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Mortgage Banking Magazine: Bay Equity Super Sizes Loans

July 26th, 2012

A mortgage lending firm based in the San Francisco Bay  Area is finding it helps to be creative when originating  jumbo loans today. The jumbo wasteland is a tricky place to navigate.

By George Adair

The Greek philosopher Aristotle is generally credited with saying that, “Nature abhors a vacuum.”

Well, I’ve got news for Ari: So does the mortgage industry. That horror vacui was the seed of the mortgage and housing meltdown we have been dealing with for the past five years.

The precipitous decline of the mortgage market resulted in the demise of more than 400 major banks and lenders between 2007 and 2009. The fallout fouled many areas of the surviving mortgage industry, not the least of which was the appetite of retail and secondary investors for non-agency loan programs.

Case in point: The jumbo loan or any mortgage loan securitized by institutions other than Fannie Mae or Freddie Mac because the amount of the loan exceeds the conforming loan limit set by the Office of Federal Housing Enterprise Oversight (OFHEO). Such loans are not eligible to be purchased, guaranteed or securitized by Fannie or Freddie. The aforementioned market collapse included the elimination of jumbo and super jumbo loan programs from the mainstream lending market virtually overnight.

When the housing market imploded, selling a house – any house – got a lot more difficult, but it was nigh on impossible to move a house with a big price tag. Folks who wanted or needed to purchase larger homes discovered they weren’t eligible for assistance under President Obama’s original housing rescue plan (the 2009 version). They couldn’t get the lower interest rates that were beginning to kick in, and lenders were loathe to provide the large loans necessary to move such houses, and for good reason. Seeing foreclosure rates skyrocket on regular home loans did not exactly engender a feel-good, open approach to larger loans which logically would be more difficult to stay current on, and have a more devastating impact in the event of default.

Nowhere was this constriction felt more than in California, where the average selling price and the percentage of the real estate market comprised of big-ticket homes are both higher than in most of the rest of the country.

During this time, little chance was taken on portfolio jumbo loans and the concept of “make sense” underwriting became extinct. As a result, the only secondary demand for jumbo residential loans came from Fannie Mae and Freddie Mac, and their interest spawned a new type of loan called the High Balance Agency Jumbo. Most lenders – at least those left standing – found refuge and safety in the government-sponsored enterprises’ nearly insatiable appetite for agency product. Immediately, one of the main challenges facing lenders became how to meet the demand for jumbo loans from brokers and borrowers.

Most lenders and banks stopped offering portfolio loan programs for borrowers that fell outside of Fannie Mae and Freddie Mac guidelines simply because they lost the wholesale lender outlet for these loans. Like so many birds of prey, mortgage professionals combed Web sites like for the latest gossip and news on lenders that were exiting the industry or going under.

Borrowers were left stranded as they tried to close escrow on homes that would eventually (and soon) lose 50 percent or more of their pre-implosion value. Dinosaurs like Aegusaures and Greenpointceratops fell hard and left many brokers scrambling for the next generation of wholesale lender to feed borrower demand.

It was truly a unique time, as brokers found themselves deleting row upon row of wholesale lenders from their “approved lender” spreadsheets. Account executives were changing firms faster than printing companies could spit out their business cards and brokers struggled to find reliable and well-priced lenders for their loan submissions.

A void clearly exists in markets like California’s esteemed Santa Barbara region and for homes perched precariously atop the seaside cliffs of Malibu, Laguna Niguel and La Jolla. Bankers struggle to offer the product directly, and at a time when so many loan originators wish they could increase their volume, a rebounding jumbo market is out of reach to them.

Limited secondary outlets, balance sheet management and the dread of owning unsellable paper repel most mortgage lenders from offering non-agency jumbo loans like a cross drives away a vampire. As a result, most lenders have expanded their offerings through indirect means, including correspondent and wholesale lender relationships.

Brokering jumbo loans to wholesale lenders is easier than banking. Gaining access to capital and investors requires significantly more work and for most the juice is not worth the squeeze. Banking big, non-agency loans requires the mortgage lender have warehouse approval, investor approval and balance sheet net worth. If one can even find an outlet, it will likely be non-delegated and riddled with quality control issues.

