Finding out what motivates sales associates to use point-of-sale lending services will help lenders trying to capture more POS business.
Trying to figure out how the preponderance of homes will be bought and sold and financed in the future, in my view, is asking the wrong question. The key question today for mortgage lenders is how to compete with or join those seeking to capture financing business at the point of sale.
Having completed a landmark study of point-of-sale lending by the 250 largest Realtors in the country (funded in part by Fannie Mae, Freddie Mac, Chicago Title and EDS), I see a strong role for superior one-stop-home-shopping providers - far greater than at present. Yet I also see traditional (especially boutique) residential brokerage firms continuing, and lending, title insurance and other home financial services all still available separately. However, as with retailing generally, more channels of distribution will be opening up and more packaged services will become available for those who want them.
Relocation-related transactions are likely to be treated on an increasingly separate basis. The Internet and online services will be used widely for information as well as to order various services, but rarely (except in the case of refis) will a complete real estate transaction and mortgage loan be accomplished electronically.
Although technology will vastly speed and simplify the process, homebuying, selling and financing will remain largely a "high-touch" activity. When people buy a home, they are acquiring a lifestyle, a neighborhood and generally their largest financial obligation. It is simply unrealistic to expect them to do so without visiting the home and the neighborhood and receiving professional counseling and assurances from one or more experts.
As busy as a typical two-income family is, both spouses will want to see the house room by room - in person and not just by video. The husband and wife both are going to want to meet some of the neighbors, walk the street, learn about the schools, talk to someone they trust about the security of the neighborhood.
While many lenders worry that mortgages will soon become a commodity and be simply ordered up on the computer, we are definitely not at that point today. It is possible that with the continued creativity of individual lenders it will never be the case. For first-time homebuyers, certainly, and for most, if not all, repeat home purchasers, there will always be a need for the advice and counsel of an effective mortgage originator.
The mortgage lending process is becoming so much simpler with most mortgages approved the same day as application, subject in some cases to verifications and always to collateral approval. Also, to aid in the search for a home, Realtors are rapidly putting all their listings and even in some cases video tours of their listings on the Internet. This can dramatically shorten the time it takes to find the right home.
The claim has already been made that a home can be bought and a mortgage obtained over the Internet, and some even say it has been done. Refinancing a mortgage may well have been accomplished this way, but I doubt if a purchase mortgage has been closed without some additional contact or a home purchased sight unseen.
In time, some will be bought and sold this way, but I am confident that until well into the next century, the preponderance of homes and mortgages will not. They will be much simpler to buy and obtain, but the process will remain predominantly a high-touch one - aided by technology.
Realtors' experience with POS lending
It was unnerving for many major lenders to learn from our company's point-of-sale study last year that 91 percent of the billion-dollar Realtors were now providing in-house lending services. Most of the less-large Realtors were also scrambling to catch up with their larger competitors. Yet, in 1994, the surveyed firms only originated $7.1 billion of mortgages, or 9 percent of what they had the potential of doing. A dozen or more firms achieved 35 percent or higher capture rates, but these numbers were averaged down by the flood of firms just entering the business.
Far larger in total origination dollars is the current trend to reemphasize retail originations. This is being motivated by the implementation last year of Financial Accounting Standard (FAS) 122. That policy statement from the Financial Accounting Standards Board effectively takes the earnings hit out of retail originations for mortgage lenders. Also spurring retail originations is growing concern by some about the apparent lower quality of brokered originations. Fannie Mae's experience with third-party originations, noted last fall in a speech by the corporation's CEO Jim Johnson, has been disturbingly poorer than the performance of the retail originations purchased by the company. The public airing of disappointment provoked a lot of critical response from the mortgage brokerage community and the careful reevaluation of origination policies by major lenders.
Winning at point-of-sale lending
Until our point-of-sale study was completed last year, I don't think traditional lenders understood well their competition or the strength of their marketing position. The owners of residential brokerage firms have very little control over the mortgage decision of homebuyers. However, their sales agents - who are independent contractors in letter and spirit - have substantial control.
