The wholesale lending or mortgage market has seen many changes since the financial crisis. Factors that have impacted this lending channel include:
- Structural changes in the industry
- Consolidation of lenders and banks
- The exit of major institutions from wholesale lending
- Regulations such as Dodd-Frank
- Stricter lending standards
The good news is that a recovery has started in 2011 and continues through the end of 2015/16.
Definition of Wholesale Mortgages
The definition of a wholesale mortgage lender is a banker that sells mortgages on a secondary market. A good example of a wholesale lender is this LinkedIn profile of Freedom Mortgage.
A lender that works directly with a wholesale company and represent their products. The lender could be bank or a broker. Like other markets, wholesale mortgage rates are usually lower than retail rates since the seller needs a profit margin. At the same time, a broker might work with several wholesalers enabling them to shop around for the best rate. A bank that does not want to originate loans can also act as a broker.
Features of a Wholesale Mortgage Loan
- Yield Spread Premium (other names are YSP, par-plus pricing, service release fee or rate participation fee): This is a fee that a broker earns for selling a mortgage based on the difference between the retail and wholesale mortgage rate charged. This is a way the broker can increase the commission rate by selling a mortgage to the borrower with a higher rate. The fee must be disclosed on the Good Faith Estimate received by the borrower (also called the HUD-1 form). Sometimes the YSP is used to cover fees in a “no closing cost” mortgage where the borrower is getting an interest rate that is high enough to cover the target a broker commission.There is a requirement that mortgage brokers disclose the Yield Spread Premium. The same requirement doesn’t exist for a direct lender that may go on to sell the mortgage on the secondary market making even more money for the lender.
- Loan Origination Fee: These are the fees charged to complete the origination process (origination refers to the entire loan process, from start to close). These fees include mortgage points that are a % of the loan. This fee goes to the company (broker, bank) that begins the loan process with the borrower. The fees are often broken down into sub-categories such as underwriting fees, processing fees and a loan origination fee.There is always a fee, even in a “No cost loan.” In this case, there is a fee buried in the form of a higher interest rate.
- Mortgage Discount Points: These are fees paid by a borrower to lower the interest rate. These fees can be from the bank to reduce an interest rate or to offset some of the origination fees.
One of the perceived villains of the mortgage crisis was the broker. Brokers were accused of putting rich commissions ahead of the interests of the customer. Brokers became a popular target based on the poor performance of loans that originated through this channel.
Brokers were not necessarily to blame. Wholesalers that supported the broker channel had the ability to select those loans they wanted to keep for their portfolio and those that would be packaged and sold. It is no surprise that bundles of low quality loans went on to fail.
Since brokers are a minority group within the industry, much of the negative discourse could simply be a shifting of blame by a larger entity, the banks.
The market share of mortgages originated by brokers fell after the financial crisis. Risk-averse banks that establish borrower quality standards beyond the reach of the average consumer precipitated some of this. Brokers saw a 25% decline in originations in the 2009/10 period. Uncertainty about the Dodd-Frank standards added to the problems that swirled around the channel.
To fill the void, a new set of non-depository mortgage bankers has emerged. These bankers believe in the many reasons why brokers make sense. Brokers can shop for the best rates among multiple lending institutions while offering higher personal service
Things started to turn around in late 2011 for the wholesale-mortgage channel. In 2014/15 the broker channel has started to re-emerge based on the historic strengths of this marketing channel:
- High-trained professionals
- Diverse product portfolio
- Entrepreneurial attitude
Another bit of good news is the major banks, such as Wells Fargo, that have exited from the wholesale channel. These banks already have large retail networks and saw wholesale as diverting business from their brick-and-mortar stores.
Beyond the major banks, lawyers and other institutions involved in estate planning are working with mortgage companies on estate planning and wealth management strategies as a value added incentive for high net work buyers.
Left behind are financial institutions that focus on supporting the broker such as non-bank entities. They offer a value proposition designed to enable the broker to make a fair profit while providing consumers with products that are more competitive than those offered by retail banks. Recently regional banks are entering the market. With the entry of new market participants comes an increase in competition between wholesalers.
The wholesale industry is also finding new customers for service. The Asian and Latino populations are perfect for brokers that can overcome cultural and language barriers. The industry is also finding ways to be cost competitive despite the regulatory burden on investments in technology.
Community banks are also interested in using a wholesaler. These banks are under pressure from regulators and would rather focus on the business of banking. Regulators are also uneasy if there is a downturn in the market. A wholesaler can support the entire origination process and assume the underwriting risk. Wholesalers also assume the tail risk away which is the risk of default later in the loans life.
Growth is also seen in the hiring patterns of companies such as Freedom Mortgage which is growing and thriving in the current economic environment.
Obstacles on the horizon include:
- Housing inventory shortages (according to the Department of Housing and Urban Development sales of new single-family houses beat expectations in 2015). One-third of United States markets is experiencing record home prices. Negative equity is affecting many homeowners as well – 13.4% (Source: RealtyTrac, 12/15)
- Rising interest rates cemented by the fact that the U.S. is experiencing a record low unemployment rate. It is expected that the Federal Reserve will keep interest rates low. Our belief is that we will not see a spike in interest rates.
- Affordability issues related to price increase
The state of wholesale today is very good. Many companies are looking to brokers to take care of customers so that they can focus on the business of banking.
Now that the trend is reversing we can expect the wholesale industry to continue to grow in share and stature. Wholesale lending will also be a small, but important part of the market.