The online commercial lending industry has found its niche — and so far it is just that, a niche — not a revolution. The vision of vast online commercial-lending markets, on which many dot-coms were founded, has faded, at least for now. But the technology companies that survive are finding a viable role by creating software for traditional mortgage lenders.
According to a recent survey by the Mortgage Bankers Association of America (MBA), a mere 2% of the $200 billion in commercial mortgage transactions last year originated online. Most activity in online commercial lending now comes from “Web enablers,” companies that offer tools to help mortgage firms utilize the Internet, the organization says.
Initially, mortgage dot-coms evolved at an incredible pace, promising to “disintermediate” the middleman — commercial mortgage bankers and— from the loan origination process. “The entire loan origination segment gained far more momentum than any other back-office segment” serving the online real estate industry — including lease administration and tenant service systems, says Joe Rubin, director of financial institutions for Ernst & Young's New York-based real estate advisory services group.
Still, that modest success has not been enough to sustain the many companies created to bring the mortgage business into the 21st century with real-time systems that have become standard in other parts of financial services.
Mortgage Lending's e-Potential
One of the most prominent survivors is San Francisco-based LoopNet, founded by co-chairman Dennis DeAndre in 1995. He was inspired to create the company while trading multifamily and retail properties. In one of his last, DeAndre received two houses as his commission. Looking to cash in these assets, he was introduced to a residential multiple listing service. “I was floored by its efficiency,” he says. “It wasn't only the most valuable channel for searching for properties, it was the only one.”
DeAndre founded LoopNet to provide a similar venue for commercial real estate. “There wasn't a lot happening on the Internet back then,” DeAndre recalls. “Starting a listing service is really interesting. The system is of no value for advertisers until it reaches a critical mass. But when it starts to catch on, it really takes off.” By his account, the site's revenue has not declined since its inception.
In 1999, LoopNet spun off its LoopLender, which brokers requests for commercial property loans from the listing service's clients. Most come from borrowers, whose information is packaged by LoopLender and then submitted to 35 lenders for soft quotes, negotiation and closing. While the venture capital-backed site charges a subscription fee, fees paid at closing determine whether LoopLender makes a profit.
“Our expertise is not necessarily deep back-end underwriting services but rather bringing in loan value,” DeAndre points out. “The fact is that mortgage brokers and mortgage bankers bring in the lion's share of the loan application volume in this country. Our goal was to be one of those people.”
The Disintermediation Tightrope
Perhaps that understanding of the role — and power — of brokers saved LoopNet from the mistakes of other startups. At about the same time as LoopLender's launch, dot-coms like RedBricks and MortgageSelector were promising to revolutionize mortgage banking by eliminating brokers. Their goal was for borrowers to fill in standardized electronic forms that were communicated directly to lenders for underwriting.
While commercial mortgage origination suffers from inefficiencies, this was the wrong place to look for them, says Daniel Szparaga, a director of MBA. “Mortgage bankers are not the source of the problem,” he says. “They do a lot of stuff for a fair price based on the market.” Moreover, he says, attempts to “disintermediate” the mortgage banker failed because the systems couldn't replicate the nuances of loan origination or capture the complexities of the commercial lending market.
Heather Shively, CEO of New York-based CapitalThinking, agrees. “Given the subjective nature of mortgage finance, there's a lot of qualitative decision-making done in the process,” she says. “It's never going to be pure Web. It's very much touch, look, feel.”
Shively knows about those pitfalls. CapitalThinking was launched in April 2000 to generate loan volume directly between the borrower and the lender. Although the site processed $70 million in transactions between April and September 2000, it shut down in September 2000 to reassess its strategy.
“Our core competency was our engineering talent, and that's where the demand was coming from,” Shively says. “The conclusion was to focus 100% on software development.” CapitalThinking has since created the Web-based bluewire system aimed at eliminating redundancies between loan request and closing.
With bluewire, Shively says, originators don't relinquish their underwriting secrets. Instead, they plug in their Excel spreadsheets to the platform, which accommodates their standards of calculation. “Our clients still control the way they look at the market,” she says. “They retain all of that intellectual capital.”
The bluewire platform is customized for each client and allows users to view task lists on a deal-by-deal basis. A software license is priced according to the scale of the client and the depth of the custom solution, or customers pay a monthly fee to host the system at CapitalThinking's data centers.
