Within the mortgage market, a number of different types of financial institutions are involved, either directly or indirectly, in the business of mortgage loans. A number of different classification schemes can be used to distinguish businesses and functions within the aggregate mortgage banking industry.
Consistent with terminology, a direct lender accepts and underwrites loan applications and funds the resulting loans. In contrast, a mortgage broker represents clients and will work with a number of different lenders in obtaining a loan. This involves taking the loan application and (in some cases) processing it through the GSE automated underwriting systems. The broker does not, however, make the loan but rather serves as an agent linking borrowers and lenders. Many large lenders classify operations in units or channels, differentiating those divisions that work directly with borrowers (generally the retail channel) from those that deal with brokers (generally called the wholesale channel). These distinctions are necessary partly because the different channels have differing cost structures, necessitating alternative pricing schema.
Depository institutions (which include banks, thrifts, and credit unions) collect deposits from both wholesale and retail sources and use those deposits to fund lending activities. Since depositories have both loan and securities portfolios, such institutions have the option of either holding loan production as a balance sheet asset or selling the securitized loans into the capital markets in the form of mortgage-backed securities (MBS). In addition, there is a market for nonse-curitized mortgage portfolios, or whole loans, because there are accounting advantages for depositories to hold loans on their books instead of securities. Nondepository lenders (mainly mortgage bankers) do not have loan portfolios, and virtually all loan production is sold to investors through the capital markets.
This distinction is important in understanding competitive pressures within the industry. Depositories that can hold mortgages or MBS in portfolios sometimes can be more aggressive in pricing different products, especially products that are accumulated in the loan or investment portfolios (most frequently, short-duration assets such as adjustable-rate loans). In contrast, mortgage bankers must price production based on capital markets execution, which suggests that it might be difficult at times for such entities to compete in some product sectors targeted aggressively by banks. However, an outgrowth of this difference is the blurring of distinctions between the different types of operations. As noted earlier, depositories that have capital markets operations have the option to either retain or securi-tize production. A number of traditional mortgage bankers, in order to obtain the same operation flexibility, have founded or acquired bank units and use these operations primarily to improve competitive positioning in sectors where the ability to retain production in the portfolio conveys competitive advantages.
Both depository and nondepository loan originators underwrite and fund loan production. However, once the loan is closed, an infrastructure is required for collecting and accounting for principal and interest payments, remitting property taxes, dealing with delinquent borrowers, and managing foreclosures. Entities that provide this operational aspect of mortgage lending are referred to as servicers. As part of providing these services, such entities receive a fee, which generally is part of the monthly interest payment. While many originators also act as ser-vicers, servicing as a business is both labor- and data-intensive. As a result, large servicing operations reap the benefit of economies of scale and may explain the significant consolidation in this industry over the last decade. As a point of comparison, the top 10 servicers comprised 55% of the market at the end of 2004, compared with 21% at the end of 1994.7
7. Information obtained from SMR Research Corporation and National Mortgage News.
Servicing as an asset may be classified along several dimensions. Required or base servicing is compensation for undertaking the type of activities just described and is either dictated by the agencies or (in the case of nonagency securities or loans) conditional on the product. At this writing, for example, the GSEs require 25 basis points of base servicing for fixed-rate loans, whereas GNMA requires either 19 or 44 basis points (depending on the securitization vehicle) for government-backed fixed-rate loans. The ownership of base servicing also provides the servicer with ancillary benefits, including interest float on insurance and tax escrow accounts and the ability to cross-sell other products using the database of borrower information. However, base servicing (in the form of interest) is required to be held such that there is an asset held on the part of the servicer that can be seized in the event of a bankruptcy.
Excess servicing is any additional servicing over the base amount and is merely a strip of interest payments held by the servicer. Excess servicing is a corollary of the process that allows the loan to be securitized with an even coupon, as demonstrated later in the section on execution dynamics. Excess servicing neither requires any activity on the part of the servicer nor does it convey any benefits; it is strictly a by-product of the securitization process.
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