Guy Ercolani has never been accused of timidity. As the No. 2 broker for the largest institutional note investor of his day, Guy has informed opinions about the note business, and he isn’t afraid to share them. He cares about where the industry is going, and as a senior figure in it, his opinions carry a lot of weight. W. J. Mencarow interviewed him.
Getting started in the note business
Q: How did you get started in the note business, Guy?
I have a background as a tax accountant. In 1989 I took a home study course from the Jefferson Institute, which is no longer in business. I started in 1990 working with just my wife, Sue. Without her mental and physical support we would not be here. She has helped make all the major decisions of the company, as well as the very minor tasks involved in running the business. She is truly my best friend.
At the time of this interview, six people worked for us: three brokers including me, two full-time support staff and one part-time. Metropolitan had recognized us as its second-largest broker two years in a row, and the previous year we did approximately $14.5 million in volume.
Q: The vast majority of people who take those kinds of classes don’t make it in the note business. What makes you different?
I had about two years’ worth of living expenses put aside at the time. Most people don’t save enough to cover their overhead while they climb the learning curve. If someone wants to go full-time right from the start, which I would strongly discourage, they should have enough saved to cover a year of living expenses: food, car payments, mortgage payments, everything. Many if not most people fail because they’re worried about keeping the lights on. They just don’t have the resources, and they have to quit before they make it.
My advice to anyone just starting out: don’t quit your day job. Most people are lured into this business by “Make $10,000 a Month Part-Time!” ads and the like. That’s just not realistic.
Direct mail versus networking
Q: You do a lot of mailings to find notes, don’t you?
Yes. Direct mail is responsible for about 60% of the deals we close. We send out between 12,000 and 15,000 pieces of mail a week, right out of our own office. We spend $2,000 a week on postage alone, not counting other advertising. I’ve been collecting names of note holders ever since I started, and our database now holds over 400,000 names. Two of our employees spend all their time preparing mailings and keeping the database current.
When I first started, I was getting a 2.75% to 3% response rate. That’s responses, not deals closed. Now if it’s three-quarters of a percent, I’d be surprised.
Someone starting out should never depend on direct mail to find note holders. Every time I say that, people think I’m saying it so they won’t compete with me. That is absolutely not true. In all honesty, it is not a good way to start, and it should never be your only way to find business.
Q: OK, what should they do?
Stick to your local county. If you want to dig up names to mail to, fine, but make it a secondary item. Focus on networking with real estate professionals, mortgage brokers and others who can refer notes to you.
Q: What about a broker who is already in business? Is direct mail a good addition to their other marketing?
It could work, but it’s expensive. If someone spent, say, $300 a week on postage, it might bring in an extra one or two deals a month.
Q: You said direct mail brings in about 60% of your business. Where does the rest come from?
The other 40% comes from networking, particularly with mortgage brokers and loan originators we have built relationships with over the years.
In our county and the ones around us, we get the discounted notes from almost every traditional mortgage broker. That’s because we make sure they never get cut out of a deal. It works because they don’t have the resources we have to sell a private mortgage at a competitive price, and we don’t have the resources they have to do originations. We are also one of the few discounted mortgage brokers licensed as a traditional mortgage broker.
Building credibility with mortgage brokers and sellers
Q: If someone wants to develop contacts with mortgage brokers for note referrals, as you have, how should they approach them?
Traditional mortgage brokers like working with other licensed brokers. In fact, many of them won’t deal with unlicensed brokers. So my advice is to get a state mortgage broker’s license. It gives you credibility with the mortgage origination community and with many of your clients. I can’t tell you how many people ask us, “Are you a legitimate business? Are you licensed?”
I’m a member of the National Association of Mortgage Brokers and can use their logo in my advertising, and that does help establish credibility. I think brokers should join their local or state chapter. If nothing else, it’s a great networking opportunity, and it gives you credibility with the traditional mortgage brokers who can refer notes to you.
Q: One of the major problems we face is legitimacy. It doesn’t help when one of the companies that lures people into the business, and sells them a $6,000 seminar, advertises that you can run your note business “out of your car.”
Credibility has been one of the biggest issues in our industry. We have our fair share of, shall we say, less than scrupulous brokers: people who will tell a note holder anything to get the deal in the door. And we’re seeing more and more of that.