The sales agent will consistently prefer to use an outside lender for several reasons, our study found. Such an arrangement allows them to blame the outside lender for any mistakes that might occur (even of their own making), and it gives them total ownership of the homebuyer, allowing them to bargain for a higher and higher commission split. Thus, the odds today are still in favor of the traditional lender over the point-of-sale lender, which is why 10 such in-house POS ventures have failed for every one that has succeeded.
Most successful point-of-sale lenders ask their real estate sales associates for the names of the best loan officers who call on them. Then the POS management simply goes out and pays whatever it takes to hire those superior and preferred loan officers.
Some of the most successful point-of-sale operations have become training academies that deliberately enroll candidates who are not loan officers but instead are effective with people and numbers. These academies train the prospects in the special skills of being an in-house mortgage originator.
Using technology as an edge
Clearly traditional lenders need to concentrate on having loan officers who are at least as good as those employed by the POS services. In the near term, there may be an opportunity to use advanced technology to get an edge or perhaps make up for the loss of some very good loan officers.
Freddie Mac's Loan Prospector and Fannie Mae's Desktop Underwriter are both available only to approved lenders/servicers and through them to mortgage brokers. Because most POS operations are set up as mortgage brokerages that offer loans from a variety of local and national lenders, the current automated underwriting (AU) systems provided by Fannie Mae and Freddie Mac are not well suited to this environment. If AU approval is granted on one loan, and the homebuyer prefers to use a different lender with a lower rate, the first approval is not transferable and a user is charged $65 to $125. Freddie and Fannie have heard complaints about this because traditional lenders would like the flexibility to make a last-minute selection between the two agencies. In my view, it's likely that portable approvals will become available before much longer either from the GSEs or MI companies that guarantee GSE acceptance once the MI has approved it.
More lenders are using an instant mortgage as a competitive tool. In our POS study last year, the automation of the in-house operations of the larger Realtors seemed to be at about the same level as that of traditional lenders. We found that 59 percent have laptops or PCs, but only about half of them either take the applications live or input them later and transmit them electronically, and only 34 percent received their rates electronically.
The capital, training and management discipline required to provide instant mortgages is of such magnitude that some traditional lenders are likely to outpace their competing POS operations in providing these perceived-to-be-superior services.
Another POS weakness
Approximately one-third of all residential home sales are handled by brokerage offices with 35 or more sales associates, which is about as small an operation as can effectively support one mortgage originator. Unless the agents are highly productive, it is even better if an office has 40 to 50 agents for an in-house mortgage originator to serve. While frequently in-house mortgage originators call on two or more offices (especially when they are just getting started), capture rates of 40 percent or more were achieved almost exclusively in offices where one (or in offices of 100 or more agents, two) is assigned. Usually in-house mortgage originators who called on more than two offices didn't achieve significantly better capture rates than equally capable outside loan officers calling on the offices.
Broker/owners with a number of smaller offices (containing 20 or fewer agents) have been following with great interest the testing of video conferencing to see if that will become an effective small-office POS alternative. One such test that we followed carefully during 1995 involved parallel testing the use of top-quality loan originators in each brokerage office against having a video conferencing hook-up to remote mortgage originators. Even though the sales associates were paid one-eighth of a point in cash as a CEO fee for using the video conferencing remote mortgage origination arrangement, and superior software was reserved for the remote originators, only 5 to 10 percent of the sales associates brought their homebuyers to the terminals. That compared with two to three times that many who continued to use their in-house loan originators. That same remote origination system is being tested with greater success in offices where there are no in-house loan originators.
Most transactions occur in brokerages without effective POS
For the time being, well over half of all real estate transactions are made in offices that are not economically or effectively served by current POS services.
Currently, various approaches are being considered or tried to correct this POS weakness. The most direct and conclusive is a trend to consolidate firms and offices to where 35 to 40 agents, with few exceptions, is the minimum size. HFS, of Parsippany, New Jersey, which recently acquired Century 21, ERA and Coldwell Banker is searching earnestly for solutions because many of the Century 21 and ERA offices are faced with this problem. HFS also has just announced the acquisition of PHH, having the largest relocation firm, a major POS and affinity lender, and, a fleet leasing operation. HFS management has said this acquisition will aid them greatly in its goal of serving all the needs of homebuyers.
