Continuing with my series, at this point I’ll start illustrating some of the restrictions that market forces are imposing on the mortgage brokers. As noted in my first post on the subject, it used to be that mortgage brokers were able to access mortgage products and rates that most retail banks could not offer. In the early 2000’s, real estate was a hot commodity, and mortgage loans were easy to come by if you were a buyer or investor. Lending guidelines began to erode to the point that most anyone could finance a new home. In situations where a home buyer found himself in financial distress, he simply put his home on the market, sold the property, and paid off the loan before going into default. Another exit strategy was to refinance the original loan into a new one with better terms. This worked splendidly for a number of years. However, once the market peaked and home values began to fall, both of these strategies became obsolete in a hurry.
As losses began to mount with lenders, they began investigating the loans that were in their mortgage pools. Their analysis concluded that loans originated by a third party (another way of saying loans acquired from mortgage brokers) performed worse than loans originated by a direct lender. This caused some lenders to exit the TPO (third party origination) business altogether. Some of the big names were the first to do it: Bank of America, Chase, and Citibank. Further, the mortgage insurance industry took notice of these findings, and some decided that the risk of a TPO mortgage was too great. As a result, some MI companies instituted policies that banned MI coverage for TPO mortgages. Others took a different approach and began to track the performance of specific mortgage brokers. Those that produced the lowest quality loans would not be eligible for mortgage insurance in the future. This was a much fairer approach, since many mortgage brokers produce quality loans and should not be lumped in with the bad actors. However, the message was clear: TPO loans present a higher risk to lenders, mortgage insurance, companies, and the end investor.
As most people know by now, the massive losses generated by non-performing loans triggered a tsunami of failures up and down Wall Street. Some of the biggest names disappeared, and others were swallowed up by healthier competitors. What resulted was an exodus from the once-prized market of collateralized debt obligations, or CDO’s, which were the vehicles used to sell the toxic mortgage products to investors. Even quicker than the proliferation of these high-risk loans was their rapid exit from the marketplace. What was left was a very vanilla landscape of mortgage programs. Essentially, borrowers could obtain a fixed rate loan (30 or 15 years) or 1, 3, 5, 7, or 10-year ARM – and all of them required full documentation of assets and income. There also were fewer outlets to broker these loans. Where there was once over 200 wholesale lenders across the country, there was now roughly 30 wholesale lenders. Subprime? Gone. Stated income or no doc loans? History. What about negative amortization loans? No longer. Since Wall Street had turned its back on anything except for Fannie Mae, Freddie Mac, FHA, and VA loans, there wasn’t a market to sell these high risk loans any longer. Niche products were gone, and conservative government-backed mortgages were the new reality.
So, brokers began to feel the squeeze of market forces. They no longer had access to unique mortgage products, and in fact they lost access to some programs because they could not secure mortgage insurance coverage for some of their low-down-payment loans. This was a big blow to the mortgage broker industry, as part of their differentiation from retail banks was now gone.
With the reduction in the number of wholesale lenders still willing to accept loan applications from mortgage brokers, another shift has occurred. The ability to offer lower rates is no longer a given. Partly the result of the increased risk associated with TPO loans, wholesale lenders’ rates are not as aggressive as they once were. This marks the second competitive advantage to disappear for the mortgage broker. First it was the ability to offer a wider variety of loan programs, and now it’s the ability to offer more competitive rates. In my next installment, I’ll illustrate how government regulations have removed the third competitive advantage from the broker: the ability to process loans more quickly than retail banks.