In our early years we lost a fair number of deals to small brokers who worked out of their homes and maybe made $500 to $800 on a transaction. That’s OK; it’s part of being in business. Now we’re seeing not just small brokers but larger, well-known brokers promising note holders things they cannot deliver. They tell sellers what they want to hear to get the deal under contract, and just before it closes they say they can’t do what they promised. There’s even a name for it: taking somebody “to the cliff.”
We never, ever quote a deal we don’t think we can get done the way we say. Many times we’ve had to disqualify a deal because of a bad appraisal or surprises in the property or paperwork, but never because we changed our minds about what we were willing to do. And it is never done at the closing table. I wouldn’t do business that way.
Q: Are you also worried about referral sources and note holders going around you and selling directly to the investors?
That was a worry when we first started. We learned to deal with it by buying the deals in our own name, in many cases now with our own money. If you do get burned on a deal, you never do business with that person again.
We’ve never signed, or asked traditional mortgage brokers to sign, a non-compete or non-circumvention agreement. More sellers have done us in than other brokers.
Will investors go direct to note holders?
Q: Are you concerned about investors going directly to note holders and cutting out the brokers?
Yes. I’m concerned that over the next few years the major players will want to do that more and more. Their margins are tightening because larger, higher-volume brokers are putting price pressure on them. I believe they see going direct to sellers as one way to make up revenue lost to price concessions.
Q: Does it make economic sense for most investors? A few, mainly structured settlement investors, run TV ads aimed at note holders. But for years the big mortgage investors have told us it isn’t cost-effective to buy notes directly, and that it makes more sense to let brokers do the handholding, due diligence and all the other work of dealing with the public.
It’s true they’ve always said that, but some may conclude that going direct is the way to increase profits. It may not be Metro or The Associates, but some may be tempted to go after that direct business again, even though about 10 years earlier Metro stopped going direct because of all the wasted time and money. Many investors have learned it’s easier to have 50 top brokers bringing in 80% of your business than to go direct to 15,000 note holders.
Remember, brokers pay for all the advertising, absorb the losses when sellers back out, take all the ridiculous phone calls, do the handholding and run after all the documents. We do the dirty work to bring a clean transaction to the investor. I don’t begrudge that at all; taking on those tasks has been very lucrative for us.
Another reason some investors may advertise directly to note holders is that large brokers are moving from being brokers to becoming investors in their own right. Large brokers have been learning about securitization and pooling. Investors have to realize that if large brokers can pool notes and get credit lines on their own, the investors may not be needed as much in the future.
Q: So one possible future is a few investors working only with brokers, some buying from both brokers and note sellers, and today’s large brokers becoming smaller investors in their own right.
Yes, absolutely. Mortgage originations have a wholesale and a retail level. There’s no reason our industry couldn’t go the same way, though I think that may be a mistake.
The risks of note-buying credit lines
Q: A relatively new product many brokers are getting is a line of credit that lets them buy notes in their own name. Several note investors offer it. How do you see this changing the business?
With my tax accounting background, I’ve been looking at this for some time. I’ve added up the figures every possible way, and frankly, it’s very hard to see how these programs can be profitable for brokers who use the credit line to keep all the notes in-house.
What’s happening is that larger brokers use the credit lines to help them pool loans in the $500,000 to $1 million range. There the credit line can be profitable, because it’s their source of cash. They keep an interest in the notes, pool them and sell them off.
There’s no problem with that, but being good brokers doesn’t make us good underwriters. We know how to package a deal and send it to an investor. We make our money and it’s gone. If the note defaults, you never hear about it. But if you own those loans on your credit line, you are responsible for the foreclosure costs and for the money owed on the line. Your liability is both business and personal. It’s always dangerous to go into a business you aren’t used to, in this case loan underwriting.
Things happen to loans that you can’t even anticipate. We’ve seen deals that were A quality when we submitted them default six months after we sent them to the lender. How many large brokers can afford to buy that back, cure the default, foreclose or do whatever it takes?
Things look sweet when the economy is good, rates are low and everyone is hyped up. But what happens when you’re holding a pool of loans, interest rates start rising and the cost of funds on your credit line goes up? And what happens if some of those loans can no longer be sold conventionally because they’ve gone into default?
