Let’s talk Correspondent Lending for a moment

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Wow, I guess I should talk about my personal problems more often on here. My post on our small slice of the subprime correspondent lending morass generated quite a few comments and emails. Our ugly mugs were even featured in the OC Register because of it. In this post I’ll answer some of the questions and comments and hopefully give a clearer picture of how you end up with a loan you can’t sell.

First some vocabulary:

A mortgage broker is a 3rd party to a transaction, who links up a person looking for a home loan and a lender who will provide the money for the loan. The broker gets a commission for putting the two together and doing the work that the lender needs accomplished in order to approve the borrower for the loan. At no point does the broker make the credit decision to lend or to deny the loan. They are merely the go-between. Once the loan is ready to go the lender funds the loan, the borrower gets their money, and the broker gets a commission check.

An investor is a bank or other organization that buys closed loans from lenders. The investor then holds the loans in their portfolio, or sells them to other investors as bonds sold on Wall Street. Some investors are also lenders, they have both the ability to generate their own loans, take loans from brokers, or just buy closed loans to sell as part of these larger bond offerings. It’s more complicated than that, but hopefully you get the point.

A mortgage banker is a lender. The mortgage bank is not an investor, and is usually a non-depository entity, meaning they don’t keep any money in savings for customers like a regular bank. The mortgage bank makes the decision to lend based on the underwriting of the file and the creditworthiness of borrower. The mortgage bank is usually much smaller than an investor, although they come in all sizes. The mortgage banker differs from a broker because they are making the decision to lend and fund the loan. Once the loan is funded they sell the loan to an investor, who then moves it up the chain.

With me still?

I can see the questions popping up now, so we’ll get a couple out of the way before I continue. First, the mortgage banker gets the money to fund the loans from another bank through a "warehouse line of credit." This line is usually for several millions of dollars and can get much higher (New Century’s warehouse lines were in nearing $10 billion.) The money is borrowed from the warehouse line at a short term rate (for us its around 10%) to fund the borrower’s loan by the mortgage bank. The money is owed to the warehouse bank until the investor purchases the closed loan from the mortgage bank. At that point the investor sends the money they paid for the closed loan back to the warehouse bank, satisfying the obligation of the mortgage bank, and the mortgage bank makes any profits that the investor was willing to pay on the loan.

"Well why would you take a short-term high interest rate loan out on a loan that you weren’t sure you could sell?" is a frequent next great question. The answer is "You wouldn’t." Mortgage banks underwrite the files to the specifications of several investors before deciding to lend on it. A mortgage bank will take a loan and have it underwritten to three or four investor’s criteria so that they can ensure that the loan will be sellable. In fact, in our case we send the loan straight to the investor and have them underwrite it directly, so there is no confusion about whether it will be purchased by the investor. This is how mortgage banks mitigate their risks of borrowing that short term money. So now you hopefully see how a mortgage bank is different than a broker.

So, back to my story. Our company is a mortgage bank. We take every precaution when we fund loans on our warehouse line to make sure we don’t get a loan that is unsellable; including the above-mentioned investor-underwrite. (Loans become unsellable when they don’t fit the underwriting guidelines of one of your investors, and for a host of other factors.) We had a loan that New Century gave us their commitment to buy the loan based on their review of the file. This commitment is called a "Clear to Close" which means that if the file is funded "closed" in accordance with the guidance issued on the "Clear to Close" the investor will buy the loan.

So we funded the loan. We borrowed the money from our warehouse line, dispersed the money to the title company and the money was dispersed by escrow, the deed recorded and the mortgage is in place. We now quickly work to sell the loan to New Century by delivering the final signed deed of trust and other closing documents to them for review and sign off. New Century did sign off on the loan and it was in line to be purchased.

As it was sitting in line, New Century’s own lines of credit (from the big boys like Goldman, Lehman, etc.) were frozen; making them unable to buy any more loans. At the same time the panic was spreading through investors as news popped up that New Century and Fremont were in trouble and that the whole market was going to hell. So they quickly revised their guidelines to make their underwriting standards more stringent. So this loan, that New Century agreed to buy, and ALSO fit the guidelines of at least 10 other banks, was now out of guidelines for ALL of them. They changed their guidelines to protect themselves from any further deterioration in the market.

We now, in the course of several days have a loan that went from highly coveted to highly despised. Which leads us back to the part 3 post yesterday. We now have to sell this loan, to someone. One of the comments asked "What are your other options" that we are exploring besides selling the loan "scratch and dent" (at a $100,000 loss)? Here is what we have as options:

Refinance the borrower to a lower loan amount with another investor who will buy the loan at a lower loan-to-value (this means we just eat the difference in the loan amounts ~$50,000)
Hold the mortgage privately (we just hold and service the loan, but that means we need to give the warehouse line $450,000)
Refinance the borrower to a lower loan amount and then give them a private second with favorable terms
Look for a better scratch and dent bid

That is it. There isn’t much that we can do besides take a significant loss on this loan. This is the same problem that is hitting larger mortgage banks (like New Century or others that face liquidity problems due to loan buybacks) except on a much smaller scale. While we have only one such loan there are many companies that have "boxes" of loans that they need to try to sell.

One other question was in regards to any legal remedies that we may have, and while I am out of time on this post suffice to say that we are looking at legal remedies at the moment. I’ll be sure to keep you posted on that end as well.