Mortgage bankers report they continue to struggle to find sufficient warehouse lines even as some observers say the worst of the credit drought seems to be over and supply may be approaching demand. Nevertheless, warehouse capacity is down substantially from its peak.
Mortgage Banking
February 2010
Robert Stowe England
Warehouse lending – the essential lifeblood of mortgage originations – began to shrink in the summer of 2007 as the mortgage market began to enter a meltdown.
The decline in warehouse lending started small in 2007. At first, lines were cut back or canceled for subprime and alternative-A lenders.
Then the pullback of lines began to be more ominous. In March 2008, for example, Citigroup’s CitiMortgage Inc., based in O’Fallon, Missouri, reeling from billions in write-downs on subprime mortgages, announced it was shutting down its warehouse lending division--First Collateral Services, Concord, California, a major independent player.
The pace of departures took off after Lehman Brothers’ collapse in September 2008 led to a widespread credit market freeze. Lehman Brothers was, in fact, a major warehouse lender. One by one, the Wall Street firms and some big banks that were providing warehouse lines began to get out, including Deutsche Bank, UBS AG and ABN AMRO Bank NV.
The mass exodus of warehouse lenders led to the collapse of many well-run, well-capitalized independent mortgage bankers, which simply could not conduct business without warehouse lines. Mortgage companies “were dropping like flies,” recalls John Johnson, president and chief executive officer of MortgageAmerica Inc., an independent mortgage banker based in Birmingham, Alabama.
During 2009, the three largest remaining warehouse lenders either exited the business or sharply curtailed their lending, leading to the low point for warehouse credit roughly one year ago.
In March 2009, former No. 2 warehouse lender National City Corporation, Cleveland Ohio, which had been acquired by PNC Financial Services Group Inc., Pittsburgh, announced in it was leaving the business entirely. National City had agreed or committed to $2.2 billion in warehouse lines to non-bank mortgage firms at the beginning of 2009.
Former No. 3 warehouse lender Guaranty Bank, Dallas, which had $1.84 billion in commitments to mortgage bankers at the time, told its customers in March 2009 that it would exit the business when current warehouse lines expired. (Guaranty Financial Group, the parent of Guaranty Bank, filed for Chapter 11 bankruptcy protection in August 2009.)
In August 2009, the largest remaining warehouse lender, Colonial BancGroup Inc., Birmingham, Alabama, was shut down by the Federal Deposit Insurance Corporation (FDIC) and its assets acquired by BB&T Corporation, Winston-Salem, North Carolina. BB&T is discontinuing all warehouse lending outside its retail footprint, according to BB&T Chief Executive Officer Kelly King, who in October 2009 named Jeff Ellison president of the warehouse lending division.
From 120 lenders in September 2008, the number of warehouse-line providers fell a stunning 83 percent to just 20 lenders by March 2009, according to Stanley Street, president of Street Resource Group, an Atlanta-based firm that provides consulting and computer software to small and mid-tier warehouse lenders.
Total commitments to by warehouse lenders to mortgage bankers plummeted from a high of $2.25 trillion in 2006 to $340 billion in 2009, according to The Reynolds Group in Summit, N.J.
“There was definitely a crisis,” recalls Tamara King, director of loan production for the Mortgage Bankers Association (MBA). “I think the good news is that warehouse lending is not as bad as it was last spring. Over the last few months there have been new parties interested in the warehouse lending space. So, that has improved the situation for our members.”
Warehouse crisis sends shock through system
The sharp decline in warehouse lenders and warehouse finance has been a shock to the mortgage banking system that pushed many independent mortgage bankers out business and sent others scrambling to find money to fund loans in the pipeline. That put a crimp on the ability of the mortgage industry to meet potential demand for home loans.
It also reshaped the contours of the industry, determining who could originate and who could not, forcing mortgage bankers to rethink their business strategies. It also restricted the scope of mortgage products that could obtain warehouse financing to basically government-related loan products tied to Fannie Mae, Freddie Mac and the Federal Housing Administration (FHA).
The decline in warehouse lending also led to an even further concentration of the industry into the hands of still fewer players. According to Inside Mortgage Finance, the top 10 originators accounted for $1.04 trillion or 74 percent of a total $1.405 trillion mortgage originations for the first nine months of 2009.
The top five--Wells Fargo Home Mortgage, Des Moines, Iowa; Bank of America Home Loans, Calabasas, California; Chase Home Finance, Iselin, New Jersey; CitiMortgage; and GMAC Mortgage, Horsham, Pennsylvania--accounted for $869 billion or 62 percent of total originations in the first nine months of last year.
