The Consumer Financial Protection Bureau has for some time been signaling their intention to issue policy guidance on the mini-correspondent business model, creating uncertainty, and speculation about its future. Is it too risky? Is it not risky enough? Are there real reps and warrants? Is it captive? Is captive okay? Can you outsource underwriting or fulfillment? Is it truly a safe precursor to full operational support of correspondent lending, or is it merely a semantic framework designed to flout the CFPB's restrictions on broker compensation?
The answer is "yes." Yes — it can be too risky and not risky enough. Yes — it can be captive and not captive. In the absence of clear guidance, the industry generated a wide array of models that fell under the umbrella of mini-correspondent. Much like other industry catch phrases, such as fulfillment or due diligence — the definition of a mini-correspondent was often "in the eye of the beholder."
Well, the CFPB has finally weighed in on the topic, issing policy guidance on July 9. The policy guidance is an open book test designed to forestall lenders from using the mini-correspondent designation to avoid broker compensation rules. The only reason lenders won’t know the answers is because they haven't read the questions the CFPB listed explicitly in the bulletin. The ruling was direct, informed, and specific. In addition, the guidance sets a clear picture of how the CFPB views "captive" mini-correspondent, exposed by the thin veil between the warehouse lender, the investor and the originator.
For many correspondent investors and warehouse lenders, the guidance was merely a confirmation and acknowledgement of a thriving well-established business model, with a few important clarifications, like Home Mortgage Disclosure Act. For others, it signals a clear warning that captive mini-c in any form or function is verboten — it is, for all intents and purposes, old school table-funding (a.k.a. wholesale lending), and clearly covered under broker compensation rules.
Much of the negative press and proselytizing by industry experts has surrounded the captive model of mini-correspondent. Regardless, the CFPB took care to specifically frame allowable mini-c. In the middle market, the newly approved version has been in place for quite some time. In fact, it has aided the building of several powerhouse mortgage bankers. Perhaps they were "little guys" who were just being exposed to mortgage banking concepts 10 years ago, but now they have learned about retained earnings, outsourced fulfillment and hedging, and they are substantive market leaders with impressive survival skills honed over the last six years.
At every juncture in mortgage banking, net worth is a milestone, allowing companies greater exposure to the secondary. Some point to the limited net worth most mini-correspondents possess, arguing that these entities lack the resources and infrastructure to originate quality loans. However, net worth isn’t the only bellwether of quality, as one can point to the high market where unlimited net worth certainly doesn't always equate to flawless operational execution. One could also alternatively argue that low net worth gives mini-correspondents an even greater reason to mind their p's and q's regarding underwriting and compliance because the downside can be a business ending event.
The mini-correspondent has less freedom to make errors and will work in collaboration with underwriting and/or fulfillment to produce quality loans. The mini-correspondent's responsibility is no less real than a large lender's. In its agreements with its correspondent investors, the mini correspondent clearly establishes reps and warrants on the quality of its origination, and when they fail to meet the minimum criterion are just as exposed to the scratch and dent market as any other correspondent. Risks are, however, mitigated through the collaboration with their warehouse line and fulfillment partners but are not removed.
Adaptation and change, by their very nature, are risks. The mortgage industry is highly entrepreneurial, and any entrepreneur worth his or her salt is going to look for innovative ways to maximize profit and minimize risk. Moving from being a mortgage broker and becoming a correspondent lender is the next step of maturation in the cycle of building an origination business. If one thinks about the mortgage industry as being a ladder of risk, mini-correspondent is simply the first step in leaving a brokered model. While only one step away from being a mortgage broker, being higher up on that ladder also means a farther fall when something goes wrong. By issuing its guidance, the CFPB is making lenders aware that it will hold them accountable for their actions.
The CFPB doesn't expect perfection, but it does expect awareness. They want you to be clear and thoughtful about what your process is, rather than running slapdash with whatever process you happen to have cobbled together. For those folks that want to get it right and mature beyond being a broker, the CFPB's mini-correspondent guidance should serve as a how-to primer, not a deterrent.
Ruth Lee is executive vice president of Titan Lenders Corp., Denver.