Who's who in wholesale 2006: here's our annual story on the top wholesale and correspondent lenders. Last year was a year of many stories in the wholesale lending space

Mortgage Banking, June, 2007 by Tom LaMalfa

Last year was an interesting one in many ways for the mortgage banking business and the overall industry. For one, 2006 was the transitional year that separated a world of attitudes--from "Anyone and everyone who wants a mortgage can get one" to "On further inspection, maybe that's not such a good idea after all." Indeed, loan quality became more and more the issue as the months passed. [??] But there was much more, too. First, there was the continued slide in origination activity despite stable interest rates; 2) the federal regulators issued guidance for nontraditional mortgages; 3) Wall Street pushed further into mortgage banking to supplement its securitization programs; 4) profit performance throughout the industry was paltry; 5) Fannie Mae's woes receded further into the background; 6) prime and subprime merged (on paper) into one big mortgage business; 7) a heightened sense of mortgage fraud lingered across the industry; 8) Wall Street pushed back tens of billions of dollars of (largely) subprime loans onto stunned lenders; and 9) industry consolidation took another step forward. [??] All nine of these topics and issues joined with the erosion of underwriting standards as important developments in 2006. All left their mark on the history of mortgage lending in America. [??] According to Freddie Mac's Office of the Chief Economist, aggregate origination activity dropped by $250 billion last year to $3 trillion. That was an 8.3 percent decline year-over-year but, more important, it represented a 28.3 percent decline from 2003's peak of $3.85 trillion. [??] Because the industry's capacity and staffing were still largely hitched to the peak level--despite the passage of three years--the longer-term decrease in origination activity was of greater importance. Technology, combined with the multiyear expansion of nontraditional products and share rivalry, led most firms to pink-slip few employees save for temps and contract employees, while beefing up on offense in the form of sales staff-loan officers, wholesale account executives and sales managers. [??] Though I was questioning what I saw as overly loose underwriting standards in this same article in 2005 and thought they couldn't get any riskier, 2006 saw competition promote still more exotic products to a less financially sophisticated population of borrowers. This was doubly so in the nonprime world, where piggybacks (80/20s) and over-100-percent loan-to-values (LTVs) met and married stated-income products, nontraditional mortgage instruments and low FICO[R] scores.

Willing borrowers were getting precisely what they wanted--an opportunity to become prime borrowers and land windfall profits from a virtual automated teller machine (ATM) in the form of a house, which is basically what happened in 2001, 2002, 2003, 2004 and 2005.

The advent of these so-called affordability products finally brought out the sheriff in third-quarter 2006's final hours. The sheriff now wanted consumer safeguards, more disclosure, strengthened risk-management procedures and more capital behind these nontraditional products. Already, fewer of these loans are being written because investor demand for them has withered.

Meanwhile, Wall Street's inroads into the primary market grew substantially in 2006. Merrill Lynch, Bear Stearns, Morgan Stanley, Deutsche Bank and UBS Securities LLC all purchased origination and servicing platforms to produce collateral for their securities issuance businesses. Their initiatives and capital brought more capacity to an industry that normally would have been contracting to better fit and reflect the down cycle following the 2003 zenith.

Against this backdrop, brutal competition for loans, share and people kept expenses up, revenues down and profits paltry. And as volume gradually declined quarter after quarter, competition heated further, and profits eroded even more.

Poor production profits were evident in the results of Wholesale Access' 2006 production revenue and expense benchmarking. For our group of 16 major wholesalers, the value added (total revenue less total expense) was only 17 basis points, down from 81 basis points in 2003 and the third consecutive year of declining profitability. Similarly, in the correspondent channel, value added fell to a mere 4 basis points last year, from 5 basis points one year earlier and 44 basis points in 2003. Housing starts, new-home sales and existing-home sales all declined in 2006.

Fannie Mae had an awful year last year, given efforts to address its ongoing accounting scandal, release of the Rudman report (a report to the special review committee of Fannie's board of directors), and the Office of Federal Housing Enterprise Oversight's (OFHEO's) assessment of the company.

As all of these developments were swirling about, many major lenders followed Countrywide Financial Corporation's (Calabasas, California) path of integrating prime and nonprime operations. Chase (Edison, New Jersey), CitiMortgage Inc. (O'Fallon, Missouri), Washington Mutual (Seattle) and Wells Fargo Home Mortgage Inc. (Des Moines, Iowa) led the way, many folding in home equity as well. The goals were cost management and better-focused, more coordinated operations. Time will pass judgment on the results of that strategy.