MAK­ING MAR­KETS

Matt Humphrey is one of the en­trepreneurs aim­ing to up­end mort­gage fi­nance with tac­tics bor­rowed from fin­tech, mar­ket­place lend­ing and the tra­di­tional mort­gage play­book

National Mortgage News - - Front Page - BY BON­NIE SINNOCK

Mar­ket­place lend­ing is, in many re­spects, an evo­lu­tion of the pri­vately funded mort­gage mar­ket, which has co-ex­isted with main­stream lenders with­out pos­ing much threat for years. Pri­vate-money lenders make the loans that tra­di­tional mort­gage lenders can’t, or don’t want to, make. Prod­ucts like com­mer­cial mort­gages and fix-and-flip sin­gle-fam­ily home fi­nanc­ing of­fer higher re­turns than vanilla res­i­den­tial loans, but they re­quire a level of hands-on un­der­writ­ing and lo­cal mar­ket ex­per­tise that in­hibits scale.

But mar­ket­place lend­ing has changed that. Tech­nol­ogy used by mar­ket­place lenders of­fers deeper in­sights and trans­parency into trans­ac­tions, while more eas­ily con­nect­ing in­vestors and bor­row­ers in dis­parate lo­ca­tions.

And now, some of th­ese same lenders have their sights set on dis­rupt­ing the main­stream mort­gage mar­ket with tac­tics bor­rowed from fin­tech, mar­ket­place lend­ing and the tra­di­tional mort­gage play­book.

Take Lend­ingHome and its CEO, Matt Humphrey. The San Fran­cisco firm is a sin­gle-fam­ily bridge loan spe­cial­ist that funds it­self both through tra­di­tional sources of fi­nanc­ing and mar­ket­place lend­ing and was re­cently ap­proved to sell mort­gages to Fan­nie Mae.

Lend­ingHome has raised $110 mil­lion in ven­ture cap­i­tal since it was founded in 2013 and is look­ing for more. It’s done six bridge-loan secu- ri­ti­za­tions to­tal­ing $183 mil­lion and has a mar­ket­place lend­ing ve­hi­cle where ac­cred­ited in­vestors can pur­chase frac­tional in­ter­ests in loans.

Ear­lier this year, the com­pany es­tab­lished a reg­is­tered in­vest­ment ad­vi­sor called LH Cap­i­tal Man­age­ment and be­gan set­ting up two in­vest­ment ve­hi­cles un­der the name Lend­ingHome Op­por­tu­nity Fund II. The par­al­lel funds will ex­tend up to $200 mil­lion in to­tal fund­ing, ac­cord­ing to reg­u­la­tory fil­ings.

Like­wise, fin­tech lender SoFi, which self-funds its loans, is ap­ply­ing for fed­eral de­posit in­sur­ance, and was the first lender to test a re­cent Fan­nie Mae home loan prod­uct for bor­row­ers with stu­dent debt.

This sug­gests that the legacy of fin­tech and mar­ket­place lenders will not be de­fined by draw­ing lines be­tween this new breed of lenders and main­stream in­cum­bents, but rather by how those lines are blurred.

GET­TING MORE OUT OF PRI­VATE MONEY

The com­pe­ti­tion be­tween fin­tech and mar­ket­place lenders and tra­di­tional mort­gage com­pa­nies of­ten fo­cuses on bor­rower-fac­ing au­to­ma­tion and other tech­nol­ogy. What gets over­looked is how dif­fer­ences in their fund­ing sources also cre­ate com­pet­i­tive dif­fer­ences.

While fund­ing from gov­ern­ment-re­lated en­ti­ties, se­cu­ri­ti­za­tions, ware­house lines and de­posits are the best-known sources of mort­gage fi­nanc­ing, there has al­ways been part of the mar­ket that goes di­rectly to pri­vate in­vestors out­side the in­sti­tu­tional mar­ket.

That’s largely where mar­ket­place lenders play.

“There is some com­pe­ti­tion for the pri­vate-money lenders that didn’t use to be there” as a re­sult of mar­ket­place lenders en­try into the mar­ket, ac­cord­ing to Gor­don Al­brecht, a se­nior di­rec­tor at pri­vate-money sub­ser­vicer FCI Lender Ser­vices Inc. in Ana­heim, Calif.

