Saturday Cup of Joe: a lending and techish newsletter

Friends & Colleagues:

Good Morning! We are in between major party conventions and politics, like the weather, is heating up. Will be interesting to see what develops coming out of the Democratic National Convention and then we all get a break, usually, until after Labor Day. Since none of the usual traditions have held true this year, we cannot count on it but I would expect some downtime for vacations in August. I hope you are lucky enough to get away for some R&R.

Of Interest: Banks versus non-banks. For a long time, I have been throwing around the idea of an article looking at how non-banks have been driven more toward the banking standard as a result of Dodd-Frank, state regulator scrutiny, warehouse/credit line oversight and general risk management practices. Is non-bank lending bank-lite or effectively the same as banking in terms of expectations and standards (if not execution)? I believe many consultants will tell you that banks are ahead of non-banks, generally, with regard to cybersecurity and fraud prevention. At the same time, states like CA and NY are driving big non-bank lenders there anyway. From a sales perspective, we have talked before about non-banks increasing market share over the last few years and how or why that might be. In response to these themes over the last few weeks, I’ve heard from several sources on feedback and wanted to share it.

Thanh Pham, a bank executive (and newly minted father, congrats!), at a large Midwest bank pointed toward FHA premiums and MSR valuations/values as one reason non-banks have grown so dramatically. If the servicing rights are valued where they have been over the last few years, non-banks can make more, which allows us to spend more and thereby win additional market share. What happens if FHA premiums get cut and/or MSR values do not turn out to be as valuable as the model predicted in the retain/sell moment originally? If MSR values are not as valuable because rates remain low for some time (as they have already) are the losses simply on paper? Or did missing out on the cash have a longer term impact that we’re not aware of yet?

Seth Sprague, an industry expert in the servicing valuation market, has an interesting perspective, especially on the topic of MSR modeling. Non-banks use servicing as the primary way to maintain contact with the customer whereas banks have several different avenues, so MSRs are more valuable to non-banks. Also, banks might not want the risks or costs associated with servicing and view the asset differently to that end. Non-banks like the idea of cash flow associated with servicing and/or the availability of an MSR sale in a rising rate environment. Where non-banks lose out is the potential revenue (from float revenue) should rates rise. In other words, the decision for non-banks has not changed all that much, but market demand/market value may play a much bigger role than anything else in the decision around servicing rights. As far as tying market share to servicing, the ability to pivot toward FHA and VA lending as big banks declined those originations may have played a larger role in non-bank growth than anything else.

The last thought was echoed by Dr. Rick Roque, who always has his ear to the ground in our industry, particularly in the non-bank world. He noted that with 300 non-depository services, the market share growth extends far beyond MSR revenue. The low rate environment has evened the playing field and brought much more attention to the nature of “personal bankers,” whereas banks continue to be viewed as institutional lenders. Non-banks are able to focus on purchase business and prioritize the relationship nature of our industry (e.g. builders, real estate agents and lawyers).

On that note in particular, we had another loyal reader contribute the following question — what about the costs? As the costs of non-bank compliance and servicing continue to rise, will the growth and flexibility typically associated with non-banks become less obvious and therefore less impactful in the market? How can non-banks continue to provide high/personal levels of service, pay higher compensation packages to top sales folks and comply with compliance/cyber/risk management investments in a rising rate environment?

The Takeaway: Timing is everything. The market responded and non-banks are having a moment. Those that succeeded throughout the market crisis have been able to grow dramatically and, in some cases, new non-banks were established and then grew dramatically. We are in a somewhat dynamic moment where trends in online lending, rates and compliance risk (i.e. hesitation by big banks to take chances in residential products or processes) will determine what happens in the next 5–10 years. We’re still in the “are we early or are we wrong” moment for online-only lenders and the new underwriting methods have not been around long enough to prove their mettle. Non-banks that stay nimble to the market but maintain revenue and costs sufficient to deal with the increased compliance costs and service levels have a chance to continue to gain market share in the coming years.

Have you heard?: The Wolf of Wall Street has become a headline for being funded by an investment in the middle of an international corruption scandal. A former Goldman banker helped a Malaysian development fund embezzle $1 billion, redirecting from Malaysian properties to US properties and assets. I mention it here because it underscores a key intersection of investment, risk and compliance. For starters, this case is totally out of control in terms of the blatant disregard for the purpose of the funds, the liability of spending the money in the US and on US projects, and the public nature of the spending involved. What is more curious is the expectation we have or should have for business partners or investors we work with. The stories, in large part, do not implicate Martin Scorsese or Leonardo DiCaprio other than to use them for the headline. If you are running a company, like Scorsese’s film company, or managing an asset like Leonardo DiCaprio, who is a brand and might as well be a company, is there a risk management practice to vet business partners? If so, how much do we care that they (un)knowingly or recklessly accepted money or spent money from a dubious source? Are they accountable? Should all companies be held to similar vendor management standards as financial services firms? Do recipients of the funds have a responsibility to due diligence? Just another high-profile reminder of how quick and easy it can be to become involved in something that’s much more serious and far-reaching than it might seem at first glance. Though we may never know what scams, schemes or plots were not discovered, it seems likely that these issues always come to light at some point. Interesting to think about the balancing of risk — regulatory risk, reputational risk and necessary business risk in the market. Is there ever a substitute for doing the right thing?