Finding secondary jumbo investors is especially difficult. The recent exit of GMAC/Ally and ING narrowed the secondary field tremendously. This is the one area of mortgage lending that remains mired in the dark ages of 2008. The reason an investor offers a bankable product through its correspondent channel is to mitigate risk and pass on most of the reps and warrants. In the jumbo arena, the service release premium on jumbo loans is so low, lenders can’t justify carrying the reps and warrants. Further, the average lender is limited by its own balance sheet, and in most cases, will not effectively help a correspondent investor mitigate risk. Any bad loan funded through a correspondent could easily put the originator into an insolvent position, effectively making its reps and warrants meaningless. If a mortgage bank is sitting on $2.5 million to $10 million in cash, just one bad jumbo loan in the neighborhood of $1 million could be devastating. Typically these are single-investor loans, where the luxury of selling to another lender due to a misunderwrite does not exist. The mortgage industry is not creating enough incentive on the buy or sell side for a meaningful jumbo market.

Beginning in 2009 and continuing today, many lenders discovered a secondary appetite for agency jumbo loans to be stronger when those loans originated through the retail channel compared to third-party originated loans submitted through the wholesale channel. Growing retail platforms are a major priority for the industry as companies find better pricing and relaxed guideline overlays. Third-party originator business was shaken up from the mortgage industry meltdown. Trust that a lender could control its quality and deliver better loans that it originated directly was proven. Bankers’ retail platform and business has opened up more warehouse and investor relationships than ever before. High-balance loans demonstrated a higher risk to the wholesale channel in a different way than in the retail channel. Exposure to early payment defaults and early payoffs is higher in the wholesale channel. Many mortgage banks have rolled out two different sets of rate sheets and guidelines to accommodate a diverging product offering between retail and wholesale. Lenders like Chase, GMAC/Ally, First Cal and Bank of America have exited the wholesale business altogether.

As a result, the über wealthy are funneled into just a few bank options for their business or look to experienced mortgage brokers with strategic and well-earned wholesale lender relationships. The private banking divisions of just a few tier-one banks can meet the retail-direct demand. Unfortunately, the 60- to 90-day closing times they offer are aggravating and make purchase transactions frustrating. Brokers with wholesale lender relationships can take the non-agency jumbo loans to lenders like Kinecta Credit Union, Luther Burbank Savings, Union Bank, Bank of Internet and a few others. Turn times are still long, but at least the borrower can feel secure that their broker is championing the loan through the system.

My high school economics teacher, Mr. Frasier, taught us limited supply makes things more expensive. That, of course, is basic supply and demand. In lending, that also makes it really tough to qualify for a loan. California’s investors and homeowners haven’t exactly earned the respect of mortgage lenders. According to a 2011 Bloomberg report on defaulting and non-performing loans, the default rate on non-agency jumbo loans was about 40 percent. That’s up from 30 percent just one year earlier. Higher default rates and fewer wealthy buyers (scoring more points with Mr. Frasier) make for both higher prices and rates.

What a conundrum for lenders! How do they create a product that is both affordable to the borrower and attractive to the bank lender? Well, the answer is so simple, that it is almost, well, stupid. No really – it is actually borderline moronic. In order to increase the attractiveness of jumbo loans, lenders have gone back to the good ‘ol days (circa 2004) of interest-only, 40-year amortization and, of course, something called an adjustable rate mortgage. To the casual observer this seems ludicrous; to the wealthy observer it sounds strangely appealing. But to the experienced mortgage professional there is more to it: It means that asset-based lending is back and it found its home nestled in the niche California 400-percent median home price market.

A common problem for both jumbo borrowers and investors is debt ratio. The wealthy are extremely crafty at not showing income. When they attempt to qualify for their loan it is common for this demographic to not understand why showing $500,000 in gross income is not enough to get a $1 million loan with 30 percent down. It takes a savvy, experienced – and equally crafty – loan officer to tactfully explain that $468,000 in expenses and deductions means they have a bottom ratio of 248 percent. After explaining this, one would be wise to duck for cover or move the phone six inches away from the ear, since the seemingly entitled borrower will be frustrated to the point of finger pointing, epithet hurling and raising the volume several decibel levels. The wealthy patron will blame the issue on a macro problem from so many bad borrowers defaulting on stated income loans. They should be frustrated. But, since modifying their tax returns to show $200,000 in taxable income is not an option, what is the mortgage professional to recommend that the borrower do?

