Total Secondary Marketing Transparency: Removing Hidden Margin to Produce Profits

I recently visited a small retail mortgage banker that employs 25 loan officers, all of which work in the corporate office.  These loan officers, like everyone else, originate mostly GSE eligible loans from Realtor referrals and previous clientele.  All of the paper written by these loan officers is funded through the internal mortgage banking operation.  During 2010, out of $180 million in production, no loan has been brokered.  This company is generating pretty good profits, earning 35 basis points of pre-tax profits right now. 

Two other interesting aspects of this operation:

1. Loan officer commissions are capped at 40% of rebate and points
2. Most of the originators working in this shop have been there for longer than 5 years

So how is it that a small mortgage banker is able to fund 100% of their production through a mortgage bank and pay only 40% commission to its loan officers without losing them to another shop? 

Let me explain....

The owners have created total secondary market transparency for the loan officers. 

They use raw investor loan pricing to establish the rate quoted to borrowers. There is no margin in rate sheets.  These loan officers lock loans directly with  investors.  The company generates no specific gain-on-sale when a loan is locked.  The loan officer's gross commission is the difference between the price quoted to the borrower and the price offered by the investor.

For example, if the raw investor price is 101.500 and the borrower is quoted a rate with no points, the gross commission earned on the transaction is 1.50% of the loan amount. Out of 150bps,  the loan officers earn 40% or 60bps. 

Many secondary market professionals would warn that allowing loan officers to lock directly with investors would reduce the company’s pull through rate with investors.  Most lenders penalize mortgage bankers who have lower pull rates by lowering the price they are willing to pay for loan production.  However, this company has an 80% to 85% pull through ratio and obtains the very best price their investor partners can offer.  

Our firm is not keen on this approach, but the 35 basis points in pre-tax earnings speaks for itself.  

Management believes loan officers are directly aligned with the Company’s objectives when they have direct access to raw loan pricing. There is nothing being hidden, all the cards are on the table.  These loan officers actually make a little more money under this program than they would with a traditional mortgage bank that builds a margin into their rate sheets.  What's astounding is this company’s earnings for 2010 are at the high end of the spectrum compared to the mortgage bankers we’ve reviewed who sell loans through best efforts commitments.

Is anyone else working in this environment and experiencing the same results?