Lenders Buy More Mortgages -- and Risks

If it is true that bankers shouldn't make loans without seeing the whites of a borrower's eyes, then the mortgage industry could be in trouble.

With increasing frequency, banks, thrifts, and other home-mortgage lenders are not even bothering to meet their borrowers.

Instead, they are buying their loans from brokers and other middlemen, many of whom are based in markets far from the lenders' home bases.

Popularity Has Grown

This is "wholesale" mortgage banking, and its popularity has exploded in the past few years. More than one mortgage out of five is originated in this indirect fashion.

Wholesalers -- a term referring to lenders who purchase the loans -- hail the method as a highly efficient supplement to their direct dealings with home-buyers. But with more and more lenders piling in, veterans of the mortgage scene are warning of trouble ahead.

A Question of Price

"Some people understand the business and other people are doing it just because it's an easy way to generate a lot of loans," said Howard J. Levine, president of Bank of New York's mortgage unit. "A lot of people are going to get burned because they really don't understand the risks."

Adds Philip C. Jackson Jr., a former Federal Reserve governor: "Some of them will end up paying a very dear price. It's just a question of who and how dear."

It wouldn't be the first time that mortgage lenders got into a mess. In the past few years, mortgage powerhouses such as Citicorp and Dime Savings Bank of New York have lost large sums by waiving verification of borrowers' income.

Others ran into trouble by offering overly generous "teaser" rates on adjustable-rate mortgages or by investing in exotic mortgage securities such as "CMO residuals."

The latest danger, experts say, again stems from a failure to follow the basics. "Many of the wholesalers just manage a big blizzard of paper that flows into the office," said Mr. Jackson, now a professor of banking at Birmingham-Southern College. "They've forgotten about the need to get their feet muddied driving around looking at subdivisions and things like that."

Recent Expansion

Wholesale mortgage banking has been around for years, but it did not take hold in earnest until the late 1980s.

Buffeted by volatile interest rates and sagging consumer demand, a number of large mortgage banking concerns began to dramatically shrink their costly branch networks. They turned instead to wholesale production, buying closed or almost-closed loans from brokers and smaller banks acting as brokers.

By 1990, 73 companies were buyers of wholesale mortgages, up from about 30 in 1987, according to Wholesaling Ltd., a consulting firm in Shaker Heights, Ohio. Together, they bought $90 billion of new loans last year, accounting for about 20% of all the originations tallied by the Department of Housing and Urban Development.

Major Participants

Some of the biggest names in mortgage banking, including Fleet/Norstar Financial Group and Norwest Corp., participate in the market. New players such as Anchor Savings Bank in Hewlett, N.Y., jumped in this year.

And nonbank companies such as General Electric Capital Corp. and Primerica's Margaretten & Co. also are turning up the heat, unfettered by capital regulations.

Fleet, the biggest player, bought $9.6 billion of loans through wholesale channels last year. That's almost three times the level of originations from its retail offices.

Fleet and some other leaders contend they are so picky in their dealings that the delinquency rates on their wholesale loans often are lower than those on their retail mortgages.

Indeed, wholesalers to date have generally escaped big problems. "I can't think of anyone who's had their head handed to them," said Thomas LaMalfa, president of Wholesaling.

Are Suppliers Honest?

But most wholesalers openly acknowledge that the strategy is risky. Their biggest fear is of unscrupulous suppliers.

Brokers, for example, can help loan applicants fudge the amount of income they earn by supplying wholesalers with phony verifications from applicants' employers.

A broker can round up other fake documents, too.

"There are outfits that actually will prepare phony tax returns," laments the chief executive at one mortgage company.

As a result, industry leaders have been calling on wholesalers to redouble their "quality control" efforts. It is widely recommended, for instance, that lenders investigate the backgrounds of brokers and routinely scrutinize at least a sample of the loans from each broker.

Are the wholesalers taking this cautionary advice? "I think they're making solid efforts, but there's still work to de done," says Leland C. Brendsel, chairman of the Federal Home Loan Mortgage Corp., known as Freddie Mac. "Not all of them have adequate controls in place."

The issue is of more than passing interest to the corporation and its main rival, the Federal National Mortgage Association (Fannie Mae). That's because these agencies ultimately buy many of the loans originated or purchased by these lenders.

Fannie Mae estimates that 36% of the loans it bought this year were at least partially originated through wholesale channels. That is up from 33% last year and 27% in 1989.

Fannie and Freddie have only recently begun to analyze delinquency trends among wholesale loans, and both agencies declined to furnish data. But Robert J. Englestad, a senior vice president of mortgage standards at Fannie Mae, said the delinquency rates on wholesale loans appear to be higher.

"It varies as to whether it's significant or not, but generally speaking they're pretty consistently higher," he said.

"When a lender starts doing wholesale business, buying loans originated by other lenders, their span of control is reduced," Mr. Englestad concludes. "They become less able to know for certain each and every detail about the borrower, the property, and overall quality of the loan."

Top Wholesalers

Purchases of mortgages in 1990, in billions of dollarsFleet Mortgage Group $9.6Norwest Mortgage 4.6Marine Midland Mortgage 4.3BancBoston Mortgage 4.1Prudential Home Mortgage 3.8Imco Realty Service 3.5America's Mortgage 2.8Countrywide Funding 2.7Greenwich Capital Financial 2.5Chemical Mortgage 2.4

Source: Wholesaling Ltd.

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