My dad taught me to “know the answer to the question before it’s asked.” Currently and for the foreseeable future, the largest pool of secondary investors is Fannie Mae, Freddie Mac and Ginnie Mae; together they purchase nearly 80 percent of all loans. No overlays, fast loan sales and an unlimited appetite for loans demands a new business-to-government relationship for mortgage bankers. Quickly replacing the secondary business-to-business model common in the halcyon days of the early 2000s, mortgage bankers are seeking direct approval with all the government-sponsored enterprises in order to participate in the agency jumbo loan market. Having these arrows in their quiver gives a loan originator better lending tools and reduced jumbo loan overlays. So long as the warehouse lines agree, today’s GSE approved mortgage lender is able to satisfy agency jumbo demand better than ever.

Maintaining a presence in the purchase market requires a lender offer a full suite of products. One can’t establish quality realtor relationships with only half a deck of loans. Being an FHA and VA lender helps mortgage lenders accommodate about 30 percent more pre-approval requests. With so many high-balance home sales in California, lenders have found FHA and VA loans to complement their offering of agency jumbo loans.

Starting in 2008 and 2009, FHA loans, long the red-headed stepchild of the mortgage banking industry, were back in vogue. Many mortgage lenders scrambled to assemble operations and sales teams adept at handling this “new” type of loan volume, new being a relative term, of course, and simply meaning that most of the loan officer and underwriter graduating classes of 2000-2008 had never touched a government loan. Lenders also needed to update their licensing in order to reach the government loan consumer directly.  Being at the mercy of correspondent, non-delegated relationships is costly to a lender’s gain on sale, so, recognizing the need to control their own destinies, companies painfully completed their 15 test cases and became fully delegated FHA and VA lenders.

Lenders that offer VA financing really do benefit the California home buyer. Increased program availability has spawned competition, lowered rates and reduced loan closing turn times. With no mortgage insurance and ridiculously, incredibly, historically, all-time low interest rates, areas with high concentrations of retired military personnel have taken advantage of VA high-balance loan programs. By offering VA loans, lenders benefit their bottom lines by adding a new channel of loan products that pay higher yields and have lower default rates. Another benefit? Client loyalty is also much higher; word seems to spread pretty fast around the military community as to the best VA lender to work with is.

When agency jumbo programs just do not fit, an originator needs to convey non-agency options fast. Portfolio asset-based loans are a good place to start. Scroll down your wholesale lender list and seek out a portfolio lender that offers an asset depletion loan. This is one of the only creative ways for a lender like Bank of Internet and Kinecta Credit Union to lower debt ratio. Some lender guidelines (including Fannie Mae agency jumbo) trust that a percentage of the asset can be counted on to supplement a borrower’s income at a steady 360-month pace. Not much is taken into account for what the borrower or the account’s custodian does with the semi-liquid assets later. But underwriting to the asset value at close of escrow is really the only concern.

Some jumbo lenders will require pledged assets. This creates a deposit, quasi-margin relationship between the borrower and the bank. Doing the math on asset depletion reveals that the amount of assets required for it to impact the debt ratio needs to be in the high six figures at least. Getting wealthy borrowers to pledge assets can be very difficult, and an originator should rightly wonder if it creates something of a securities or investment advisor relationship between the borrower and the agent. Thumbing through the 20 hours NMLS pre-licensing courses doesn’t yield a single chapter on recommending investment vehicles to borrowers.

For jumbo borrowers that do meet sub-40s bottom debt ratios, there are plenty of portfolio programs available. Offering loans in the sub-fives will require an adjustable rate mortgage and maybe even a soft-prepay (for originators who joined the industry ranks after 2008, this means the borrower pays a couple of points if they refinance in the first year or two). Working through a wholesale lender is the most effective way to serve the jumbo borrower. Banking the product is something most boards and executive teams have little interest in doing.

The continually evolving jumbo loan market requires close attention from loan origination through underwriting to finally sell loans in the secondary market. Today’s mortgage lenders are keeping a watchful eye on how to best position their companies in the open waters of the jumbo loan market.

Originating a jumbo loan today is akin to opening a time capsule dug up from the basement of the former Countrywide headquarters, revealing ARMs, interest-only, 40-year amortization and even prepays for loans made on high risk property in an uncertain economy. Will we ever learn?

George Adair is an area sales manager for Bay Equity Home Loans.  The company was recently ranked No. 5 on the San Francisco Business Times list of the “Top 100 Fastest-Growing Private Companies” in the Bay Area. He also hosts The Loan Show on KSRO radio in Sonoma County. When he is not selling or talking about mortgage loans, you might encounter George, an avid mountain biker, somewhere in the hills of Northern California.


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