A life or death matter
The loss of a warehouse line is no small matter for mortgage bankers, many of which keep several lines, including backup lines, so they can be sure they can temporarily warehouse their loans.
“Warehouse lenders--they decide whether you live or die,” explains Brian Koss, managing director at Mortgage Network Inc., an independent mortgage banker based in Danvers, Massachusetts.
The collapse of warehouse lending has also been accompanied by a collapse in the number of end investors. The investor market, for its part, has contracted dramatically during the last two years. In 2005, there was a base of more than 600 institutional investors purchasing warehouse-financed loans. By the next year, that number had dropped to about 200. By September 2007, according to Street Resource Group’s research, some 40 percent of all production volume was flowing through 10 investors, with 60 percent through just six of the largest investors.
At year-end 2009, 50 percent of deliveries for investors other than government-direct (Fannie Mae, Freddie Mac and Ginnie Mae) went to the top three: Bank of America, Chase and Wells Fargo. If you add in two more investors, the top 75 percent for investors other than government-direct were to Bank of America, Chase, Wells Fargo, Citi and GMAC/Ally Bank.
Since the crash of warehouse lending, players that have remained in the business of warehouse lending have increased their lines to surviving, well-capitalized mortgage bankers, while more lenders have joined or rejoined the ranks of warehouse lenders.
Some warehouse lenders contend there is now no longer a shortage of warehouse funds, because they are able to extend their lines to meet the needs of mortgage bankers.
However, other mortgage bankers would beg to differ with the notion that there is adequate supply. “If you talk to [borrowers],” Street says, “they say they are not able to fund refinance loans right now.” He adds, “Mortgage bankers are having to delay closings because of the unavailability of funds.”
Still a shortage?
So is there, in fact, still a shortage of warehouse lines? Opinions vary. For example, while Street concluded there was definitely a “true deficit of supply” as recently as early November, he now believes that the supply and demand have roughly equalized, as a result of a decline in demand based on steadily lower estimates of origination volume for 2010.
Street calculates warehouse demand at 40 percent of $1.5 trillion projected origination volume for the year – or $600 billion. Meanwhile, Street estimates that current commitments for warehouse lines by providers are worth $325-$350 billion. However, given the increased frequency with which warehouse lenders have been able to turn their lines, this commitment can meet a demand for $600 billion in mortgage originations.
Even though supply and demand may be moving into balance, the players may continue to change, according to Street. “I believe that the regional and community commercial banks will still gain in market share of the overall warehouse supply chain, but that commitments are being ‘laterally displaced’ from existing warehouse lenders to new entrants into the warehouse lending space,” Street says. This will “reduce supplier-side risk in general, and [more specifically] from the fallout from BB&T and NatCity in particular, rather than being driven from creating new overall capacity,” Street adds.
Street calculates that there has been an increase in the number of warehouse lenders from a low of 20 a year ago to about 30 to 35 warehouse lenders today--exclusive of community banks that have entered the warehouse lending business, he adds.
Yet, others still expect there to be a shortage of warehouse lines. By his own “conservative estimate,” Jim Reynolds, founder and managing partner of the Reynolds Group, Summit, New Jersey, estimates that, even under a conservative scenario, the undersupply of warehouse lines is likely to be $235 billion, based on the expectation that mortgage originations requiring warehouse lines could rise significantly above 40 percent overall originations. Reynolds’ firm conducts due-diligence work on mortgage banker clients for warehouse lender companies.
Based on a survey of warehouse lenders by Reynolds, under the most conservative of three scenarios, demand for warehouse lines in 2010 will be $570 billion, while current warehouse lending capacity is only $340 billion.
The shortfall will be greatest for small cap mortgage bankers because they are likely to see the greatest gains in mortgage origination volume. “The bottom line is that their needs are not being met,” Reynolds says, “which is not good for the country because they serve a very important purpose. By growing their origination capability, the small cap mortgage bankers reduce the degree of concentration of the industry in the hands of a few players, he argues.
Other observers of the warehouse lending market agree that there is still a shortage of warehouse lines. “As many of my discussions with warehouse lending executives indicate, while volume of applications has been sustained and recruiting capital to increase capacity is easier, they are turning down 4:5 applications, so the issue isn’t liquidity as much as the tightened credit standards and requirements for a line,” according to Mary Kladde, chief executive officer of Titan Lending Corporation, in Denver, one of the companies that provides back-office support for mortgage bankers and, since March 2009, has provided a mortgage warehouse lending services platform for community banks.
“We are really seeing compression in the market. The small cap market has almost no remedy,” Kladde says and it is “unlikely that they are going to see it again anytime soon,” she says.
