The basics of being a mortgage banker

June 14, 2024 1:37 PM

The term "mortgage banker" can be used to describe companies from "all facets of the real-estate finance industry," according to the Mortgage Bankers Association, which represents a wide range of housing and commercial financing firms.

However, a reference to an "independent mortgage banker" is more likely to specifically apply to a nondepository institution that funds single-family mortgages using lines of credit or other sources of financing from third parties. These companies most commonly obtain this financing from entities known as warehouse lenders. Warehouse lenders are often banks.

IMBs typically sell their closed loans off to government-related or private investors in the secondary market rather than holding them in portfolio. While this is a strategy nonbanks may rely more heavily on, depositories also may utilize originate-to-sell strategies.

Mortgage bankers are able to generate profits when they can sell their loans for more than it costs to originate, fund and manage them.

Strategies mortgage bankers use to source loans

There are three main ways IMBs and banks in the business may source the mortgages they sell. Companies may operate in just one channel, all of them or some subset thereof.

The first is through a retail operation in which they originate and close the loan themselves. Retail loan production may be done in-person or through what's known as a direct-to-consumer strategy like a website or a call center.

Independent mortgage bankers also may use what are known as third-party origination channels. There are two main types of TPO arrangements. In one, a mortgage banker buys closed loans from other parties. In the other, a lender in this business will fund mortgages for borrowers who have been working with loan brokers. Brokers act as a go-between for borrowers and lenders. Purchases of closed loans are done through what's known as the correspondent channel. The wholesale channel funds loans from mortgage brokers.

Mortgage bankers are distinct from brokers in that the former's role is to fund and close loans while the latter's is to source them for lenders that are good matches for their consumer clients' needs.

Options mortgage bankers have for selling loans

Loans that mortgage bankers originate can be sold to government-related or private investors. Investors may aggregate the loans before selling them in bulk to other buyers.

Mortgages also can be securitized by government, quasi-public or private entities. This involves a process in which loans are pooled and used as collateral for mortgage-backed securities. MBS serve as a vehicle through which mortgage borrowers' payments can get distributed to investors.

Typically agreements for mortgage sales may involve either "best efforts" or a "mandatory" delivery. A mandatory delivery requires the seller to commit to following through with a specific amount of loans at a particular time on a specific day. Best efforts delivery is more flexible. Buyers price accordingly for the type of delivery used.

How servicing plays a role in mortgage banking

Other loan-related assets that mortgage bankers can choose to sell or retain are servicing rights associated with their loans.

"The economics for a mortgage banker include the best execution on what they're able to sell loans for in the market. Servicing is a big part of that value proposition," said Satish Mansukhani, managing director of investment strategy at Rithm Capital and the author of a report on servicing investment strategies.

Owners of servicing rights receive a portion of the interest on loans designed to compensate mortgage companies for work done to handle the operational tasks around managing payments.

Originations and servicing can counterbalance each other when interest rate cycles shift. Servicing usually fares better when financing costs are higher and originations tend to have the advantage when rates are lower, although the two haven't always been perfect offsets for each other.

Ways mortgage bankers may manage servicing

Ownership of mortgage servicing rights and the operational responsibility for them can be split. An investor may hold the rights to the interest payments and contract with another entity known as a subservicer to handle the operational tasks involved.

The work can be further subdivided to have specialist entities handle subcomponents of it. A special servicer, for example, may focus on working with borrowers who have had trouble making their payments.

A missed payment can put strain on servicers because they may bear some responsibility for advancing money to investors when borrowers go delinquent.

The value of MSRs to a buyer or holder can go beyond the slice of interest associated with them or the ability to sell them to investors.

MSRs can be used as collateral for corporate financing. Also customer contact involved in managing monthly payments could be viewed as an opportunity to cross-sell other products to borrowers.

The customer contact also allows servicers to encourage borrowers to stay with their current mortgage provider, which is important for the reasons that follow.

When borrowers prepay their existing loan to get one with another company, it cuts off the ongoing interest payments to the MSR holder and can be detrimental to a servicing portfolio's value. That can hurt pricing and investor demand for MSRs. These two risks can become more pronounced in a falling interest rate environment.

To maximize MSRs' value, holders may want to apply a retention or recapture strategy in which they aim to identify when the borrower might be looking for a new loan and make offers that might encourage them to stay with their existing provider.

In addition to being subject to prepayment risk, a lot of complex accounting and other rules apply to MSRs and the operational responsibility for them, so some mortgage bankers prefer to sell the rights rather than retaining them.

Mortgage banker regulation and compliance

Both the origination and servicing aspects of mortgage banking operations navigate complex regulatory and compliance requirements.

Whether mortgage bankers are IMBs or depositories originating to sell, they are subject to exacting specifications for loan, property and borrower data set by the end investors in their mortgages. Often these investors are government-related entities.

Servicers also are subject to strict investor requirements in addition to many types of regulation, particularly when it comes to borrowers who have fallen behind on their mortgage payments.