surviving changing markets mission impossible?. mission impossible
TRANSCRIPT
Surviving Changing MarketsMission Impossible?
Mission Impossible
Your Assignment
Manage Your Mortgage Company Through Changing Markets:
• Minimize Product Risk
• Avoid Repurchase Requests
• Reduce Overhead at the Right Time
• Keep your Warehouse Lender Happy
• Goal: Survive with Your Net Worth and your Warehouse Line Intact!
Causes of Changes in Mortgage IndustryInterest Rate Cycles • Graph of Interest Rates from 1980 to
2003– Includes Mortgage Origination Volume
– Employment in the Mortgage Industry
• Change in Products Acceptable to Investors– The primary cause of the current downturn is
the use of stated income to “qualify” borrowers for loans they cannot afford to pay
Mortgage Industry Cycles
0
200
400
600
800
1000
1200
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
0%
3%
6%
9%
12%
15%
18%
ORIGINATIONS (BIL. $) EMPLOYEES (THOUS) 30-YR FRM (%)
Source: Mortgage Bankers Association of America
Risks Faced in this Market
• Repurchase requests
• Unsaleable loans
• Lack of liquidity
• Lack of Net Worth
• Excess Overhead
• Changing Loan Guidelines
• Loss of Warehouse lines
The Survival Solution:PLANNING
• “Success is not an accident—it is always accompanied by a plan.”
--(Dave Hershman in Mortgage Daily, 5/25/04)
Planning and Evaluating Options• Defend Against Repurchase
Requests• Sell Loans PRIOR to Funding• Get Additional Liquidity if Needed• Know Your Breakeven Point• Make Cost Cuts Until You are
Profitable• Avoid Warehouse Default by
Keeping Covenants
Defend Against Repurchase Requests• Get servicing records from investor• Contact borrower to determine whether
payments were made• Bring borrower current through direct
contact or broker• Go after brokers & borrowers for fraud• Hire a good advisor and/or attorney• Re-negotiate Sale Contracts to reduce
repurchase risk: EPD periods and Reps & warrants
Sell Loans PRIOR to Funding• Changing Guidelines are the Number
One reason that mortgage companies have been failing
• Forward Commitments do not typically guard against guideline changes
• Bulk selling presents an unacceptable risk at this time for even largest sellers
• Flow selling to trusted investors on a prior-approved basis is least risky
Lack of Liquidity
• Liquidity is your cash and assets easily converted to cash
• Allows the company to make haircuts and margin calls required by lenders
• The resource used to negotiate on repurchase requests
• The life-blood of your business• Can be added through equity, lines of
credit or subordinated debt
Know Your Breakeven Point: • In order to plan your success, you
need to know your breakeven point.– Must be able to split fixed versus
variable costs– Formula:
Indirect Expenses divided by Net Revenue Percentage
Breakeven Calculation
1. Calculate Indirect Expenses (total expenses less commissions and loan-related costs)
2. Calculate Net Production Revenue as a percent of Indirect Expenses
3. Divide Indirect Expenses by the percentage derived in #2
Breakeven Example
• Monthly Production of $30MM
• Revenue of $300,000
• Total Expenses of $225,000 include:– Commissions of $100,000– Direct Loan Expenses (appraisals,
credit reports, underwriting fees, Etc) of $50,000
Breakeven Example Revenue as a percent of production:
Assumptions: Calculate Net Revenues:
Production $30,000,000 Gross Revenue $ 300,000
Less Direct Expenses:
Total Revenue $ 300,000 Commissions $ (100,000)
Expenses: Other Direct Costs $ (50,000)
Commissions $ 100,000 Net Revenues $ 150,000
Direct Loan Costs $ 50,000 Divided by Production $ 30,000,000
Other (Indirect) $ 75,000 Net Revenue as % of Production 0.50%
Total Expenses $ 225,000 Indirect Expenses: $ 75,000
Divided by Net % Revenue 0.50%
BREAKEVEN $ 15,000,000
Project Your Staffing Needs:• Calculate number of loans each
type of employee can handle in a month
• Create spreadsheet with various monthly volumes as the column heading and each type of employee as a row heading
• Plot out the number of each type of staff needed for each level of volume considered likely
Make Cuts When Production Falls• The best way to preserve capital is
to reduce staff as quickly as possible
• Don’t wait until you see losses to cut staff—use your projections to determine timing
Warehouse Line Default RiskMajor Covenants include:
• Minimum Net Worth Covenant
• Maximum Leverage
• Minimum Liquidity
• Restriction on Losses
• Restriction on Distributions
Covenant Formulas:
• Adjusted Net Worth: GAAP Net Worth less officer receivables, illiquid assets (real estate, stock); plus subordinated debt and servicing portfolio
• Leverage: Total liabilities divided by Adjusted Net Worth
• Liquidity or Current Ratio: Current Assets divided by Current Liabilities
Keys to Avoiding Covenant Violations• Use your projections to cut costs before
you incur losses• Use your breakeven analysis to plan your
overall approach—adding new products, moving into new geographic areas, etc.
• Use off-balance sheet financing to avoid leverage and current ratio problems
Summary
• This is a cyclical business-plan early and often!• Pre-sell all loans prior to funding to avoid
guideline shifts• Vigorously defend against existing and future
repurchase requests• Don’t wait to cut costs-when you see losses on
your financial statements, it’s too late!• Manage your capital and leverage to avoid
covenant violations• Look into off-balance sheet financing to provide
flexibility• Keep your capital intact and get to Mission
accomplished!