Big Banks Leave Black Hole in Correspondent Lending
The race for the exits is intensifying among big banks that purchase mortgages from correspondent lenders, creating liquidity issues for loan originators and radically reshaping mortgage servicing.
Citigroup Inc. told correspondent lenders this month that it will no longer purchase "medium or high-risk" loans that could result in buyback requests from Fannie Mae or Freddie Mac. That pullback comes after giant loan buyers Bank of America Corp. and Ally Financial Inc. pulled out of the correspondent channel at the end of 2011, and MetLife Inc. exited all but the reverse mortgage business.
Lenders in the market say another big player, PHH Corp., has pulled back as well. The largest private mortgage lender is facing liquidity constraints and a probe into reinsurance kickbacks by the Consumer Financial Protection Bureau.
"This is not good for the world," says FBR Capital Markets analyst Paul Miller. "We already know the retail arms have shut down high-risk loans. If the correspondent channels take the same step, ouch!"
Brett McGovern, president of Bay Equity LLC, a San Francisco mortgage lender, says Citigroup asked him to take back about 20% of the loans that he had agreed to sell to the bank.
"The list [of buyers] is shrinking and not as robust as it was a year ago," McGovern says.
The reasons for exiting correspondent lending vary among the largest banks, and not all of them are pulling back: Wells Fargo & Co. remains the dominant player in the sector. But the other big companies' retreat has had a domino effect on the mortgage industry.
Tom Millon, chief executive of Capital Markets Cooperative, a Ponte Vedra Beach, Fla., company that provides secondary marketing services, says lenders are knocking on his door, "freaking out," and "scrambling," because there are fewer big bank aggregators to buy loans.
"Everyone is very conservative about credit going forward and one of the big culprits is the repurchase risk looking backward," Millon says. "Lenders are concerned about liquidity for their pipeline and there are not a lot of alternative sources of liquidity. … It's a dislocation, a disruption."
Matt Ostrander, chief executive of Parkside Lending LLC, a San Francisco wholesale lender that bypasses the large bank aggregators and sells loans directly to Fannie Mae, predicts that the shift in the marketplace is likely to get worse.
With fewer banks buying loans, sellers have to wait even longer for the buyers to review and purchase their mortgages. Those longer timelines can cut into profits, because lenders cannot turn their warehouse lines over as quickly and fund other loans.
"Some of these companies are getting crushed because they can't flip their loans quickly enough," Ostrander says.
Some lenders have been forced to lay off staff or have burned through their funding. Anthony Hsieh, the founder and CEO of loanDepot.com, an Irvine, Calif., online lender, says he recently closed a nascent wholesale division due to "thin margins" and the need to focus on retail lending. At one point, he says, it took Wells Fargo 38 days to review mortgages he was trying to sell, though that delay has since dropped to about 22 days.
"It can cause capacity constraints," Hsieh says.
But banks argue that the lenders can cause delays themselves, by not delivering a full loan package, or if files are incomplete or include stipulations.
Wells Fargo spokesman Tom Goyda says the San Francisco bank has been adjusting the time it takes to review mortgages as its share of the market expands.
Wells is focused on "controlled profitable market share growth in a changing business environment," Goyda said in an emailed statement.
"Over the past several months we have been building our capacity to reflect our market share growth and are working toward turn times that are consistent with historical standards," he added.
Lenders also say that their usage of warehouse lines is at its highest level in years.
"Part of it is increased volume and part is the time it's taking companies like Wells and others to review and purchase the loans out of line," says Larry Charbonneau, a managing director at advisory firm Charbonneau & Associates Inc. "It's not unusual to see 21 days, when in the past it was 12 days, maybe 18."
The pullback by some of the large banks can be attributed to Basel III capital rules, which allow banks to count mortgage servicing assets toward no more than 10% of their Tier 1 capital — much more stringent than the current 50% cap. The new cap would crimp the capital ratios of mortgage-heavy institutions, causing those companies to reduce their acquisition of mortgage servicing rights.
Though mortgage servicing is still concentrated among the handful of top banks that process mortgage payments in bulk, those banks are facing increased scrutiny over how they handle servicing, defaults and foreclosures.
"The regulatory risk has all of the big banks evaluating their appetite for mortgage lending," Hsieh says. "In any industry, when someone large exits, the rest of the competitors want to take that over — but that's not the case in our industry today. Not only are others not jumping in, they're looking at it from the perspective of, should they be getting out?"
Some well-financed lenders have taken a different route by selling loans directly to Fannie and Freddie. But there are pitfalls there as well.
Seller-servicers are required to have a minimum net worth of at least $2.5 million plus additional funding to service loans. (They also can sell the servicing rights to a sub-servicer.)
McGovern says the changes made Citigroup are "the latest example of the importance of selling directly to the agencies and not relying on the loan aggregators."
But the pricing of mortgage servicing rights is being upended. The Federal Housing Finance Agency has offered two options to revamp the economics of mortgage servicing rights. In the meantime, market pricing is extremely volatile.
Andrew WeissMalik, the chief operating officer of 360 Mortgage Group LLC, an Austin wholesale lender, says third-party originators don't have a lot of options.
"For us it's either sell to Wells or Fannie Mae," WeissMalik says, adding that his company has opted for the latter choice: "Putting loans into the portfolio and servicing them is really becoming an economical solution. We think this is a new paradigm in the industry where the mid-tier [mortgage] banker is going to become a mid-tier servicer."
The company is setting aside half of its profits in a reserve account to cover servicing-related advances, he says.
Others are quick to point out that retaining mortgage servicing requires significant liquidity, to prepare for the possibility of borrowers becoming delinquent. In that case, the servicer must fund principal and interest payments to investors, which can quickly eat up cash.
Even servicers with ample credit lines, or access to deposit funding, face other growth constraints.
A large independent lender or small community bank can retain some servicing "for a little while," Millon says, "but they will run out of capital pretty quickly. It's not such a panacea because you have to have capital to support the servicing."
Still, other industry members say the bigger issue is how the industry will adjust if and when the housing market comes back. If large banks with significant capital do not have the appetite to scale-up originations, it is still unknown who will, or can, fill their shoes.
"There are jokes that there's the 20-20 club," says Hsieh. "There are only 20 independent mortgage players with above $20 million net worth. And that's not enough to meet pent-up demand from borrowers. There's a real capacity issue."