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Broker to Banker: Manage the Risk and Reap the Rewards
By David Lykken
A consultant's advice on how to make the switch.
If you’re a mortgage broker, chances are good that during the past several months you’ve considered becoming a mortgage banker.
There are lots of reasons why brokers are thinking about becoming bankers. For one thing, they can make more money because they can sell the loans on the secondary market. Second, they have more control over the process. And third, proposed HUD regulations affecting yield spread premium (YSP) make becoming a banker more attractive.
Risk Vs. Rewards
If you’re considering moving from broker to banker, you have to make sure you see more than dollar signs. You may need to make some critical shifts in your thinking and work with people who can help you understand and manage the additional risk you’ll be taking on.
As a mortgage broker, your drive is to get every deal funded. That’s how you make money. If the loan goes bad, you’re not penalized (short of fraud).
Mortgage bankers also want to get deals funded. But they’ve got to consider their ongoing contingent liability, which makes a substantial difference in their willingness to do the loan. Yes, they’re still under pressure to keep production levels up. But if they’re going to be successful, they know they must watch out for loans that could come back to bite them.
This all might seem obvious. But at a recent conference, I overheard two brokers who had recently become bankers talking about an underwriter they wanted to hire. “I really want to get this person to work for us,” one of them said. “He approves everything!”
These bankers knew intellectually that what is good for a broker is not necessarily good for a banker. But on a gut level, they didn’t “get” the repurchase risk and the contingent liability that goes with that.
Warehouse Lines of Credit
Your initiation into the land of risk starts with establishing a line of credit to fund your loans from a warehouse bank or correspondent. Your company—and frequently you personally—are financially responsible for these lines. So correspondents will look at you and your operation very carefully before offering you credit.
When warehouse bankers are making decisions about whom to offer a line of credit, they consider a number of factors: net worth, credit history, experience, character, and credibility.
Net Worth Requirements
Most everyone knows that a company’s net worth determines the level at which they will be able to operate as a mortgage banker. Short of raising additional capital, your net worth is what it is. If your company’s net worth is less than $250,000, you will have fewer options available to you as a mortgage banker. If it is greater than $250,000, then you will have more options.
For example, your net worth will determine which investors you can sell to. My experience is that most brokers wanting to become bankers do not have the sufficient net worth (much less the experience) to deal directly with Freddie Mac or Fannie Mae. There is typically more involved in selling loans to Fannie and Freddie than to investors like Countrywide.
Credit or Leverage
Leverage is the amount of money you can borrow depending on your liquid net worth. “Liquid” means cash, security, and loans to be sold. It typically does not include non-liquid assets such as real estate, furniture, fixtures, and equipment.
The warehouse lender wants to know how much money it will have access to (in order to pay down the loan amount) if you can’t sell your loan in a timely manner. Your net worth is determined by an audit from a licensed CPA firm—hopefully, one that has experience working with mortgage lenders with warehouse lines.
Leverage is expressed as a ratio whereby you multiply your net worth by a fixed number. A typical warehouse lender will leverage a lender’s liquid net worth 15 times to as much as 20 times.
For example, if your net worth is $100,000 and the ratio is 15:1, you can get a line of credit of $1.5 million. If your net worth is $500,000, your line would be $7.5 million. If you have $2 million, your line would be $30 million.
New mortgage bankers have net worths all over the board. Some started out with a net worth of $50,000 (and still received lines of credit) and others have started out with millions. The higher your net worth, the better the terms of a warehouse line and the greater dollar amount you can leverage.
Experience
Warehouse lenders are more hesitant to give lines of credit to people who have never had one or managed one. If you don’t have that all-important experience, you can overcome it in one of three ways:
Work for a company and manage the line in-house
This is the most affordable way to gain experience. But it has an obvious drawback: You must wait to start your own firm until you’ve worked in the business for several years and built up a reputation.
Hire the knowledge
Bring someone in house who has that experience. If that person has a positive reputation (you can always get a reference from their past employers or the warehouse bank), they can give you the edge you need to obtain the line. There are two negatives to this choice. First, because of the waves of refis in this busy market, talent is hard to find. Secondly, some employees are afraid that they’ll be let go once they’ve educated the owners. So they tend to keep crucial knowledge to themselves.
