Welcome to today, the aesthetically pleasing palindromic 8-18-18 in the U.S. The year is flying by and there are a lot of issues facing lenders right now so let us plunge in with letters I’ve received recently. As a reminder, these opinions are those of readers and may or may not reflect those of Chrisman LLC.
Regulations have a purpose
Ken Perry, President/Founder of The Knowledge Coop, sent, “I have a couple thoughts for you as the industry goes through some pretty significant regulator and regulation changes. I have so many thoughts on the Zillow issue, but one thought keeps occupying my mind.
“A regulator’s job is to make sure an industry remains clean and only good guys get to win. When Cordray took power, he went too big on the enforcement side and the result was a scared industry where even the best companies dialed back their growth plans. He created fear that increased compliance in the industry while decreasing availability of credit. We can all agree that was the wrong way to go. Mulvaney has stepped in and swung that pendulum to the other side. With Mulvaney in power there is a complete lack of fear. This will lead to an increase in the availability of all kinds of credit, including the credit that drove us into the great recession.
“When Zillow grew they did it through programs like co-marketing. The CFPB under Cordray was working to stop that. An enforcement action would have stopped the violations and potentially damaged Zillow’s pocket book so much that they would not have been able to grow without bringing their system into compliance. Since Mulvaney withdrew the enforcement action they were able to step up and buy a mortgage company that will potentially take tons of business from other originators.
“A weak regulator might feel good in the short term but the damage we will see over the next few years will lead to the next recession. Regulators have such power to keep this in check, but we have yet to see a solid middle of the road federal regulator that stops badges while loosening credit availability in a reasonable manner. Next time we crash and start looking for people to blame let’s remember that the first group to beg for increased irresponsible behavior was the ‘Bureau’ and Mr. Mulvaney.” Thank you, Ken.
Recently we had comments on LOs having two jobs. It prompted one attorney to write, “The dual employment comment, a HUD approved Mortgagee can employ someone who is licensed as both an MLO for the lender and a realtor with a separate company / brokerage, so long as that employee does not work on FHA loans. Correct? Simply employing that person is not prohibited so long as you abide by the handbook guidance for FHA loans specifically. Further, this issue a classic mortgage compliance case study in my opinion. My reading of many folks on training and compliance side is that even the appearance or potential for conflict of interest leads them to recommending the company cannot participate in the practice at all. Second, instead of documenting the company’s analysis that a conflict of interest does not exist, companies either proceed without documentation or don’t participate in anything because the documentation requirement. This is a microcosm of what distinguishes companies in our industry.”
An industry vet responded with, “Mortgage management type people instinctively don’t like the dual license situation, but often are afraid to articulate to their LOs why. They would much rather use the excuse that there’s a compliance/legal prohibition than to say to an LO, ‘Well, it’s not expressly prohibited, but I don’t want you doing that because (i) it takes your focus away from getting loans and (ii) I don’t my company to have liability for your real estate sales business when I don’t get any of the revenues from that (how does consumer know when the LO/Realtor is wearing which hat). Much easier to just say, ‘FHA prohibits it,’ so the compliance folks are just giving the managers cover.
That said, in my experience, an LO who wants to get realtor license (or sell insurance or financial planning etc.) is usually not a great LO and is just looking to find more ways to profit off fewer customers rather than growing their lending business. Accommodating that LO with conflict oversight measures and increased insurance coverage just lowers the value of a marginal LO to begin with. I think that might be ok if the lender owns affiliated businesses and can make additional revenue too, but not if the LO is making all the other money…, and FHA is still a problem.”
This week Fannie Mae came out with: “In response to lender feedback, we’re reiterating our existing policy that premium pricing must not be used to fund any portion of a borrower’s down payment, including funding a Community Seconds® (with an exception for eligible housing finance agencies) or other second mortgage loan. Premium pricing is unacceptable when a borrower is charged a higher interest rate in exchange for a lender credit in excess of actual closing costs, a second mortgage loan, or other borrower benefit (such as a gift card, furniture, or appliances). View the fact sheet for details and examples of acceptable and unacceptable premium pricing.”
The Agency’s announcement prompted one observer to share his opinions. “Rob – This Fannie announcement that just came out is newsworthy. The back story is that some lenders have been rolling out the Chenoa conventional program that uses premium pricing to allow for a zero down conventional loan, that uses premium pricing to pay for the cost of the second. These loans do not meet the Fannie Mae selling guide and would be repurchases. Fannie does have a list of approved entities that have special waivers for premium pricing for community seconds, and Chenoa is not on the list. I think the list is called Home Ready preferred and the most updated version on their website was July 16.
“The folks at Chenoa are not the most honest actors in the industry. They committed frauds against HUD under a scam charity called the Rainy Day Foundation several years ago, all on the DOJ website. After they moved to the Chenoa tribe’s housing agency, they started doing premium pricing on FHA loans and have being doing this on a national basis for a couple of years. When Fannie did a May 1 announcement this year that Native American tribes are approved entities to fund Community seconds, the Chenoa tribe rolled out a Fannie Mae premium priced program, telling people that Fannie Mae has approved their program, when per Fannie Mae that is not true.
“Chenoa’s correspondent rate sheet shows prices that are about 300+ bps worse than the correspondent market price for a Fannie Mae 97 LTV first trust deed, so it is just a coincidence that they are then using their ‘corporate’ funds to make the 3% down payment, and this is not in any way related to the gain-on-sale they make by buying first trust deeds 300 bps below market price levels.