As a mortgage origination tool, Shively says bluewire is catching on in ways CapitalThinking's previous incarnation could not. For example, Stamford, Conn.-based GE Capital Real Estate chose bluewire to process its $18 billion portfolio. The software allows GE to store documentation for complex deals, as well as expedite the workflow process.
Head of Class, Back of Office
Other technology companies are following a similar path to the back office. “The Web is a process enabler, it's not a people replacer,” Rubin says. “When you talk about the savings from some of these applications, we're less focused on firing people and far more focused on making those same people a lot more productive.”
For example, these products accommodate different underwriting protocols, converting reams of data into an electronic format accessible by all parties.
Replacing paper is the goal of Birmingham, Mich.-based e-Cognita Technologies, which concentrates on streamlining the legal documentation of loan transactions. Focused on back-office functions from its start in 1998, the firm avoided the problems of other over-ambitious startups. Co-founder Dan Bober was a lender, while co-founders Jim Simpson and CEO Katheryne Zelenock were attorneys. “We recognized the pains that were a part of the process,” Zelenock says.
e-Cognita developed Streamloaner to facilitate the closing process. “We're trying to close loans in the traditional way, but better, faster, cheaper,” Zelenock says. The firm's first task was to create a common data platform. “Lenders complain because they're re-entering information. Lawyers complain because they're receiving inconsistent or incoherent messages. Getting people on the same page is huge.”
Streamloaner processes 300 loans in the time it takes to close 200 loans manually, she adds, and the one-time license fee can range from $125,000 for a small firm to $1 million for large lenders. Zelenock says that the privately held company will attain profitability by the end of this year.
Similarly, MortgageRamp developed its DealCentral product, which concentrates on the original loan query, rather than underwriting. MortgageRamp costs only $100 per month for each user.
According to Mike Greco, president and CEO of the Davidson, N.C., offshoot of GMAC Commercial Mortgage, it also provides a national network of ancillary services. “We can download to the vendor immediately when and where he needs to go, because it's already in our database,” he explains.
Greco also differentiates Mortgage-Ramp from CapitalThinking, which he says focuses on customized solutions. “We have that capability if that's what you want, but we are a product for the masses, like Wal-Mart,” he says. “There are hundreds of thousands of potential customers throughout the industry,” Greco emphasizes. “The key is volume.”
Origination à la eBay
While some players have retreated to the back office, there are still efforts to create online markets for parts of the commercial lending business. For example, Melville, N.Y.-based Precept Corp., founded by former Nomura banker Frank Scavone, launched an online origination auction in fourth-quarter 2001.
The concept is similar to that of the online auction service eBay. Precept analyzes and underwrites loans upfront, then multiple lenders bid on the opportunity online. The borrower then selects the winning bid. The catch is that borrowers commit to a full underwriting by Precept even before the auction begins, and lenders also must accept Precept's underwriting standards, co-authored by partners such as Standard & Poor's, Morgan Stanley and Salomon Smith Barney.
Precept's goal is to streamline the infrastructure and cost of the origination process. “It costs a lender about 125 basis points to maintain an origination platform,” Precept CEO Frank Scavone reasons. “A good amount of cost has to do with going through deals they don't win.”
According to Scavone, the benefit is that Precept reverses the transaction sequence and performs all the real estate analysis up front, reducing the time lenders spend making a decision from 50 hours to one and a half. Consequently, the cost of origination also is reduced, a savings that filters down to the borrower.
So far, the Precept site has closed $85 million in loans, which Scavone says has come from mortgage bankers. In other words, the banks that funded Precept are its biggest customers. For example, Cohen Financial, a minor investor in Precept, has a symbiotic relationship with the lending site. “We have been trying to funnel a certain amount of our origination activity to Precept to help them evolve,” says CEO Jack Cohen.
While the notion of overnight “disintermediation” of mortgage origination has faded, the drive for efficiency has not.
For example, the MBA's Mortgage Industry Standards and Maintenance Organization (MISMO) is laying the foundation for a programming language that will speed communications among the various parties of a loan. “It is an agreement among business partners to use specific styles and definitions when exchanging information,” Szparaga says.
For now, the industry is tracking the progress of surviving dot-coms as they attack inefficiencies in the business. The greater their success in cutting costs, says Rubin, the greater the push for more automation. “The whole industry is waiting for testimonials from the pioneer customers, so I think you can still see a stampede toward these kinds of applications,” he says. “Hopefully, it will be this year.”
Contributing Editor David Sokol is a New York-based writer.