But are the fin­tech mar­ket­place lenders re­ally giv­ing tra­di­tional pri­vate-money mort­gage lenders much of a run for their money?

“Are they re­ally com­pet­ing? Ac­tu­ally, not that much,” said Al­brecht, who num­bers mar­ket­place lenders among his cus­tomers.

Mar­ket­place lenders with tech­nol­ogy plat­forms started by try­ing to horn in on pri­vate-money mort­gage lenders’ turf as orig­i­na­tors, but af­ter see­ing the ex­tent to which the mort­gage mar­ket is reg­u­lated, many shifted gears and de­cided they’d rather pur­chase lenders’ loans, he said.

Re­gional pri­vate-money lenders are com­pet­i­tive with na­tional lenders like banks that have “ho­mog­e­nized lend­ing to the point where lo­cal nu­ances aren’t taken into con­sid­er­a­tion,” said Brett Crosby, co-founder and COO of PeerStreet in Man­hat­tan Beach, Calif.

But some fin­tech and mar­ket­place lenders are em­ploy­ing a na­tional strat­egy aimed at com­pet­ing with them.

Lend­ingHome does this by an­a­lyz­ing “credit pa­ram­e­ters down to each dif­fer­ent city or state per the el­e­vated or re­duced risks lev­els in those mar­ket con­di­tions,” said Lend­ingHome’s Humphrey.

“We can con­trol all of this and make changes daily if need be, and pre­fer to, rather than rely on lo­cal lenders of vary­ing qual­i­ties that may had ad­verse se­lec­tion bias of which loans they choose to sell,” he added.

While pri­vate-money lenders may com­pete against each other, on the sur­face it seems like the chances of many mar­ket­place lenders com­pet­ing in the tra­di­tional mort­gage mar­ket is slim. So why should tra­di­tional mort­gage lenders care about this de­vel­op­ment in the pri­vate-money mort­gage mar­ket?

One an­swer is that, while the mar­ket for loans funded by small pri­vate in­vestors has been lit­tle more than a niche, it now has growth po­ten­tial it didn’t have be­fore.

“Th­ese crowd­fund­ing com­pa­nies re­ally aren’t do­ing any­thing that hasn’t been done be­fore in terms of fund­ing pri­vate mort­gages, but now you have the in­ter­net, and sud­denly the num­ber of in­vestors grows,” said Rick Sharga, chief mar­ket­ing of­fi­cer at Ten-X in Irvine, Calif.

The pri­vate-money mort­gage in­vestor mar­ket was orig­i­nally built on word-of-mouth con­nec­tions, but mar­ket­place lend­ing plat­forms have made it eas­ier to broadly dis­sem­i­nate in­for­ma­tion that in­vestors can use to size up po­ten­tial in­vest­ments.

“The mar­ket­place lenders have opened up the pri­vate money world,” said Al­brecht. “In­vestors can get into it that wouldn’t oth­er­wise. It used to be you have to have some­body to bring you into it. It was a net­work­ing busi­ness.”

Tap­ping this type of fund­ing could help tra­di­tional bank or non­bank mort­gage lenders di­ver­sify their cap­i­tal bases. In­sti­tu­tional in­vestors can pro­vide larger amounts of cap­i­tal, but they also pose more coun­ter­party risk be­cause of their in­flu­ence.

For tra­di­tional lenders, the value of the mar­ket­place lend­ing strat­egy is that “it’s a source of di­ver­si­fi­ca­tion of fund­ing,” said Brad Walker, CEO of In­come&. Pro­nounced “In­come And,” the San Fran­cisco com­pany fo­cuses on sin­gle-fam­ily mort­gage in­vest­ments.

LOW­ER­ING THE COST OF FUNDS

Lenders should not only take a page from fin­tech and mar­ket­place lend­ing strate­gies be­cause they can di­ver­sify fund­ing sources, but also be­cause they have been fo­cus­ing on strate­gies that lower costs.

“What’s go­ing to dif­fer­en­ti­ate which com­pa­nies suc­ceed in the fin­tech space is the cost of cus­tomer ac­qui­si­tion,” said David Nor­ris, chief rev­enue of­fi­cer at loanDe­pot in Foothill Ranch, Calif.