I’ve worried that we might see one of the major brokers with a credit line start to falter. We haven’t, or at least haven’t heard of it. At the time of this interview I had been approved for credit lines but had no hands-on experience with them yet.
Where the industry is heading
Q: So where do you see this industry going?
I think we’ll see more consolidation among large investors, through partnerships, mergers and outright sales of firms to holding companies.
There is plenty of business to go around, more being created than we ever thought possible. If someone wants to get into the business, they shouldn’t be afraid of competition. There is plenty of it, but if you’re afraid of competition, you can’t get into any business. You’re not in a desert selling water. You’re in a business with tons of Realtors, mortgage brokers and bankers who touch our industry every single day. Over the past decade it has become more and more common for people to sell their notes, and the large brokers, at least, have gotten better at digging those notes out.
The other side of the coin is that as people realize they can sell their note, they also realize there are many potential buyers. Sellers shop these deals to death, trying to squeeze out every last dime. It’s harder for a large broker to do a deal for a very low profit than it is for a small broker.
Twenty to 25 years before this interview, you could make 18 points on a deal. Now if you get 5 points, 5%, you’re doing well.
Q: If you had one lesson to teach new brokers, what would it be?
Don’t try to retire from one deal. Make enough to cover your overhead and some profit, then move on to the next one. Don’t gouge the customers.
Q: If they do, they won’t get the deals.
Yes, but sometimes they do get those deals. One of the biggest problems is students coming out of the so-called “training centers.” They poison the waters, Bill. They don’t have the knowledge to sell these deals. They overpromise and underdeliver. The broker didn’t do the deal at the price he said he would, so the seller now has a bad attitude. When he gets a card, a letter or a phone call from you, the legitimate broker, he doesn’t want to do the transaction because he doesn’t believe you can deliver.
Negotiating by phone and the ethics gap
Q: You do business all over the country, so almost all your negotiating is by phone. What’s your advice for negotiating successfully over the telephone?
You have to earn credibility with note sellers over the phone, and that’s very difficult to do sincerely. I believe people should do business locally, at least at the beginning. It’s far better to meet note sellers face to face. You build credibility far better and faster sitting with them in their living room or your office, speaking and looking professional. That can make up for not having the size or the pricing of a large broker. You make it up in service.
When you’re a large broker, you can bring deals in the door without meeting face to face. We can offer note holders very quick closings because we have title company relationships all over the country, we have our own money to buy deals, and we have the knowledge and experience to know we can deliver when we say we can. A smaller broker may not have those advantages, so they have to make it up with personal service and face-to-face sincerity.
And I mean sincerity. Our industry is short on people who are sincere in their convictions and who will deal at the price quoted. There is so much bait-and-switch going on: brokers who promise to pay 135% of the balance for notes, offer to buy the note in installments, send out multi-page contracts with huge penalties for all sorts of things, and worse. I’ve seen contracts where the promised installments aren’t even mentioned.
Q: In my opinion, most of what is taught as “negotiation” is simply how to lie and manipulate people.
I agree with you 100%. You used to think, “Well, those people won’t stay in business long,” but guess what: some of them are still out there.
People are lured into this industry by promises of big dollars. Ask anyone why they signed up for one of these expensive courses, and they’ll say they were told they could make $10,000 a month part-time. You know as well as I do that’s impossible. I’m not even sure you can be a part-time broker anymore. I think it would be hard to work a full-time job and be a part-time note broker.
I don’t want to sound negative, and I’m not. I’m not afraid of competition, and I think there’s plenty of business to go around. I just think we have to find a way to grow these people into ethical businesspeople. Realtors and licensed mortgage brokers have codes of ethics they must follow. Our industry lacks that, and even if we had one, there’s no enforcement. There’s no one to pull your license or your membership in a national association.
That’s another reason I think note brokers should become licensed mortgage brokers and join their local mortgage brokers association. We are, and we have to abide by the law and by the National Association of Mortgage Brokers’ code of ethics and rules.
It’s one of the glaring weaknesses of our industry. We don’t have a code of ethics, and we wouldn’t have enforcement if we did. If someone has a complaint about a note broker, there’s nobody to turn to unless there’s a gross violation of the law. But we are getting larger, and if there are enough complaints, the government will force regulation on us.