“As I put to my customers, you have to be flawless or have some massive compensating factors to entice a warehouse lender. We have had clients turned down for a bankruptcy that happened 25 years ago,” she says. “If you have less than $500,000 net worth, there just isn’t anyone interested in stepping out “on faith” with you. If you have any foibles, skeletons, missteps – good luck, [mergers and acquisitions] may be your only course of action,” she adds.
A number of events could change the expectation for warehouse funding supply. For one thing, the Term Asset-Backed Loan Securities Facility (TALF) from the Federal Reserve is schedule to end its massive intervention in the mortgage market, after completing its $1.2 trillion in purchases of mortgage-backed securities (MBS).
The entry of the Fed through the TALF market has kept mortgage interest rates lower than they would be without such support. In fact, the announcement of the launching of the program prompted an immediate decline in mortgage rates and set off a refi wave that helped generate $1 trillion in originations in the first half of 2009.
When this component of the TALF program ends, interest rates are expected to rise, all else being equal. However, given that 2010 is an election year, Reynolds expects federal officials to do what they can to keep interest rates low or limit the degree to which they rise post-TALF. Reynolds admits his view may run counter to those of bank economists, but says his forecast is not based on market and economic factors, but is instead “based on a political equation.”
More wild cards could come from continued consolidation in the banking sector and actions by the Federal Housing Administration to remove some lenders from its approved-lender list. Removal of those lenders could have adverse impacts on the warehouse lenders that have been providing them funds, according to Reynolds.
In December 2009, FHA revoked the authority of Melville, New York-based Lend America (also known as Ideal Mortgage Bankers) to make loans insured by the FHA. In response, Lend America closed its loan-making operation and laid off most of its 600 workers. Warehouse lenders exposed to Lend America face potential losses on those lines.
Lend America was the first lender in the country to receive approval from the Department of Housing and Urban Development (HUD) to underwrite, close and insure HOPE for Homeowners loan transactions without prior HUD review. In May 2009, the lender launched a $500,000-a-month print and broadcast advertising campaign to promote HOPE for Homeowners.
Banking consolidation takes a toll
Earlier in 2009, bank takeovers had a decidedly negative impact on the availability of warehouse lines.
A decision to terminate the warehouse lines came from National City Corporation’s new owner, PNC Financial Services Group. PNC announced a deal to acquire National City in October 2008 for $5.58 billion shortly after the regional bank received approval for $7.7 billion in cash from the federal government under the newly enacted $700 billion Troubled Asset Relief Program (TARP).
A bit of good news came in May 2009 when JPMorgan Chase said it had decided not to exit the warehouse lending business completely. When the bank acquired Seattle-based Washington Mutual (WaMu) in 2008, it acquired WaMu’s warehouse business, which had 10 customers when JPMorgan Chase announced it was getting out of the business. A company spokesman told (ital) National Mortgage News (end) last year that JPMorgan Chase would continue providing warehouse lines “to a subset of these 10 customers.”
The next big blow to warehouse lending came when Colonial BancGroup failed in August and most of its assets were acquired by BB&T. Not only was Colonial the largest bank failure in 2009, with about $25 billion in assets, it was one of the largest warehouse lenders. At the time of its demise, it had an estimated 70 mortgage companies as clients, according to Stanley Street.
Earlier, in April 2009, Colonial BancGroup, suffering high loan default rates, signed away 75 percent control of the company to Ocala, Florida-based Taylor Bean & Whitaker, a mortgage banker, in return for a $300 million injection. However, the deal was called off in late July. The injection, it was hoped, would make it possible for Colonial to apply for TARP funds to boost its capital.
Unfortunately for Colonial, instead of a federal rescue there was a federal raid. On Aug. 4, Colonial’s mortgage warehouse lending division, based in Orlando, Florida, was raided by federal agents associated with the Special Inspector General for TARP. That same day, Taylor, Bean & Whitaker was also raided by the feds. Colonial said at the time it was facing a Department of Justice criminal investigation into “alleged accounting irregularities” in its mortgage warehouse lending division.
On the day of the raid of both companies, the FHA also suspended Taylor, Bean & Whitaker from originating and underwriting new FHA-insured mortgages. Ginnie Mae also defaulted and terminated Taylor, Bean & Whitaker as an issuer of its mortgage-backed securities.
Unlike PNC when it acquired National City, BB&T is not entirely leaving the warehouse lending business. It will continue to provide warehouse lines for lenders who are within BB&T’s retail banking footprint.
The decline in originations that occurred in the second half of 2009 may also be complicating the task of boosting the number of warehouse lenders, according to Paul Miller, an analyst at FBR Capital Markets, Arlington, Virginia.
