Just about anyone who is in the residential mortgage business has heard by now the dire prediction made by Countrywide Credit Industries Inc. chairman and chief executive Angelo Mozilo that within five years the U.S. will have just five major servicers, down from about 150 today.These firms service $1 billion or more each in residential loans. Yes, it would seem that going to five from 150 is a pretty big deal, and yet another sign that the servicing pond is turning into a puddle.

Mozilo, who heads the publicly traded Countrywide, is one of the most well-respected mortgage managers operating today. When he talks, people listen. And he isn't the only one who believes in the "five in five" theory. Kerry Killinger, the head of mega-thrift Washington Mutual Inc. has said as much, as have other well-respected industry players.

There is no question among mortgage professionals that the servicing side of the residential finance industry is consolidating. In 1994, for example, the top five residential servicers in the U.S. (Countrywide, G.E. Mortgage, Fleet, Prudential Home, and Norwest) serviced 12.91% of all outstanding mortgages in America. Six years later, the top five (Wells Fargo, Bank of America, Chase, Washington Mutual, and Countrywide) service 33.01% of all residential loans. Indeed the evidence is overwhelming.

But though the servicing side of the business (which entails the monthly processing of loans for a fee) is consolidating rapidly, the origination side appears to be going the other way.

Who says so? Well, Franklin Raines, chairman and chief executive officer of Fannie Mae, the largest mortgage investor on the planet. In a speech at a Prudential Securities conference in October, Raines predicted that while the servicing side of the business consolidates, the origination function will actually "deconsolidate."

Why? According to Raines, who began his career on Wall Street and served as director of the Office of Management for the Clinton Administration, the Internet will make it "harder for anyone to corner" the origination market.

"My own view is that while servicing consolidates we will actually see originations deconsolidate," he noted. He also said that loan brokers control about 70% of the origination market.

Third-Party and Direct Lending
Percentage of Total Production

Quarter Retail*   Third-Party
2Q 1998   49.30% 50.70%
2Q 1999 43.40% 56.60%
2Q 2000 43.40% 56.60%
3Q 2000 37.80% 62.20%

*A retail loan is any mortgage produced through direct-to-consumer means, either through a branch, telemarketing or Internet operation.
**A third-party loan is any mortgage originated either through a loan broker (using table funding) or purchased after it was already funded by another lender.
Source: U.S. Banker/Mortgagestats.com

The 70% figure has been thrown around before, mostly by the National Association of Mortgage Brokers, a trade group that represents brokers, and by mortgage consultant David Olson of Columbia, MD. However, there has been no hard evidence, really, to support the 70% figure. Then again, terminology is probably to blame.Ten years ago if you said the word "mortgage broker," it usually referred to a residential lender that produced a loan but did not hang onto the servicing rights. Today there are scores of lenders that originate, have a mortgage banking license (not a brokerage license), but want no part of the servicing function. A mortgage banker, by today's definition, has a mortgage banking license and funds the loan with the company's own money, usually through a warehouse line or a depository parent.

Mortgage brokers, on the other hand, do not fund loans with their own money and serve only as facilitators--that is, they find the borrower, process the paper work and submit it to a wholesaler lender (Countrywide, Chase, Wells, BoA, WaMu, etc.) for funding approval. This type of lending, where a wholesale funder is involved, is called "table funding."

There are three types of lending channels available to mortgage lenders: retail, wholesale and correspondent. The retail channel includes lending through brick and mortar branches and directly to consumers through (usually) a telemarketing operation or the Internet. Wholesale is the table funding channel where brokers dominate; and the correspondent channel involves the purchase of a mortgage after it has already been originated by someone else. Correspondent lenders include small to medium-size mortgage bankers, thrifts and community banks.

According to statistics compiled by Mortgagestats.com, a U.S. Banker affiliate, the wholesale channel accounts for 26.1% of all loans originated while the retail channel accounts for 37.8% and correspondent 36.1%. This is based on a survey of the top 150 lenders in the third quarter of 2000. In that quarter about $288 billion in residential loans were produced.

If the wholesale channel represents brokers, then it can be assumed that brokers account for just 26.1% of all production, not 70%. But because everyone has a different definition of broker, it is more likely that correspondent lenders are being lumped into the broker channel. If that's the case, brokers and correspondents accounted for 62.2% of all loans produced in the third quarter, which is somewhat close to Raines' 70% number.

Together, broker and correspondent lenders are known as third-party lenders. Is third-party lending growing? You bet--and that's where Raines' deconsolidation prediction comes into play. In the second quarter of 1998, during the height of the refinancing boom, third-party lenders accounted for 50.7% of all loans produced while retail lenders accounted for almost half. Today, retailers have just shy of 38% of the origination market, which means the mega-lenders (the top 40) are using brokers and correspondents (that is, third-party lenders) in increasing numbers.

Is this good or bad? It all depends on where you sit. It would appear that if anything deconsolidation benefits the small-to medium-sized lender that knows his/her local market.

Frank Houttekier, who runs a small mortgage brokerage business in Michigan, believes that deconsolidation is a fact of life and that he and other brokers will thrive.

"I think we are going to see the mid-level players dissolve," he says. "I think we're moving toward an industry where you have lots of small players and very large players. I think we will have an industry that favors the regional and local shops."

Houttekier, who has been a broker for his 12-year mortgage career, has no desire to become a mortgage banker and become involved in servicing loans. "Simple is good," he says. "I have seen people in the industry misbehave with their warehouse line and die."

He and other small lenders also have benefited from automated underwriting software given away or provided cheaply by Fannie Mae and Freddie Mac. This, says one Fannie critic, has empowered, "smaller lenders at the expense of larger ones."

It is assumed that Fannie and Freddie would actually rather have a mortgage market where there are 30,000 loan brokers and correspondents because it takes power away from mega-originators like Bank of America, Countrywide, Wells Fargo Home Mortgage and so on, who can demand volume discounts for selling loans to these secondary market giants.

So, yes, strangely enough (and ironically enough when you consider what's happening in servicing), it appears that the origination function is deconsolidating. But that also means decreased job opportunities for loan officers that work for any of today's top 40 or so lenders. It could mean the loss of employment as the mega originators rely on loan brokers and third-party correspondents, as opposed to their own employees, to produce loans.

Houttekier, who also serves as chairman of media relations for the Michigan Mortgage Brokers Association, notes that three years ago loan officers were quitting their mortgage banking firms to become brokers because they could make a killing during the refi boom. Brokers receive a point or more for every loan originated. If you're a super producer, know the local market and can network with Realtors and financial planners, a broker can make six-figures during a hot market.

But today, with production volumes down compared to the peak years of 1998 and 1999, loan officers and underwriters are getting laid off. What's a mortgage professional to do? Go to work at McDonald's or sell shoes? Not likely. They become mortgage brokers either by joining smaller but established brokerage firms or starting their own firm from scratch. But as Houttekier notes, "This time around they're becoming brokers because they have no choice."

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