Analysis: Small lenders ride U.S. mortgage wave as big banks cut back

Guaranteed Rate, Inc, a home loan company, opened shop in 2000 in Chicago with a single office. Now it is one of the 20 biggest U.S. mortgage lenders, with more than 140 offices.

Most of that growth has come in the last two years and Chief Executive Victor Ciardelli said in an interview he is not planning to slow down.

"We've hired over a thousand people over the last year and we're trying to hire a ton more," Ciardelli said.

Guaranteed Rate is one of scores of independent mortgage lenders and community banks pushing up through the rubble of the housing collapse, as profits rise amid improving demand for home loans for new purchases or mortgage refinancing. They are winning business from banks such as Citigroup Inc or Bank of America Corp that have retrenched after the financial crisis.

The five biggest U.S. mortgage lenders controlled just 53.2 percent of the market last year, down from nearly two-thirds in 2010, Inside Mortgage Finance data shows. As small lenders grow, that share could shrink to 40 percent of the $1.8 trillion mortgage market by 2014, a recent FBR Capital Markets report forecast.

The rise of smaller lenders is a boon for consumers. Several smaller lenders said lower costs, low interest rates and their faster processing times allowed them to be more aggressive on pricing than the bigger banks.

"When the big guys get backed up, they have a tendency to raise their price, to slow down volume. And that gives other lenders an opportunity, because the consumer thinks, ���Why would I pay an extra $100 a month,'" said Brian Hale, chief executive of Stearns Lending Inc.

Stearns, a home lender based in Santa Ana, California, saw originations increase 107 percent in 2012.

But the proliferation of lenders also comes with risks. While mortgage experts said underwriting standards are stricter now than in the years leading to the financial crisis, the rush into the sector raises the risk that regulators might not be able to police them effectively.

The Consumer Financial Protection Bureau, for example, has unveiled new rules for underwriting standards, but the bureau that was formed in 2011 as part of financial reforms has yet to prove itself.

"The CFPB is a very new agency that has been building out its examination force. They've been doing a very good job of that, but nevertheless a lot of the examiners are relatively new," said Patricia McCoy, a financial-institutions law professor at the University of Connecticut and a former senior mortgage-market official at the CFPB.

A CFPB official said the agency was staffing up and would continue to grow until it is at full capacity.

Small lenders, some of which are backed by private equity and hedge fund money, are also aggressively taking advantage of federal guarantees to make home loans geared toward low-income borrowers - more so than the big banks. Such loans, which are insured by the Federal Housing Authority (FHA), require a down payment of as little as 3.5 percent of the purchase price, compared with the usual 20 percent.

The CFPB's mortgage regulations specifically exempt the FHA, noted Guy Cecala, the publisher of Inside Mortgage Finance.

"There's no question that the FHA has the loosest underwriting of any mortgage program in the industry right now, and that naturally brings some risk," Cecala said. "The million-dollar question is, How much risk?"

Meanwhile, fast money looking for big returns is pouring into the sector.

"I get offers to be purchased by hedge funds and private equity all the time," Guaranteed's Ciardelli said.

To be sure, the increase in business for small lenders could be cut short as big banks ramp up. The two biggest players in the market now, Wells Fargo & Co and JPMorgan Chase & Co , have been gaining market share in recent years. Others such as Citigroup and Bank of America pulled back from the market during the financial crisis, but have been hiring loan officers in an effort to regain lost share.

Moreover, mortgage rates have risen recently, which could ultimately cut into demand for home loans.

But for now, small lenders and experts said the ramp up by the large banks is not enough to make up for all of the business they shed.

"There is a real opportunity for well-capitalized community banks and independent mortgage bankers to take market share," said Richard Bennion, director of residential lending at Seattle-based HomeStreet Bank.


One reason for the rush into the market is enormous profits. The U.S. Federal Reserve last year said it was buying $40 billion of mortgages a month, which adds to demand for home loans and increases profits for banks that make loans and sell them to investors.

JPMorgan, for example, said earlier in January that margins from selling mortgage loans to investors were about 1.60 percentage points, more than double the historical level of about 0.65 percentage points.

Those kinds of margins give smaller competitors room to cut rates and still make money.

On its website at the end of January, Guaranteed Rate offered a $300,000, 30-year, fixed-rate home loan for 3.5 percent with up-front fees of $1,250. It claimed that compared favorably with three large banks - Wells Fargo, Citigroup and Bank of America - whose rates that day ranged from 3.625 percent to 3.75 percent for a similar mortgage, with fees starting at $3,200.

"The big banks are doing pretty well just turning on the lights and opening up the doors at their branch offices every day, so there's no need to compete on pricing," Inside Mortgage Finance's Cecala said.

Citigroup spokesman Mark Rodgers said the bank continually seeks to ensure that its mortgage rates are competitive. Wells Fargo spokesman Tom Goyda said he is confident his bank's pricing is competitive and noted that price is not a customer's only consideration when shopping for a mortgage. Bank of America spokeswoman Kris Yamamoto said rates and fees depend on multiple variables and that the bank offered discounts to certain customers who maintain assets with the bank.


While the FHA's lending has gradually decreased since the crisis, it has been a source of opportunity for smaller lenders. The agency insured $213 billion of loans in fiscal 2012, compared with $218 billion in 2011 and $298 billion in 2010, according to its 2012 annual report to Congress.

Cecala said this puts the FHA at 13.5 percent of the lending market, within its stated target range of 10 to 15 percent, and down from over 25 percent in 2009, when FHA lending peaked.

More so than big banks, many independent lenders are relying on FHA loans to keep their origination volumes high.

"This recession hit a lot of people hard and (the FHA program) gave us the opportunity to support those folks in a situation that was difficult for them," said Stanley Middleman, CEO of Freedom Mortgage Corp.

The Mount Laurel, New Jersey-based lender said about 35 percent of its $13 billion in mortgage origination for 2012 was FHA lending.

In contrast, JPMorgan's total government lending, which includes FHA, as well as programs targeted at veterans and rural homeowners, made up less than 21 percent of its overall origination volume, a spokeswoman said.

A Wells Fargo spokesman said an estimate of FHA lending at 15 to 20 percent would be reasonable, but would not confirm an exact number.

At another lender, Sherman Oaks, California-based Prospect Mortgage, FHA lending accounted for over 25 percent of its $8.42 billion in loans in 2012, a company spokesman said.

"We like to think of ourselves as the lender for the masses, not the classes," said Doug Long, Prospect's president of retail lending.

(Reporting By Anna Sussman; Editing by Carrick Mollenkamp, Dan Wilchins, Paritosh Bansal and Andre Grenon)