraud or the economy, but no one cared either way.  They wanted the defaults to stop because big banks who sold loans at a great profit to one another began litigating over whether a loan was improperly underwritten which could then trigger a buy back.  It became an intense case of a hot potato - who had the loan and who was trying to get whom to buy the loan back because it was 30 or 60 days late.

In came the US government.  First they put in rules to license and professionalize those individuals in the mortgage world; to weed out the unsavory individuals who had come from the brokers that were doing subprime loans - and many of whom were thieves working with straw borrowers and stealing money by lying on mortgages unknown to banks, bankers and other parties who were severely hurt financially and who's reputation were negatively hurt by such acts.

Then came the many, many underwriting changes that tightened credit access to borrowers.

And, in the interim, HUD (who had taken control of Fannie and Freddie) and the new Federal oversight - the Consumer Protection Financial Bureau (CPFB) began to enact laws and regulations that dictated lending.  Those laws and regulations impacted everything from mundane disclosures, timing of said disclosures to what constituted "predatory lending" including "high cost loans" and what was a proper loan - i.e. not lending to those who could not afford a loan, also called the "Ability to Repay" loans under the Qualified Mortgage "QM" theory.

 These seem rationale and in fact, they are.  However, to comply with these things required an army.  Lenders were scrambling to A. Figure out the new law.  B.  Figure out how it affected them.  C. Figure out how to implement it. C. Figure out who was responsible in the company to make sure that these things were happening.

All of a sudden, Mortgage Bankers saw that instead of the five (5) departments outlined in the beginning paragraph, they needed a sixth (6th) department.  An Internal Auditing Department also known as a "Compliance Department" that reviews all the forms and systems and audits select files to insure compliance with hundreds of federal, state, agency, investor and internal credit overlay regulations and guidelines.

If this department did not exist a lender faced serious consequences that include:  1.) Buy back of loans from banks who find the loan does not conform to lending requirements and 2).  Serious regulatory retaliation for flouting the rules and regulations of state and federal Regulators.

One buy back, one regulatory fine could and does wipe out profits and could result in a company facing serious financial challenges and stresses.  Just ask Bank of America, JP Morgan and others who have paid billions and now have openly questioned the wisdom of lending FHA loans in a move to defend themselves from government regulators.

This sixth (6th) department is costly, however.  Typically, it needs to be headed by an attorney who can interpret legal regulations so that those can be implemented by management and the Compliance Department that oversees compliance and internal auditing.

Any company putting out a product has someone on board reviewing the quality of the product that is put out to accomplish basically two goals:  1. To get repeat business because the product is of excellent quality.  2. To defend against lawsuits brought against sloppy products or dangerous products that harm a consumer on some level.

This is a new concept to Mortgage Bankers who never had to deal with this before.  They view this as a cost of doing business that can't be passed onto the consumer (pricing doesn't price in this cost as it has remained flat).  But, regulators require that lenders eliminate mistakes in mortgages and that loans are perfected at point of origination.   In addition, there are reports to managers and internal reviews that must be done and must be produced to an outside audit to show the company is actually doing these things and is on the look out to make sure their products conform to the laws.

The bottom line is that these departments are a cost of doing business for a mortgage banker and these departments will bring with them significant costs that Regulators in their "high cost" calculations have pretty much made sure lenders can not "price in" these costs to the consumer to offset them to a net zero effect. 

In other words, expect to spend a lot of money in this department.

Looking at the business it is clear that small and mid-size Mortgage Bankers simply can not afford these departments and simply can not afford not to have these departments.  Many are holding out hoping to remain under the radar of regulators while issues about buy backs get sorted out (can a lender force a loan back because, in reality, it just is not performing and they scoured the file to find one, tiny, small mistake and they called out as "we gotcha, you have to buy this bad loan back now or we will sue you".   And, do not think for one minute that banks do not do that to Mortgage Bankers.

This is not going away.  Lenders need these departments.  This requires lender to either bite the bullet and open, fund and get behind this department - or they need to A. Close  B. Merge or C. Sell to another lender.  Period. 

According to industry experts, any lender not closing 25 million a MONTH is just not going to be able to afford to comply and in the end - be it in the next few months or the next one to two years, will be forced into A, B or C listed above.

Let's look why lenders under a 20 to 25 monthly million in loans won't make it:

Say you're lender is closing 12 million a month.  And, it has three to four investors.  In this environment, they already are pressured to give more to one lender to get preferred pricing but fear doing that to alienate lenders 2, 3 and 4 who they need in case lender 1 makes a negative business move.  So, that puts their gov pricing at say 300 to 250 basis points and their conforming say at 250 basis points.

Say they are doing 50/50 in business.  So, they are grossing on average 275 basis points.   And their average loan size is around 180,000 dollars, which outside of any growing market in the US is pretty much on target.

They are grossing 330,000.00 a month.  LO's will take $100,000.00 in commissions and costs (base salaries, volume bonus, company FUTA/SUTA/UI costs, benefits, et al)    The remaining 220K now goes to support staff salaries.   If you have 12M a month @ 180K average loan; you're kicking 67 files out a month.  That requires a minimum of 2 underwriters and 2 processors.  That's 25K in salaries, bene's and other employee costs right there.  Now you're left with 195K to pay for the salaries of the people in accounting, closing, pricing/secondary.   That's another 40K a month spread out over those people - which is on the low end.  That 195K is now 155K.

You need to put 10% of your gross in reserves for buy backs - so that 10% of the original 330K.  So, your 195K is now reduced to 160K.

Then there's rent, leases, phones, copiers, and all the other fixed costs which will run the gamut depending on how many offices and if you're in a high rent or low rent district.  Most lenders pay out about 50K a month for these services if doing this amount of loans.  

All of a sudden you're left with 110K and you still have to pay the receptionists, the owners and you have to save for the annual audits and the attorneys.  Financial audits alone will cost over 50K and attorney retainers run around 70K a year.  That's 120K a year - or 10K a month.  

Now you're at 100K left.  If you've invested millions into a business, you expect to make a tad more than the average salaried person as you need to return the investment.  Most owners earn over 180K a month in this area and that reduces the available cash to 85K which seems like a lot - but there are a million things not listed including E&O insurance, general liability, sexual harassment insurance, employee training, previous unpaid costs, and, of course, the costs to appraisers, title companies, Fannie/Freddie, DU/LP, credit reports et al that were not caught or borrowers refused to pay - and do not forget that one mistake on a Good Faith must be paid by the lender.  

That 85K quickly drops to 10K or less.

Which means, there is no cash left to bring on a department at will cost about 120,000.00 USD a years.

So, either you up your volume (and increase your costs) or you close, merge or sell - because you can not afford to ignore compliance and adherence to compliance.  And, at this volume, you can not afford to pay for it.

Which means that in the next few months and years there will be a migration and Mortgage Bankers who are local or regional will begin merging with bigger players leaving large Mortgage Bankers licensed in 30, 40 or all 50 states and Banks and Credit Unions providing access to credit to borrowers.

Just as the days of Mortgage Brokers has come and gone, the days of small and mid sized mortgage bankers are about to end as well faced with the regulatory changes imposed upon bankers as a result of greedy people on wall street selling sub prime loans, greedy loan officers hawking them and con artists who took on roles of loan officers, realtors, attorneys, appraisers and even the average Joe on the street - who stole from lenders; requiring these changes to defend the financial market from a repeat.

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