Mortgage Pools in a Liquidity Crunch
The liquidity crunch in today's market has seriously limited mortgage brokers' ability to place loans with lenders and most lenders' ability to fund loans they wish to underwrite. This strain on capital significantly reduces both brokers' and lenders' ability to make money. Brokers in today's market must seek additional sources of revenue if they want to stay in business. Brokers who are interested in additional sources of revenue to complement their broker business should consider forming a mortgage pool, or mortgage fund. This article will discuss the state of the market as of the date of this article, the benefits and risks of a mortgage fund, and a consideration of whether the mortgage fund would be proper for a broker to create. The Liquidity Problem of Today The financial market for mortgages were structured as follows: brokers who wanted additional streams of income would have a warehouse line where they would originate loans and place on the warehouse line. The warehouse line was from a medium-sized institution or private money lender who themselves had even larger warehouse lines with large institutional banks. The end buyer was of course Wall Street. However, when Wall Street stopped buying, the mortgage market crashed. The securitization of mortgage-backed securities dried up and, in turn, so did the money lent down the chain to allow brokers to make additional money. This market is still the case today. However, through alternate vehicles, brokers could make between three to ten percent (3-10%) more than they are currently making purely brokering loans. What is a Mortgage Pool? In essence, a mortgage pool is nothing more than a sophisticated securities offering. Brokers (who want additional sources of financing) and even current lenders form these pools and find investors who want to invest with the mortgage company in expectation of a certain amount of return on their investment. The broker or lender pools the investors' money together in a company and loans it out at a certain amount of interest, depending on the market conditions, type of loan product, risk, and their investors' expected return. Investors receive a monthly or quarterly distribution and the broker (you, not the investor) receives an asset management fee, a servicing fee, and other fees in connection with running the company. How Exactly Does a Mortgage Pool Work? Two companies are formed: (1) a limited liability company which will be the lending company, and (2) a corporation, which will be the Manager of the lending company, and the company in which the broker will make its money. The manager will act as both a mortgage broker to the fund and as well as the manager of the lending company, which puts the manager in control of the lending company. The manager can typically expect to make between 3-10% of the lending company's raised capital per year through creating a mortgage fund, depending on the aggressiveness and structure of the fund. Types of Mortgage Funds In today's market, a lot of lenders are moving away from origination to REOs, purchasing "scratch and dent" notes and purchasing pools of loans from lenders who either are out of business or will discount a package of loans to free up capital to make more loans. The mortgage pool is perfect for all of the above. Mortgage Pool Offerings There are two types of offerings that lenders can use to raise money for their mortgage pool: (1) a private offering and (2) a public offering. Private Offerings The typical offering that most lenders are attracted to is private offerings. There are two types of private offerings: (a) a federal private placement memorandum and (b) a state registered offering. Both of these are discussed below. Federal Private Placement A private placement memorandum is a private securities offering that allows brokers or lenders to raise an unlimited amount of money from investors. They may also lend money in all 50 states and accept money from investors in all 50 states. However, the fund cannot generally advertise for investors, can only accept money from high net worth or high income individuals, and are limited to 500 investors without registering the offering with the SEC. State Registered Offering A state registered offering is a private offering that allows brokers or lenders to raise an unlimited amount of money from investors in one state. Lenders can advertise for investors within that state, but can only accept investors in that one state, can only accept money from high net worth or high income individuals, and are limited to 500 investors without registering the offering with the SEC. This model is not available in all states, or, if it is, could be extremely difficult to obtain approval in the state. Public Offering A public offering of securities might be the best avenue for current mortgage lenders to raise capital for a mortgage pool. A public offering is a registered offering with the Securities and Exchange Commission, and allows a lender to raise up to $25,000,000.00 in capital. The benefits of a public offering are immense: the lender (1) can advertise and accept money from investors in all 50 states, (2) can accept money from an investor without regard to their net worth or income and (3) can have an unlimited number of investors in the pool. Is Creating a Mortgage Fund Right For Me? Mortgage funds are serious undertakings that should only be created by brokers who are experienced in the market or have the capital necessary to make such a mortgage fund. Mortgage funds can be costly to start: (a) you must hire the attorney to draft the documents, (b) pay consultants to help formulate your business and (c) decide how to service your loan portfolio. Furthermore, a mortgage fund is a securities offering and carries with it its own unique risks and rewards. Brokers should consult with an attorney who is experienced in creating private placement memorandums, state offering circulars or public offerings and an attorney who is an expert in creating mortgage funds. There are several vendors available on the internet who will charge a small fee to do a private placement memorandum. However, those types of offerings are fraught with peril and should be avoided. However, if done correctly, mortgage funds can create the additional streams of revenue currently lacking in your capacity as a mortgage broker and give you what you do not have: a renewable stream of income. Conclusion With the lack of capital in the current market, brokers who want additional capital resources should consider a mortgage pool. Unlike using a warehouse line of credit, brokers will have (a) a renewable source of income and (b) the control to set the guidelines on which loans to make and which to reject. Mortgage pools make sense for those who are serious in creating additional and renewable streams of income and who have the capital to front the start up costs associated with a new business venture. You should consult an experienced attorney in this area before deciding whether to create a mortgage fund.