POS is a growing trend
The powerful forces behind the growth of one-stop-home-shopping will likely produce continued rapid growth in this activity:
* Since the 15 percent to 17 percent mortgage rates of 1981-1982, Realtors have been trying to figure out how to profitably be in the mortgage business. Finally, after much trial and error, more than a dozen of the major ones have succeeded and are sharing their "secrets" with everyone else. Annual mortgage origination volume for the very best of these is $1 billion or more. Some of these successful operations are Fannie Mae- and Freddie Mac-approved lenders. They are producing pretax profits of $300 to $500 per loan, which in some cases in total exceeds the profits of residential brokerage (which are only $100 to $150 per home closed - or double that if they sell their own listings, which doesn't happen often).
* The profit margins of the residential brokerage business are so thin that those not yet making lending and title insurance profits are absolutely determined to do so, to remain viable competitors. The profit erosion can be traced largely to substantially higher payouts to sales agents, provoked initially by the "100 percent commission" firms (REMAX in particular).
* HFS' robust entry into residential brokerage franchising (with the addition of Coldwell Banker giving it a 20 percent market share), and its determination to make major profit contributions from an entire array of one-stop-home-shopping services (home improvements, title insurance, lending, temporary living accommodations, security systems and so on) will galvanize any laggards into trying to do likewise.
* The commitment of Fannie Mae and Freddie Mac to substantially reduce the cost of financing a home through new automated services and making those services broadly available has lessened the technology advantage of major traditional lenders. This should (once portable approvals are available) make it possible for POS lenders to have as effective or superior services as the largest participants in the market.
* Sales associates require a superior service if they are to elect an in-house alternative. This internal discipline has meant that successful POS lenders produce loans of above-average quality, making it attractive for traditional lenders to participate and for Fannie and Freddie to accept these new entrants.
Realtors' POS operations as correspondents
The billion-dollar Realtors are generally the largest firm in each market. Unlike the less-large Realtors that have typically entered joint ventures or rent-a-desk arrangements, 66 percent of the POS lending operations of the largest firms were broker-owned.
Because they typically generate loans of above-average quality and have an excellent staff (having hired from other lenders some of their best people), they will ordinarily be highly attractive loan correspondents or wholesale customers. Yet they are continually shopping the market, because their sales associates and homebuyers promptly let them know when someone else in town is offering better rates or is providing better service. To be used extensively you will need to excel in at least one of their four basic needs and be competitive in the remainder - service, rates, products and underwriting.
The fear that POS lending is accelerating the trend that's turning mortgages into commodities was a concern not validated by our study. Homebuyers most often rely on their sales associate to help them find a mortgage. The sales associate is mindful that the homebuyer is increasingly rate conscious and probably won't be comfortable with a rate that is 1/4 to 3/8 in discount off from the market. Yet within that band of rate tolerance, the quality of service will most often control the final selection. This is only logical because the sales associate is personally most concerned about getting the transaction closed on time and receiving the brokerage commission.
Another misconception corrected by our findings was that computerized loan origination systems (CLOs) were not, as feared, so easy to use that homebuyers would submit their own mortgage applications. Such systems have been widely marketed, but none of the major Realtors purchased or installed them. A highly trained and professional mortgage originator is involved in taking every mortgage application.
The importance of being a preferred lender
Of all the POS lenders we studied, one in five was approved by 60 or more lenders, and one claimed that it was approved by 150 lenders. Yet when asked how many lenders accounted for 80 percent of total lending, 95 percent of them worked with nine or fewer lenders. Of the billion-dollar firms, 92 percent worked with eight or fewer lenders. Those that only worked with one lender accounted for 13 percent of the billion-dollar firms and only 9 percent of all firms studied.
Typically five to six lenders did the bulk of the business, and the top lender might do one-half to one-third of the financing business. Clearly there are financial incentives for a lender to work at becoming one of these preferred lenders.
In terms of local vs. national lenders, most all multilender systems had both, and the preferred lender came from both categories in the various instances. In some cases the preferred lender gave incredibly great service and was usually competitive on rates. In other instances the preferred lender usually had the best rate, and its service was competitive. Sometimes a preferred lender had a particularly great and unique loan product. Less often the preferred lender was easier to work with on underwriting issues, but because such accommodation usually involved a little higher rate, greater volume usually went to a more competitively priced lender.