Whether they use a mar­ket­place lend­ing model or not, fin­tech lenders also have to be ef­fi­cient when it comes to fund­ing costs, said Steve Abreu, founder and CEO of Newfi Lend­ing in San Fran­cisco. “If you can’t ex­e­cute a good price to the cus­tomer, your model fails,” he said.

The many in­ter­me­di­aries in the sec­ondary mort­gage mar­ket and se­cu­ri­ti­za­tion can look very in­ef­fi­cient when com­pared to reach­ing out di­rectly to in­vestors through a mar­ket­place lend­ing plat­form, said Crosby.

So it could be worth con­sid­er­ing whether there are ef­fi­cien­cies in the mar­ket­place lend­ing model that could be in­cor­po­rated into hous­ing fi­nanc­ing re­form.

“There are a lot of as­sump­tions baked into what I’m say­ing, but the ex­ist­ing mar­ket is ripe for trans­for­ma­tion,” said Crosby, who works for a mar­ket­place lender that pri­mar­ily funds in­vestors’ sin­gle-fam­ily bridge loans, but would con­sider fund­ing home mort­gages in the fu­ture.

It would take time given the sheer size of the mort­gage mar­ket, the num­ber of in­flu­en­tial and en­trenched play­ers and the heavy reg­u­la­tion, but “there is no rea­son that the whole in­dus­try can’t go this di­rec­tion,” he said.

“There is no rea­son the whole in­dus­try can’t go in this di­rec­tion.” — Brett Crosby, Co-founder and COO PeerStreet

While fin­tech strate­gies may have some po­ten­tial to be trans­for­ma­tive long-term, they aren’t go­ing to be the sole win­ning busi­ness model in the mort­gage mar­ket. Some fin­tech com­pa­nies have had a tough time mak­ing a go of it. And when it comes to the mar­ket­place lend­ing strat­egy, sev­eral com­pa­nies have found they can’t get by us­ing that type of fund­ing alone but rather in con­junc­tion with tra­di­tional sources.

This sug­gests that what will emerge is a con­ver­gence of mod­els.

THE HY­BRID AP­PROACH

Al­ready there clearly are mar­ket­place lenders that are buy­ing loans from the tra­di­tional mort­gage mar­ket and start­ing to di­ver­sify into tra­di­tional fund­ing sources, and vice versa.

There also are tra­di­tional lenders as­pir­ing to be fin­tech com­pa­nies, and fin­tech com­pa­nies work­ing to be more like tra­di­tional mort­gage lenders.

In ad­di­tion, more and more main­stream mort­gage lenders are adopt­ing the kind of bor­rower self­serve tech­nol­ogy plat­forms orig­i­nally more com­monly as­so­ci­ated with tech­nol­ogy star­tups.

Quicken Loans in Detroit has for some time been a vol­ume leader in the mort­gage mar­ket and com­pa­nies like Abreu’s Newfi Lend­ing and Nor­ris’ loanDe­pot were founded by mort­gage in­dus­try veter­ans but are known for their fin­tech-style au­to­ma­tion, among other things. For ex­am­ple, loanDe­pot also has a fin­tech-like strat­egy in that it is a non­bank that of­fers mul­ti­ple con­sumer fi­nance prod­ucts.

While a lot of non­banks in the mort­gage mar­ket are mono­line com­pa­nies, Nor­ris finds car­ry­ing a full range of con­sumer fi­nance prod­ucts bor­row­ers are likely to need and the vol­ume of busi­ness it gen­er­ates com­pelling enough that he thinks it will be the wave of the fu­ture.

“Spe­cial­ists will not sur­vive longterm,” said Nor­ris.

Non­bank com­pa­nies com­pet­ing in the fin­tech space do seem to be more fre­quently of­fer­ing ex­panded prod­uct lines than mort­gage lenders tra­di­tion- ally have in the past, but there are vary­ing opin­ions on how far to take that di­ver­si­fi­ca­tion, and how fast.

“We think very few will be truly ex­cep­tional at one ver­ti­cal, let alone mas­ter­ing mul­ti­ple,” said Humphrey.

His firm, which started by us­ing tra­di­tional fund­ing sources to pri­mar­ily fi­nance sin­gle-fam­ily bridge loans, has ex­panded into more tra­di­tional loan prod­ucts and mar­ket­place lend­ing, but at a de­lib­er­ate pace.