Got Me Thinking: DealB%k from NYT posted a report by the National Community Reinvestment Coalition that questions the inherent biases of urban lending. In this case, the group profiled St. Louis in addition to Milwaukee and Minneapolis, specifically focusing on income profile, racial makeup and mortgage lending. According to the report (see link), in neighborhoods with similar income profiles, mortgages were made at a higher rate to neighborhoods that were mostly white. One possible (and obvious) explanation was there were more mortgage applications from those neighborhoods. This begs the question, though, about what responsibility banks and mortgage companies have to market and, for lack of a better word, percolate mortgage applications from all neighborhoods equally? Whether we think about this problem from a regulatory compliance risk, marketing opportunity or overall risk management practice, how should leaders of lending units and lending institutions manage the balance between devoting resources to generating mortgage applications, marketing to likely borrowers and ensuring fairness and responsible lending for all people in all communities? Take a quick look at the end of the post and you’ll see there’s quite a bit of uncertainty and speculation surrounding whether the low approval rate in minority areas is a function of credit scores, incomes, access to banking services or something else. Until we get a better idea of what is within a specific bank’s control and what is not, these questions are not going to get any easier.

A Look Ahead: In the same vein as last week’s thought — being first and being wrong feel the same — Reuters published a comprehensive look at a specific threat to online lenders: stacking. Stacking is the practice of borrowers attempting to receive loans from multiple lenders at the same time or borrow from one lender to pay off an existing obligation. Without real time credit monitoring software or proper investment in similar controls, these marketplace lenders are finding their underwriting risk is greater than they anticipated. In response, some are devoting more resources to software that specializes in rooting out the “stackers” so that the underwriter can evaluate risk accurately,while others are simply denying those applications (when the software or underwriter catches on). One customer profiled in the piece has 6 rounds of loans to keep up with his obligations and is now running out of access to credit; his business accepted a 39% interest rate on the most recent round of borrowing.

Sidenote: We value the tough things. Whether it’s physical fitness, education, religious/spiritual practice or professional experience, we put a higher premium on the difficult and hard to achieve accomplishments. Doctors, lawyers and Ph.Ds are among the respected and well-compensated fields in our professional landscape. We pay for the struggle of having completed 7, 8, 12 years of schooling and achieving an expertise in a particular field. We respect and hold up the physically fit (some would say too much, in fact), because we recognize it is not easy to achieve or maintain. It might be simple — eat right and exercise — but it’s not easy. We respect discipline. One author said it a little differently, “if it doesn’t suck, it is not worth doing.” I don’t necessarily endorse everything in this article but I thought I would pass it along as there is a lot here.

First, I would ask — what tough thing are you not doing that you should tackle today, tomorrow or this week? Second, this made me think of a sermon I heard many years ago that has always stuck with me. The basic idea was this: if you do something generous, nice or charitable for someone and immediately look for recognition or thanks from others, then that is your reward. You’ll get the small, immediate boost (i.e. pride). If you do not ask or expect anything in return, you are building credit and building trust for a much, much larger payoff later (i.e. respect). The author in this piece has a similar approach. If we just dream about something or just tell someone all our ambitions, we may feel the boost or the flood of positive feelings, but if we never act, we will never achieve anything. We will never have the tangible result we talked about. Real and lasting accomplishment, which includes that lasting satisfaction we’re all looking for, comes from activity, not planning. Let’s go out and do this week.

Today’s Thought: “The person who agrees with you 80% is a friend and an ally.” — Ronald Reagan, as quoted by Oklahoma Governor Mary Fallin in Thursday’s RNC remarks. And I’ll add should be treated as valuable. Unfortunately, Governor Fallin said this to tepid if not non-existent applause. There was no support for that sentiment. (See video at 6:15). I did not see her speech. I heard this quote on PBS later in the night, from Mark Shields, who used it as an opportunity to describe what had changed in the Republican Party. Republicans, according to Shields, no longer hold that belief or share Reagan’s perspective. I was more interested in applying this idea to our businesses. I think of two ways: First, an 80% solution executed today is better than a 99% solution that takes years to create or deploy (tip of the hat to General Patton); likewise, in many ways, an 80% employee already on your team might be more valuable than terminating that person and trying to hire an 85% or 90% employee. Second, I think it is a fair measure of consensus in our organizations as well. We cannot operate trying to get unanimous consensus on everything we do. It’s impossible. Sometimes the leader has to find the 80% “friends” or the 80% common ground among the team and exploit that to achieve productivity and success. That should not be viewed as a weakness; rather, it should be embraced as a successful strategy to achieve action. We have lost that practicality in politics (apparently) but perhaps we can honor that principle in our businesses to successful ends.

Have a productive week.

Continued success,

Written by

Thinker, curious leader, once an attorney…always trying to answer well.

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