Table funding vs. closing with their own funds
Most large Realtors that set up mortgage companies in the early 1980s arranged for warehouse lines and closing with their own funds. That was done because there was 100 basis points or more of additional gross revenue for doing so vs. being a mortgage broker. Since then the returns for high-quality brokered product have risen by 50 basis points or more and the value of closing with your own funds has narrowed. Now the difference between the two is only about 1/4 to 3/8 of a point.
Those with adequate capital are typically maintaining a small warehouse line and closing some loans in their own name (some attractive investors will only operate on that basis). These companies, however, do the bulk of their business on a table-funded basis, because they figure the expense and risk of closing with their funds is greater than the incremental return.
Some of the large players have sought approved lender/servicer status so they can have direct access to Loan Prospector and Desktop Underwriter. Some also are building up some servicing to improve the quality of their earnings and their salability.
The study found that in almost every case the POS lenders took no market risk. Even when closing with their own funds, the mortgages had been presold. Similarly, rate locks were all previously covered.
The smaller Realtors' approach
The less-large Realtors in our study still ranked among the top three or four in large markets, or the first or second in smaller markets. Only 12 percent to 13 percent of these firms launched POS lending on a broker-owned basis. Instead they typically entered a joint venture or rent-a-desk arrangement.
Most of the time this partnering was with a mortgage broker, but frequently a mortgage banker and occasionally a commercial bank or other financial institution was involved. In some instances, there was a strong desire to have the partner be a portfolio lender, because it was felt a portfolio lender would always be in the market and would be more accommodating of self-employed customers.
Many of these Realtors had failed in establishing POS lending previously. Others had heard of others failing and thus considered partnering with a proven lender appealing. Partnering involved less risk and less cash outlay (often the Realtor is required to put up minimal initial capital) and appeared the best approach to catching up with one or more larger competitors. The management of these less-large firms often feels stretched thin as it is. They consider partnering as a way to be competitive without taking as much of their time.
Rent-a-desk arrangements
A number of the Realtors currently in joint ventures had first entered into rent-a-desk arrangements. Even more of those now in rent-a-desk agreements explain that it is a low-risk way for them to learn the business. If it works out well, they plan to upgrade the arrangement to a joint venture. In some, but not all cases, they have explained this plan to their lending partner.
Most lenders in rent-a-desk arrangements have figured out that if they "strike gold," they are going to have to share the profits with the "owner of the mine." Even with this awareness, it is clear that it is equally in the lender's interest to see how well they can make in-house lending work and get along day-to-day with this Realtor organization before becoming entwined in a joint venture. While the lender essentially bears all the start-up costs, the lender also get to keep all of the profits until the leases run out and a joint venture can be negotiated.
If a rent-a-desk lender essentially provides only his own mortgage products, there is a good chance that even after a joint venture interval, the Realtor eventually will want to move into a multilender program (Coldwell Banker and others have done so). If the partnering lender has proven superior up to that point, in all likelihood that company will become the preferred lender under the expanded program.
If that is the anticipated outcome, if it were known to the lender at the outset, would the lender still have entered into the rent-a-desk arrangement? I think the answer is probably "yes," and for confirmation talk to PHH Mortgage Services, Mt. Laurel, New Jersey. In a number of instances it has progressed from rent-a-desk, to joint venture (single lender), to preferred lender in a multilender arrangement. You might say that if you were, like PHH is, affiliated with the largest relocation management company, then it would have been easy. I can assure you that it was not easy for them, nor will it be for you, but it is well worth the effort.
Accounting for rent-a-desk failures
In many rent-a-desk situations, we noticed that the broker/owner had just sat back and watched to see how well the lender could "pull this new service off" On the other hand, the lender saw it as a trial run, not worth considering a top priority until there was evidence that it would work. As might be expected, it usually failed for lack of a major cooperative effort.
In other cases, the broker/owners have thrown themselves into the effort, excited that they "are going to school on someone else's money" and that whatever is made successful will be converted into an attractive joint venture. When the broker/owner became personally involved, the senior management of the lender was as well. Much more often, these have been successful.
Failure rate by POS structure
Rent-a-desks that started doing well invariably converted to joint venture or broker-owned lending operations. Hence they were not among the great successes that we found in both the joint venture and broker-owned POS structures. However, the failure rates were about the same in all three categories, with the foremost reason being a lack of appreciation of how to earn the support of the sales associate.
