Wednesday, February 12, 2014

Smaller Community Banks and Credit Unions: Have the Cake and Eat It Too

Smaller community banks and credit unions play a unique role in many Americans' financial lives by providing various financial products with great customer service.  However, these community banks and credit unions often cannot keep a large number of mortgage loans on their books due to a host of reasons, including, without limitation, high compliance costs, overhead costs associated with retaining mortgage loan professionals, risks associated with borrower default, etc.  As such, they often just refer their customers and members to other financial institutions in order to avoid the "headaches" associated with originating mortgage loans.  

However, I believe smaller community banks and credit unions can capitalize on existing customer relationships, originate loans to their customers, yet at the same time manage their costs and risks.  With the right setup and relationships, they can do so by selling their mortgage loans to the secondary market mortgage investors.  To that end, I often advise them of four options with varying degrees of risks, rewards, and costs associated therewith.  Below is a slightly modified email I recently sent to a community bank:
Option 1 – Marketing Services Agreement
With this option, the Bank can refer its customers desiring a mortgage loan to another mortgage company.  To move forward, you will need to select a target mortgage company(ies), enter into a formal marketing services agreement, and implement procedures required under the agreement.   
The benefits of this option include, without limitation: (1) no origination activity is required of the Bank; (2) the Bank receives a certain fixed amount for its bona fide marketing services provided to the mortgage company; and (3) the Bank will not have the compliance duties related to originating mortgage loans. 
The disadvantages associated with this option include, without limitation: (1) the Bank has little to no control over the borrower/customer’s mortgage loan experience with the mortgage company; (2) the Bank may lose the customer(s) due to a perceived lack of financial products, i.e., mortgage loans; and (3) the Bank misses the opportunity to make income from those mortgage loans on a per loan basis. 
Option 2 – Brokering
Under this option, the Bank can process mortgage loan applications made by its customers and make limited income on those loans by brokering such loans to a secondary market wholesale lender.  A brokering relationship typically necessitates a loan brokering agreement, and the Bank will need to hire loan originators and processors. 
The benefits of this option include, without limitation: (1) the Bank can conduct certain origination activities, therefore, will have control over the customer service experience in the loan origination process; (2) the Bank can help its customers with their mortgage loan needs; (3) the Bank can make some income on each loan, i.e., broker compensation and broker fees; (4) the wholesale  lender of the loans will underwrite, close, and fund these loans, and absent fraud or misrepresentation, the wholesale lender should shoulder most of the liability in connection with the loans. 
The disadvantages include, without limitation: (1) because of the QM points and fees limitations, loans with lower principal amounts may fail the QM points and fees test (3%), which may impact the salability of such loans; (2) the Bank will not be able to leverage its own strengths – available funds to close and fund the loans for greater compensation; and (3) originating loans will require the Bank to hire a loan originator and contract/employee processor.  
Option 3 – Mini Correspondent
Under this option, the Bank can close and fund mortgage loans to its customers and earn greater income on such loans.  Becoming a mini correspondent will require the Bank to establish some mortgage lending infrastructure, such as formulating contractual relationships with investors, hiring loan originators and processors, and finding third party vendors (credit reporting, flood cert., loan documents, MERS, etc.) 
The benefits of this option include, without limitation: (1) meeting existing customers’ mortgage needs; (2) closing and funding the loans in the Bank’s name will help the Bank earn greater income (in comparison with brokering) when the loan is sold; (3) the loans will be underwritten by the investors not the Bank, which effectively reduces the Bank’s liability; and (4) the Bank can outsource the closing, funding, and post closing associated with such loans to a third-party provider . 
The disadvantages include, without limitation: (1) the cost associated with hiring loan originators and processors (employee or contract); and (2) the Bank will need to have compliance expertise. 
Option 4 – Full Correspondent
This option will require the Bank to have a complete mortgage team (in house or contract) in order to originate loans, including loan originators, processors, underwriters, closers, and post closers.  The income on each loan is greater than what the Bank could get under the other three options, so will be the cost.  This is probably is not a viable option for the Bank at this time.
For most smaller community banks and credit unions, going the mini correspondent route may be the best choice.


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