Engage a consultant
A good consultant has existing, trusting relationships with a variety of bankers. You can leverage these relationships because the consultant can give you a recommendation. This can make the difference between getting the line or not getting the line. Before engaging a consultant, check references to make sure that the firm has these existing relationships, and make sure they were helpful to the other client in the process of getting a line of credit.
Character and Credibility
After the numbers are crunched, the warehouse banker will still want to get a good feeling about you. If a warehouse lender has some instinctive negative “hunch” about some aspect of your application, the lender may ask you additional questions, delay a decision, and even deny the application package. Be honest up front and remember that this industry is very much about relationships. Make sure you cultivate and nurture them.
Your Business Strategy
This is a good time to regroup and ask yourself important questions about your objectives and overall strategy. These include:
* Do I want to sell on a servicing retained basis or a servicing released basis? Most brokers who have recently become bankers sell their loans on a servicing released (whole loan) basis. I’ve found that new bankers don’t usually realize that when they retain the servicing, they will be earning a point to a point and a half less in price.
* How many states do you want to work in? You will need to pay a licensing fee in each state where you do business. Most mortgage bankers retain an outside law firm to monitor the state licensing laws. It costs between $750 to $1,000 for the legal and licensing fees in each state. Most new originators practice in just one or two states.
* Are you in business to work until you retire, weathering the cyclical peaks and valleys? Or, do you only want to be in it as long as this refi run lasts, enjoy your gains, and “build to sell?” Your choice can be driven by a number of factors, including your age and your financial goals. We’re in the best of times now, and lots of people want to get into the business. But new mortgage bankers haven’t experienced the sudden, dramatic adjustments that can traumatize this industry. You can make money on both sides of this cycle (expansion and contraction), but you must be prepared and have a well thought out strategy devised with input from mortgage veterans of several business cycles.
* Do you want to grow your business on the conforming purchase market, or do you want to focus on niche loans such as subprime or second mortgages? If you’re not familiar with subprime lending or second mortgage lending, thoroughly acquaint yourself with the possible differences in licensing and regulations. Become familiar with the lenders to whom you will be selling these types of loans. This will enable you to understand the risks involved so you can decide if these niche markets are right for you.
* Can you live with the increased risk of being a banker, or are you going to lie awake at night wondering about things like repurchase risk and my personal guaranty of my warehouse line? I regularly meet mortgage bankers who live in perpetual fear of something going wrong in their banking business. For example, they’re worried about having to personally guaranty performance of the loans they’ve sold in spite of the best efforts to originate quality loans. People prone to worrisome thoughts like this would do better to stay as brokers, rather than grow old quickly from fear. Someone willing to understand the risks involved is better equipped to manage those risks.
Finally and most importantly, ask yourself what makes you happy. Do you really enjoy what you’re doing? It’s a cliche, but life is short and this business is fast-paced. Becoming a mortgage banker is a very manageable risk if done right. Carefully choose the course for your business that allows you to achieve your financial objectives without assuming risks that cause you undo stress.
DAVID LYKKEN is the owner and founder of Mortgage Banking Services Direct, Austin, Texas, 512\301-6273, e-mail:
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Following are David Lykken’s suggested guidelines for making the transition from mortgage broker to banker:
* Understand the risks versus the rewards of becoming a mortgage banker. Make sure you are aware of the changes you’ll encounter as a banker.
* Make sure you meet the appropriate net worth (minimum of $250,000) and credit/leverage requirements. The higher your net worth, the more options you’ll have available to you.
* If you aren’t experienced at managing a credit line, you could work for a company first, hire someone to take on this responsibility, or work with a consultant.
* Determine your overall business strategy. For example, decide whether you want to sell on a servicing retained basis or a servicing released basis, and how many states you want to work in.
* Be certain that you’re choosing the direction for your business that enables you to achieve your desired financial goals without assuming risks that cause you unnecessary stress.
