Growing your business - the strategic approach.

As anyone who has ever planted a tree, flower or good old rutabaga knows, as a plant grows and develops, its needs change. Fertilizer is critical at one stage of development, pruning at another. To ensure a healthy, thriving plant, resources must be matched with the stages of development.

The same is true for today's mortgage originator. As an originator's business grows and changes, so do his or her needs. To grow a healthy, thriving business, an originator must match resources with his or her business' stage of development.

Mark Casale, senior vice president of Advanta Mortgage, Fort Washington, Pennsylvania; Lee Wells, president of Mortgage Corporation of America, Southfield, Michigan; and Paul Pennington, CEO of Goodrich & Pennington, Rohnert Park, California, have spent some time analyzing how the right business partnerships and strategic alliances in the mortgage industry can help an originator grow and build a company at any stage of development.

"The subprime industry as a whole is facing some significant issues," says Casale. "Credit quality in terms of the expanding percentage of higher LTV and lite document products in the market has fueled increased competition. Rising prepayments are a continuing concern. The prepayment issue and the aggressive accounting practices of whole-loan buyers have resulted in lower P/Es for the public companies in the market. In addition, the combination of hedge losses [due to the decline in the Treasury rates] and widening spreads have severely hampered liquidity in the form of reduced working capital and warehouse lines."

According to Casale, today's mortgage correspondent (generically speaking, the small to midsize mortgage banker) is really focusing on the origination process, with liquidity and cash flow being the primary concern. The cash is used to cover payroll and marketing. Relatively little has been spent on developing the infrastructure analytical support needed to build bigger businesses. And now, with constrained liquidity, many face reduced warehouse and working capital lines and little or no access to capital.

This high-growth market over the last couple of years has resulted in aggressive buying and an inflation of premiums; in fact, in Casale's view, as well as that of Wells and Pennington, the premiums being paid just a couple of months ago were higher than the intrinsic value of the loans. The market, however, seems to be righting itself with a reduction in working capital, forcing large whole-loan buyers to reduce premiums to the correspondent.

"The marketplace could not continue to support premiums of six or seven points," says Wells. "Although it's really difficult to predict, three or four seems a more realistic number."

While the higher revenue was a good thing for originators, Casale points out it has also attracted more players to the market. "We've seen lots of new entrants. If someone can come into the market and originate a loan for four or five points and sell it for six or seven, that's a nice spread. This spread attracts new entrants coming down from conforming markets or coming in from other businesses."

A major concern Casale points out is that because the premiums were so good for many originators, not enough attention was paid to the cost of doing business. "Pricing is continuing to come down. Folks who haven't focused on costs are having a hard time making a living - if they are even surviving," he says. "The increase in prepayments and concern of lower P/E is reducing the capital in the equity market for some of the larger players. If they don't have the capital, they don't have the cash to pay the premiums. As a result, we are seeing many players exit the correspondent business."

Casale suggests that originators preparing to face this changing market should begin asking a number of strategic questions, such as:

* Where do you want your business to be a year or two from now?

* How much capital will it take to get there?

* How do you stay profitable in the face of lower premiums?

* How do you differentiate your origination strategy from that of your competitor down the street?

* What is the true value of your company, and what drives that value?

* Now that investor base is shrinking, a lot of relationships are based strictly on price. If price is less of an issue, what else do you get out of the relationship?

* Do your investors help increase the value of your company, or are they just bidding your pools?

When looking at the future of his or her business, today's originator really has three basic options: (1) Keep originating the loans, selling them into the secondary market and getting premiums-with this option, the originator just has to hope that the premiums will be enough to keep him or her in business. (2) Decide whether to continue growing in the face of increased competition as industrywide consolidations continue, or to sell the company. (3) Form an alliance or strategic partnership, which can provide access to capital and a sophisticated back-office operation without the downside of having to sell the entire company.

For Wells and Pennington, strategic partnerships have provided the necessary framework for the growth of their businesses.

"MCA wouldn't be the organization it is today without strategic alliances, particularly our alliance with Advanta Mortgage," says Wells. "Even though MCA is a sophisticated organization, Advanta's partnership has been immeasurable to our success, particularly in our nonconforming business. Advanta helped enable us to grow our business to the level we wanted. For any originator, I believe strategic alliances are absolutely essential to growing a business."

MCA is a full-service mortgage banking enterprise. The organization, located in Southfield, Michigan, was incorporated in 1985 and has 60 branches (44 retail, 16 wholesale) from coast to coast. MCA began in the conforming loan industry, but today nearly half its business is in nonconforming loans.

"We've made a concerted effort to reposition our capital into nonconforming product," says Wells. "One of the ways we have been.able to do this is through our partnership with Advanta and taking part in Advanta's piggyback securitization program." Through Advanta's piggyback securitization, originators participate in securitizations without having to have the capital to do their own securitization program.

For Pennington, the piggyback securitization program was also key for his company's growth.

"A couple of years ago we were hearing of all the people in our industry doing securitizations on Wall Street," says Pennington. "At that time, to do a securitization on Wall Street was a minimum of $100 million. I didn't have the assets to pull together $100 million worth of loans. As time went on that $100 million changed to $500 million and there was no way I could do that. One of the relationships we had established was with Advanta, and we were able to take part in their piggyback securitization. Our first security with Advanta was for approximately $6 million. The securitization that we closed in the second quarter had $75 million to $80 million in it. That's where we have evolved over time."

Pennington also points to his company's partnership with Advanta for loan servicing and how that has helped develop the business. "We recently got a report on a security that has $120 million of our product in it, and I'm now able to show people what our servicing is, what our delinquency rate is and what our loan-to-value ratings are. They have these sophisticated systems that I don't have. Access to that gives us the detailed data that we need. I'm involved in a transaction right now in the $1.2 billion range, and it wasn't that long ago that our company couldn't play in that ballpark. Our strategic alliances enabled us to grow to this level," he says.

While both Pennington and Wells agree strategic partnerships are essential, both say it's critical for organizations to carefully select those partnerships.

"Alliances create a lot of value for both organizations," says Wells. "There's new intellectual value created out of an alliance, and I think it's important to be able to protect that or keep it within as small a realm as possible. If it becomes a generic thing, then you don't have a strategic advantage with your partnership. Even though Advanta has a lot of different partners, the way they put the partnerships together makes it unique for all their partners. That's been very important to me and MCA."

Pennington says the individuals worked with on a day-to-day basis are critical to the partnerships.

"You need to be able to call up and say, 'Hey, I need some help here,' and they respond," he says. "The companies I've done business with who didn't respond in that manner, I don't do business with any longer. It's not that I outgrew them, I just can't do business that way."

Whether you view your business as a seedling, sapling or mighty oak, a strategic alliance can help ensure you thrive today and flourish tomorrow.

Mark Casale is senior vice president of corporate finance for Advanta Mortgage Corporation in Fort Washington, Pennsylvania. [Advanta is a highly focused financial services company with 2,600 employees, approximately $11 billion in managed assets and an additional $7.6 billion in assets serviced for third parties. Advanta provides consumers and small businesses with innovative products and services, including mortgages, equipment leases, business credit cards, insurance and deposit products. The company also provides a full range of loan purchasing, contract servicing and securitization services to the mortgage industry.] Lee Wells is president of Mortgage Corporation of America, in Southfield, Michigan. Paul Pennington is CEO of Goodrich & Pennington, in Rohnert Park, California.