Another joint venture failure factor was in assigning the day-to-day coordination between the lender and the Realtor to a regional head who perceived his or her greatest interest was in making the retail operations of the lender succeed. On one level the large traditional lender needs to compete head to head and beat the POS approach. Yet that division of the lender that is assigned to join forces with the POS lending activity needs to see that as its primary goal.
Some difficult policy questions
In a number of instances, the biggest or second-largest lender in town has teamed up with the biggest or second-largest Realtor in town. At times these unions have been highly successful, but not until some difficult policy questions have been addressed and resolved. Mortgage rate policy is one of the first issues. There is no way that a POS service can succeed if its rates are not competitive with retail rates in the market, especially the rates of a key local lender.
It is customary in POS joint-venture agreements to have a rate competitiveness clause, which provides that if the lender's rates do not remain competitive (usually measured by periodic surveys), the agreement may be canceled by the other party. If the lender is fundamentally committed to increasing its retail participation, while picking up as much POS lending as possible, this may be a deal-breaking issue. But it is far better to resolve this upfront rather than six months into the joint venture.
A second issue will be the compensation of in-house mortgage originators. In our study we found that the most successful POS lenders uniformly attracted the best mortgage originators they could find. Usually they needed to and did pay top dollar for them. Occasionally, when they were the largest Realtor in town, they succeeded in getting the top originators on a little lower commission than the street with the promise that they will be able to make more total dollars - and usually they have.
If you run a traditional retail operation in addition to your POS joint venture, you must ask how such an approach will affect your retail originators. Can you live with the joint venture paying more than you are paying? What if a number of your best originators want to come to work for the joint venture? Those that have succeeded at POS lending have learned that you can't do it halfway. You can't have the joint venture operate with one hand tied behind its back. As Bob Pittman, founder of MTV, and until recently, head of Century 21, has said - it is like Procter & Gamble selling against themselves with competing top brands - by doing it well, they gain more total market penetration and profits.
A third issue to wrestle with is special service promotions, such as fast track processing, underwriting and closing services. You cannot offer these to your retail customers without extending them to the joint venture as well. This may create deep frustration within your retail loan management ranks, but it is best to get it out in the open and resolved before entering a joint-venture agreement.
How pure can a joint-venture POS lender afford to be?
Although less than 10 percent of POS lending is with a one-lender menu, there have been some great successes. It is easier if the particular mortgage market is not highly rate competitive and if the POS lender is truly committed to being consistently competitive with its rates.
Because the best POS lenders have achieved buy-side capture rates approaching 50 percent, few participants are going to be satisfied unless they set that as their goal. This primary focus on capture rate comes because it has been found to be the major determinant of total profits. In turn, the major determinant of capture rate is the trust of the sales associate and the homebuyer in what the mortgage originator is offering.
The most compelling case an in-house mortgage originator can make for using his or her service is: "We have shopped the mortgage market for you and have available to you the most competitively priced and best quality processing operations both locally and nationally."
This is why Coldwell Banker (now owned by HFS) shifted from a single-lender to a multilender POS service. It is also why a number of other POS joint ventures have invited outside lenders to enter their systems. Yet we have noticed that it has been difficult for the neutrality or true openness of the system to be maintained for very long. The temptation is just so great to tilt the table in favor of the host lender or for the guest lenders to feel as though that's the case and withdraw or not give their best rates to the system. There is also the temptation for the sales associates to sense that the system is "rigged" and feel they need to shop every loan. A mediocre capture rate is the result.
Another approach, driven by Realtors' desire to minimize their upfront investment and maximize their profits, is to enter into a POS service center agreement with a major lender that would also become a preferred lender on a multilender system. It is only natural that the preferred lender would want to give preference to its products by giving the in-house originators a higher commission for its product. But that risks endangering the trust between the mortgage originator and the sales associate that you have shopped the market for them and are giving the homebuyer the best that is available.
Some major lenders, such as PHH Mortgage and PNC Mortgage, are really working at becoming effective hosts to lender-neutral systems. Why should POS joint-venture lending be left to mortgage brokers or mortgage banking conduits, when with carefully erected "Chinese Walls" a large traditional lender could meet that need as well or better?
