We’ve been writing a lot on the profits of high performing mortgage bankers in 2009.

Last year looks to have been a great year for most mortgage bankers, especially for those who originated FHA loans and sold them through mandatory delivery commitments.  Higher performers made in excess of 65 basis points in pre-tax profits. 

Common denominators among high performers are the size, components and deployment of their capital.  The higher performers had a strong balance sheets and were very liquid.  They used their capital wisely to exploit opportunity in the market.  Some of the key uses of capital and liquidity were the following:

  • Capital was used to procure and build warehouse lending capacity to support their production expansion strategies
  • Increase warehouse capacity helped to improve the mortgage banking captive rates for retail operators, resulting in higher gain-on-sale revenues
  • Capital was used to build technology to help them become more efficient and productive, driving origination costs lower
  • Capital helped to procure more secondary market investor partners
  • Capital and liquidity enabled them to manage some of the settlement timing issues that can sometimes occur when actively managing a mortgage pipeline
  • A strong balance sheet helped operators recruit high quality loan originators.  High quality loan originators were and are seeking strong companies with staying power

What if you were a good operator, made reasonable profits over the past couple of years and knew there were opportunities to grow the business and increase profits, but lacked capital to support your growth aspirations.  How could you increase your balance sheet to expand the business?  

Let’s look at several ways to increase capital:

  1. Organically: After tax earnings are kept on the balance sheet.  For some owners, this is problematic because they may not be able to retain much on the balance sheet because of personal financial needs.  Some operators may have to take a cut in pay to grow their net worth.
  2. Debt: Sometimes preferred debt can be used to beef up the balance sheet, providing extra liquidity.  Some investors and warehouse may count this, but generally debt is not considered in the calculation of core net worth.
  3. Equity Capital, Common Shares:  This might be a quick way to raise capital, but it may dilute an owners’ share of the company.  For example, if 50% more capital is needed, the owners’ share of the company may be reduced by 50% if the stock is common.
  4. Preferred Capital:  This is the best approach allowing an owner operator to increase net worth and liquidity without giving up control of his company.  Warehouse lenders and investors will count preferred as core capital and it frees up existing capital to be used to expand the business.  Generally the preferred has a coupon rate, stipulations for a share in the earnings and a conversion-to-common rights upon a liquidity event.  

We’ve recently worked with a private equity firm that has developed a unique preferred capital plan to help mortgage bankers grow their business.  The plan allows the earnings to be divided into two components:  

  • The first component is the profits the owner generated historically.  Those profits continue to be earned by the owner.
  • The second component is the profits generated as a result of the increase in capital.  Those profits are shared by the owner and the preferred shareholder.  

There is a saying in the business world that “you raise money when you don’t need it”.  With the many changes in the industry, there have become many opportunities.  The smart operators are raising money today so they can exploit those opportunities in the future.