Orig­i­nally fin­tech and mar­ket­place lenders grav­i­tated more to­ward other forms or con­sumer fi­nance with higher risks and higher re­turns, like “fix and flip” and per­sonal loans, but as they strive for scale the size of the sin­gle-fam­ily mort­gage mar­ket has at­tracted them to it as well.

Tra­di­tional sin­gle-fam­ily mort­gage lend­ing “def­i­nitely isn’t one of the low-hang­ing fruits in the mar­ket but it is a large mar­ket,” said Walker.

Lend­ingHome and SoFi are ap­proved to sell loans to the tra­di­tional sec­ondary mort­gage mar­ket’s big­gest par­tic­i­pant, Fan­nie Mae.

Lend­ingHome started with tra­di­tional in­sti­tu­tional non­bank fund­ing sources and a fo­cus on the kind of sin­gle-fam­ily real-es­tate-se­cured bridge loans star­tups tend to fa­vor, but re­cently di­ver­si­fied into mar­ket­place and con­sumer mort­gage lend­ing as well, said Humphrey.

“We cre­ated a pri­vate cap­i­tal mar­ket­place, and now we’ve moved over to help first-time home­buy­ers and a lot of those loans ac­tu­ally fall into a more con­form­ing spec­i­fi­ca­tion. They could be sold to Fan­nie or mid­mar­ket or main­stream banks,” he said.

Tra­di­tional mort­gages rep­re­sent about 20% of its vol­ume cur­rently and are grow­ing at a faster rate than its bridge loans did, he said. Bridge loans only rep­re­sent about 2% to 4% of the mort­gage mar­ket, Humphrey noted.

The size of the tra­di­tional mort­gage mar­ket helped draw the com­pany to it, he said. And the more re­cent di­ver­si­fi­ca­tion of its fund­ing into mar­ket­place lend­ing helped it price its loans more at­trac­tively for bor­row­ers.

“We were able to re­ally di­ver­sify that [fund­ing] strat­egy to where we weren’t be­holden to any one in­vestor group,” Humphrey said.

The com­pany’s top ex­ec­u­tives re­flect its blend of tra­di­tional mort­gage and fin­tech ex­per­tise.

While Humphrey is a mil­len­nial who has founded sev­eral star­tups and went to col­lege at age 13, the com­pany’s chief fi­nan­cial of­fi­cer, Robert Stiles, is a mort­gage in­dus­try vet­eran who pre­vi­ously was the CFO of Na­tion­star Mort­gage Hold­ings in Dal­las.

Another com­pany blend­ing dif­fer­ent old and new mort­gage fund­ing strate­gies is In­come&.

In­come&, while reach­ing out di­rectly to in­vestors, is work­ing to serve re­tirees po­ten­tially more in­ter­ested in ac­cess­ing the main­stream mort­gage mar­ket’s lower-risk cash-flows than tak­ing on more risk in order to reach for yield the way mar­ket­place lenders’ in­vestor bases tend to.

The com­pany struc­tures the in­vest­ments through a twist on tra­di­tional se­cu­ri­ti­za­tion.

In­come&’s in­vest­ment ve­hi­cle, the Prime-Rated Mort­gage-backed Obliga- tion, is backed by in­di­vid­ual loans that in­vestors can iden­tify as spe­cific through their needs through the com­pany’s plat­form.

But gen­er­ally for mar­ket­place and fin­tech lenders, tra­di­tional mort­gages can be “a hard place to start” be­cause of the higher re­turns their in­vestors tend to want, said Crosby.

WORLDS COL­LIDE

It’s not al­ways so easy to blend old and new mort­gage lend­ing mod­els.

“The words ‘in­no­va­tive’ and ‘game chang­ing’ and ‘fi­nan­cial ser­vices’ typ­i­cally don’t go to­gether,” said Sharga.

Tra­di­tional mort­gage lenders can find “plug and play” fin­tech- style bor­rower sys­tems to pur­chase; but they also have to re­place legacy sys­tems. Star­tups don’t. At fin­tech lender ef­forts to en­ter the tra­di­tional bank­ing sys­tem, like SoFi’s, have not al­ways gone so smoothly.

How well each type of mort­gage lender han­dles the chal­lenges in this con­ver­gence of mod­els will de­ter­mine which com­pa­nies sur­vive.

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