Compensation issues
In our study we came across numerous POS lending situations where management had begun by offering in-house mortgage originators salaries of about $40,000, or substantially reduced (from market) commission schedules. In nearly every case they were total failures. In some cases the reasoning was that the job of an in-house mortgage originator was much easier than that of a loan officer on the street. Perhaps that is the case if a 5 percent to 10 percent capture rate is acceptable. Yet achieving 30 percent, 40 percent and even 50 percent capture rates, requires sales and marketing skills equivalent or superior to the best on the street. For those who have been successful, it is generally conceded that doing a superior job internally is more demanding than excelling as an originator on the street.
Over time, if POS lending comes to dominate many major metropolitan markets, making in-house positions truly coveted jobs, there may well be an opportunity to bring the commission scales down. Also, if homebuyers become accustomed to obtaining their mortgage where they buy their home, and if the mortgage counselor becomes almost purely a counselor and doesn't have to do much selling, then a lowered compensation structure would probably work.
The jury is still out on whether remote mortgage origination can be used to lower the cost of mortgage originators. As long as sales associates have the option of using a top-quality face-to-face loan originator (whether in-house or from the street), they may well opt for that alternative.
As to commission splits, the more successful point of sale becomes for all of a homebuyer's needs, ownership of the homebuyer will shift from the sales associate to joint ownership by the sales associate and his or her "home services" firm. As that occurs, and technology allows the sales associates to become more productive, company revenues will probably be raised by charging sales associates for more of the services they receive, and even some splits may come down. The total sales commission is likely to come down somewhat as well - particularly on the listing side.
Brokerage operations financed by lending profits
In our study we found that profitable POS lending typically yielded from $300 to $500 per loan closed (pretax profit), while the residential brokerage pretax profits per home sold (without also having the listing) only averaged $100 to $150. Many broker/owners said that it would not be worthwhile staying in the realty business if it weren't for the profits they saw coming from POS financial services. Some even said they would be willing to run their brokerage activities at break-even just so they could make a good profit on the POS lending, title insurance or perhaps other financial services.
Yet firms that have accepted running their residential brokerage operation as a break-even delivery system for POS financial services have found that this strategy has often become self-defeating. When the residential brokerage branch managers get the impression that they are simply a vehicle for allowing profits to be made in lending and title insurance, they become discouraged and often lose their competitive edge.
The really good managers often leave and go with a firm where they can make a profit and are considered a core business. It is doubly hard when the mortgage originator in the office earns much more than the brokerage manager (often two times or even greater). In such circumstances, it is tempting for the mortgage professional to begin informally running the office. The ego of a good Realtor/manager just can't take this kind of treatment.
Two corrective measures being used or considered are, first, to reevaluate cost allocations among residential brokerage, lending and title insurance. If residential brokerage is indeed the delivery system for POS lending and title insurance, why shouldn't they bear a larger share of the cost of this delivery system? One organization, where the profits of lending and title exceeded still respectable profits of residential brokerage, was also asking this question when it came to bonus time.
Another factor that can make the residential brokerage branch manager more of a team player with POS lending and title insurance services is for his or her bonuses or even equity participation to be related to these important services.
The next stage in one-stop shopping
While only 27 percent of the 230 Realtors we surveyed have title insurance or closing services, among the billion-dollar firms 38 percent did. Nearly all of those who hadn't yet were actively considering doing so, were receptive to an offer or were actively working to change the local laws so they could. The profitability and nature of these services varied considerably around the country, but it was generally found to be more profitable per transaction than brokerage, but usually not as profitable as lending.
Well-run operations offering title insurance or closing services achieved even higher capture rates than lending services, so that the total profit contribution from this area was very significant.
As the market comes to accept and expect an instant mortgage, it will be even more logical for all home-related services to be ordered electronically at the point of sale.
Superior one-stop-shopping for home services is a new and growing reality. Most lenders will want to find ways to participate in this business trend. Yet even as this side of the business grows, many homebuyers will choose other options, and successful alternative strategies will thrive.
Weston E. Edwards is founder and president of Weston Edwards & Associates, Laguna Beach, California. He is also founder and chairman of the Housing Roundtable and chairman of the Mentor Income Fund.
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