The End of Large Bank Wholesale Lending – A Resurgence of Middle Market Mortgage Banking – Chase…a Leading Indicator
This week, Chase shut down wholesale mortgage lending while keeping retail and correspondent lending alive. I believe this hasty move is a result of terrible performance (low pull-though rates and low margin), despite a soaring loan application volume. This may be the first visible sign of how tough the mortgage industry really is right now and how little of this recent surge in loan applications are actually resulting in profitably funded loans. As a matter of fact, significant losses can occur when a mortgage bank can’t effectively manage its pipeline of locked and in-process loans. Of note, Credit Suisse recently shut down their wholesale division (Lime) in December. The announcement came out of the blue. This was a new operation formed in 2008 and they only handled Fannie, Freddie and FHA loans with no baggage.
This story just out by National Mortgage News points to the gist of this story – just because rates fall and ‘applications’ are up does not mean loans are ‘funding’ banks are making money. Moves like this are to get better clarity about what in the pipeline is real and what may actually fund. This way they can manage and hedge their pipelines better and potentially pass better rates onto the borrower. I can’t post the entire story because NMN is subscription – sorry:
“As the refinancing boom gathers steam selected residential funders are beginning to charge “rate lock” fees to both consumers and loan brokers, according to industry participants.”
Wholesale is priced better than retail because it is supposed to be easier on the lender by leveraging an army of mortgage brokers to aggregate the necessary paperwork and qualify the borrowers prior to the wholesale lender ever seeing it. Because this makes the loan process for the wholesale lender much quicker and more efficient, they offer below market rates to the broker. This allows the broker to add in their fees while still offering a market rate to the borrower, but wholesale has turned into a very expensive origination channel since rates turned down in late Nov.
The mortgage application/rate lock fall-out, especially on the wholesale side, is extreme due to a) brokers locking and submitting with multiple lenders, trying to get the best rate and the largest commissions; b) appraisals coming in too low and killing the deal; c) borrowers not qualifying for today’s sensible underwriting standards; d) turn-around times being so long that borrowers switch lenders for better rates/quicker funding, creating even longer turn-times; e) rates not really being what borrowers hear quoted in the news or up-front by the loan officer; f) lack of reasonably priced Jumbo money. Many of these ‘challenges’ also effect the retail channel as well.
If fall out and profitability in wholesale were not a problem, then why not ramp up that division? It is not like they are lending their own money – all loans now are Fannie, Freddie and FHA and sold/securitized post-haste. The primary cost of doing wholesale loans comes from overhead and risk from hedging and buybacks – much of the same as with retail.
We know that based upon primary vs secondary market prices, many banks are not passing through to the home owner all that they could. Instead, they are choosing to make a great deal of money on each loan. Hey, more power to them. But when up to 75% of all wholesale loan applications fall out after submission by the broker, a major problem is affecting the lender’s ability to perform profitably across their entire mortgage platform.
Of course, not all lenders are running a 75% fall out rate, but three that I track closely have relayed to me that they expect wholesale pull-through rates in the bubble states to be about 25-30% in January. Back during the boom when literally anyone could qualify, pull-through rates were 75-80%. Now even the best lenders are not running greater than 50%. This is one of the greatest challenges affecting the mortgage space in general, with the worst performance coming from the mortgage broker/wholesale side.
Now, back to Chase… Chase’s decision to exit wholesale was simply a choice to do fewer loans more profitably by focusing on retail and correspondent business. On the retail side, banks have better control of their loan officers because they can fire them if they do a bad job with respect to quality and pull through. In addition, most bank loan officers do not broker their loans out so the bank has a better idea of what will actually get funded. This is unlike wholesale, where the bank is always guessing as to what is real, but still has to hedge the deals. On the correspondent side, banks also have better control than with wholesale because their middle market mortgage banker clients must deliver what they commit to and the bank has recourse to make the mortgage banker buy back the bad loans.
I believe other large banks will follow Chase’s lead out of wholesale over the near-term. This will prove bad for the mortgage and housing industry as a whole, as there will be less competition in the mortgage finance arena. When fewer players control the market, rates will suffer as profitability is focused upon.
However, as large banks exit wholesale and focus on retail and correspondent, it will provide a playing field in which local and regional middle market mortgage bankers can flourish. That is, of course, if they can get the warehouse capacity. Fewer banks and more local and regional middle market mortgage bankers slugging it out on their home turf is great for mortgage and housing. -Best, Mr. Mortgage
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