“The dozen or so guys behind Chenoa appear to have made between $30-50 million in the last three years with the premium priced FHA loans, and as they learn today that the lies they have been telling lenders that Fannie Mae has approved their program will now get exposed, and people will start getting repurchases, this will get ugly and Chenoa will get desperate. HUD hates what they are doing with FHA loans, by putting people into houses with zero down, zero skin in the game, and the highest FHA note rates in the country, way above market rates. Rumors are that HUD is going to re-look at allowing them to do premium pricing at all, or to do it outside their areas of tribal jurisdiction. Chenoa will fight this fiercely, as they may cease to exist if HUD retools its policy.”
The changing credit world
Tom Millon, CEO of Capital Markets Cooperative, said, “The mortgage industry is delivering more non-QM loans not specifically for borrowers with student loan debt, but for borrowers with higher-than-QM debt ratios and borrowers with non-traditional forms of income. Fannie Mae, Freddie Mac and FHA have made some adjustments for how student loan debt is treated in the underwriting process. Most non-QM loans land more for higher-DTI borrowers and some non-QM investors will accept DTI ratios up to a maximum of 50 percent.
“In addition to loan amounts that will go as high as $3 million, interest-only loans, and FICO scores as low as 500, some non-QM investors accept 24 months of bank statements to verify income. It’s a mix-and-match combination for many of these loan options, but something outside of the qualified mortgage definition. I expect more innovative loan products in the non-QM space throughout the rest of the year, which will provide additional opportunities to borrowers who may not have great credit scores or DTI ratios, but do have the income to repay.”
M&A and LO comp – can they co-exist?
A long-time mortgage observer penned, “I read your piece on LO and sales compensation. Before sales-related comp, the margin is 128 BP, with 14 (11%) going to owners and 114 (89%) going to LOs. That recipe is, simply, not sustainable.
“If you and I went temporarily insane and decided that we wanted to buy a mortgage banking company with a Hedge Fund or Private Equity partner, this is how it would work: Let’s say the purchase price is $20 million. They would ask us, as sponsors, to come up with 10-20% of the equity, $2-4 million of risk money, that we would have to contribute. Our capital partner would have a preferred return of 8-10%, so they receive the first $1.6-2.0 million in profit, and that is cumulative. We would receive 20-30% of the profit in excess of the preferred return ($1.6-2.0 million), so we get the LAST profit dollars.
“Let’s say that 14 basis net margin equates to $1 million in profit. In that case we would never see a penny coming our way, as 14 BP does not even cover the preferred return and that is cumulative, so if we don’t cover the preferred in year one we have to make that up in year 2-3-4-5, etc.
“Now let’s look at the LO deal. They don’t have to put up any capital or risk money. They receive the FIRST 89% of the profits If there is anything left after that, we as owners can make a small profit. As owners we have not only the risk of loss, but compliance. repurchase and liability associated with certifying financial statements, etc.
“So, which one of these deals would you rather do? You would have to be out of your mind to want to be the sponsor in buying a company. But being the LO is a GREAT deal with no risk and getting most of the profits.
“If you asked Warren Buffet to write you an insurance policy insuring fraud, compliance, repurchase, certifications, that sort of thing, what would he charge us for that policy? Now this would not include the risk of loss from operations, which would stay with us, just insure these other risks. Buffet would probably charge all the 14-basis points margin that we get as owners, so we would end up getting zero and still have the risk of loss from operations.
“Lastly, owners don’t realize how much their risk has escalated while their share of profits has declined. As an example, let’s say that net margins back in the day were 100 BP after LO and Sales comp. In that case owners/capital have risk of about 3-4 units on a 10-point scale. At net margins of 14 BP, the owners/capital have risk equal to about 8-9 units on a 10-point scale. All the margin cushion is gone. So, as owners your risk just doubled or tripled, while your profits have almost disappeared.
“When I say that this LO comp is unsustainable, this is not a moral issue about what is right or wrong. But there is virtually no other place in the business world where you can make the type of deal the LOs have. Capital WILL eventually be compensated, and it may take some time for that to happen. I believe it will become worse over the next few months as desperate owners chase volume and LO recruits. I don’t know what the tipping point will be or when we will see that, but this current formula is not sustainable. Nobody wants to be the first penguin into the water. This bear market will burn all the fat from around the edges.”
IS A COMPUTER MALE OR FEMALE? A Spanish teacher was explaining to her adult class that in Spanish, unlike English, nouns are designated as either masculine or feminine. “House for instance, is feminine: ‘la casa.’ Pencil, however, is masculine: ‘el lapiz.’”
A student asked, “What gender is ‘computer’?”
Instead of giving the answer, the teacher split the class into two groups, male and female, and asked them to decide for themselves whether computer’ should be a masculine or a feminine noun. Each adult group was asked to give four reasons for its recommendation.
The men’s group decided that ‘computer’ should definitely be of the feminine gender (‘la computadora’), because:
1. No one but their creator understands their internal logic;
2. The native language they use to communicate with other computers is incomprehensible to everyone else;
3. Even the smallest mistakes are stored in long term memory for possible later retrieval; and
4. As soon as you make a commitment to one, you find yourself spending half your paycheck on accessories for it.
The women’s group, however, concluded that computers should be masculine (‘el computador’), because:
1. In order to do anything with them, you have to turn them on;
2. They have a lot of data but still can’t think for themselves;
3. They are supposed to help you solve problems, but half the time they ARE the problem; and
4. As soon as you commit to one, you realize that if you had waited a little longer, you could have gotten a better model.
The women won.
Visit www.robchrisman.com for more information on our industry partners, access archived commentaries, or to subscribe to the Daily Mortgage News and Commentary. If you’re interested, visit my periodic blog at the STRATMOR Group web site. The current blog is, “With Regulations, Be Careful What You Wish For.” If you have both the time and inclination, make a comment on what I have written, or on other comments so that folks can learn what’s going on out there from the other readers.
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