Central Pacific Mortgage, the “net branching” operation that CitiMortgage agreed last week to sell, was in full compliance with Department of Housing and Urban Development rules, according to the executive who is buying it.

Nevertheless, industry sources say that large lenders are busy distancing themselves from the practice of using net branches — in which they form partnerships with independent brokers or smaller companies, usually during down cycles in the mortgage business, to boost origination volume.

“In the 23 years that we’ve done net branching, we’ve always taken the approach that these branches have to operate … in accordance with the specifications put forth by HUD,” said John Courson, Central Pacific’s president and chief executive officer, who has agreed to buy it. “ Ours do and always have.”

He declined to say why CitiMortgage had agreed to sell him the company. CitiMortgage would say only that it wanted to emphasize its “traditional channels” for mortgage lending.

But Mr. Courson did say it had been clear to the management of Source One Mortgage Corp. and CitiMortgage that he had wanted for years to buy it. The Citigroup Inc. unit acquired Central Pacific — generally credited with inventing net branching — when it purchased Source One, a subprime lender, in May 1999.

“They were clearly aware,” Mr. Courson said. “I’ve always wanted to own a mortgage banking company.”

What Mr. Courson will pay has not been disclosed.

HUD contends that in violation of its policy, several unapproved lenders have been using the partnerships to originate FHA loans. It recently issued a clarification of its rules and acknowledged that it is investigating several companies for violating them.

Under HUD rules, net branches must be substantially absorbed by the larger firms — from profit-sharing to taking on the employees — to originate FHA/VA loans, which are insured by the FHA insurance fund and administered by HUD.

The Mortgage Bankers Association indicated last week that many of its members — especially in Texas and the Midwest — have expressed concern that some lenders have been blatantly violating HUD rules.

“Net branching is now generally looked at with some degree of wariness, suspicion, and concern,” said a mortgage industry consultant who asked not to be identified. “And it’s becoming an area where lenders generally now say, ‘You know, let’s not get involved in that. Let’s keep our distance.’ “

Firms involved in net branching fear that regulatory pressure will spread from FHA/VA loans to conventional loans, assuming Fannie Mae and Freddie Mac take the same approach as HUD, the source said.

Fannie could argue that it approves lenders but does not delegate that approval to the net branches, the source said. “They don’t authorize large lenders to take that approval and basically rent it out to a bunch of little branches,” he said. “What occurs is a system of, ‘You bring us your volume, and we’ll rent to you investor approvals,’ or in HUD loans, ‘You bring us volume, and we’ll rent to you the right to insure the loans.’ “

Bud Carter, senior director of residential finance for the MBA, said the practice represents an unfair advantage over his members, who are FHA approved, and that the MBA supports HUD’s efforts.

Mr. Courson said that he had no qualms about HUD’sefforts, and that the agency was justified in its approach.

“It’s very clear in the HUD regulations the standards and requirements for a branch office,” he said. “And whether you choose to call your branch office a traditional retail or a net branch, they must all meet those same standards.

“Those who are concerned are those whose branch offices don’t meet the standards that have been part of HUD regulations for years,” Mr. Courson said. “You, as the seller-servicer, have to be responsible, both financially and operationally, for all the activities that are conducted in your retail branch offices.”

A source close to CitiMortgage said it decided that net branching is too much like a franchising arrangement for the CitiMortgage brand.

Since its inception in 1977, Central Pacific, of Folsom, Calif., has never swayed from its net branching mission, Mr. Courson said. “That’s all we do.”

Mr. Courson argued that net branching is not only an efficient and competitive way to run a mortgage company, but operationally is no different from the way traditional lenders are managed.

“We need to manage our branches the same way as any other large mortgage bank,” and the only meaningful difference lies in how the branch managers are paid, he said. “We view our offices as retail mortgage lending offices that have a different compensation plan.”

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