Because housing demand is going to be weak, Miller argues, “We’re going to get less production--and this is feeding the lack of warehouse lines.”
Another reason warehouse lenders are holding back is that many of them are part of large banks that have their own mortgage origination arm, and “they don’t want to feed brokers to complete against them” for the potential customers for mortgages that are provided in the current weak housing market.
Impact on smaller mortgage bankers
For Mortgage Network Inc., the collapse in warehouse lending forced the company to dramatically revise its origination and business strategies, according to Koss.
When warehouse lenders first announced they were heading for the exit in 2008, Mortgage Network was a $4 billion wholesale and retail prime lender licensed in 40 states. “Wall Street died and their lending power went away,” recalls Koss, who adds that this significantly reduced the amount of warehouse lending available to his company.
In addition, the warehouse lenders that Mortgage Network relies on began putting increased restrictions on the company’s warehouse lines of credit. “This put us in a position of more and more dropping out of the game,” Koss says.
At the same time, the lender saw that it was being adversely selected on the third-party originator side on the loans coming through the lender’s wholesale channel. “So, we made the tough decision to leave third-party [originations] and to shut down wholesale operations on Dec. 1, 2008, and put all our eggs into being a retail player,” Koss says.
Going from a $4 billion mix of 60/40 wholesale/retail, now Mortgage Network is 100 percent concentrated on producing $2 billion in retail originations in 12 states on the East Coast.
The company’s experience is, in fact, being replicated across the country by other small independent lenders, according to both Street and Reynolds.
Koss sees some improvement from the conditions that prevailed in the spring of 2009, when the company was down to one warehouse lender and he feared the company would have no warehouse lines. He says that by the fall of 2009 the outlook had improved as major banks began to have talks about the possibility of extending warehouse lines to Mortgage Network.
By January the outlook improved further when, Koss reports, Mortgage Network was in the process of arranging for a third lender to provide warehouse lines.
The banks with warehouse lines, for their part, have been setting down demands on how the business is to be run, Koss adds, including the fact that they refuse to take any third-party originated loans. However, he reports, as Mortgage Network has been able to expand its providers beyond mortgage services to non-mortgage services, the conditions and warranties demanded by borrowers have been scaled back.
To do more with less, Mortgage Network has had to streamline its loan delivery system so that it can turn over the existing warehouse lines more frequently. With a faster delivery system, made possible by the firm’s proprietary information technology system, the current lines have been sufficient to allow Mortgage Network to increase its capacity from $1 billion to $2 billion in retail originations per year. An additional line could allow further expansion.
Encouraging signs
Koss also sees positive signs in the fact that a lot of the Wall Street firms that entered the warehouse lending business, and then left after Lehman’s collapse, have kept their warehouse lending capabilities “on mothballs” preserving some key people who ran those operations while temporarily redeploying them.
“They like the business because the profit margins are excellent” on government mortgage product from Fannie, Freddie and the FHA, according to Koss. “They already have the technology. They just have to turn it back on.”
The big names that are still in the business or that have come back to the business seem to be focused on providing warehouse lines for the larger mortgage bankers--those with a market cap of $25 million or more--essentially meeting the demand of these players, according to the Reynolds Group’s Reynolds. “The big players have come back into focus on the large caps, and they seem to be taking care of them pretty well,” he says.
Reynolds identifies at least three larger financial firms that are providing warehouse lines: Credit Suisse, Citigroup Global Markets and Wells Fargo. In addition, Reynolds says he has seen term sheets from Goldman Sachs Group Inc., New York. Bank of America has also been providing warehouse lines during these difficult times to its largest correspondent lenders, according to industry sources. Calls were placed and e-mails were sent to Wells Fargo, Bank of America, and Credit Suisse, and each declined to comment on warehouse lending. A spokesperson for CitiMortgage reports that they have not re-entered the warehouse lending business since leaving it at the end of 2008. However, Citigroup’s corporate banking division is engaged in warehouse lending, according to a spokesperson.
Koss thinks that a confluence of factors prompted more banks to get into or get back into warehouse lending, after the warehouse lending crisis “made it to Washington” at the end of the first quarter of 2009.
At that time, Freddie Mac and Fannie Mae indicated some interest in getting into the warehouse lending business. Banks realized, Koss suggests, that “they were about to lose their business to the government-sponsored enterprises [GSEs].”
Freddie Mac’s pilot program
Last year Freddie Mac launched a pilot program to “help some of our customers” get needed warehouse line liquidity, according to a company source. Freddie Mac is working through warehouse lender NattyMac LLC, St. Petersburg, Florida, which is owned by Guggenheim Partners LLC, which since June 2009 has been run by executive chairman Alan Schwartz, former chief executive officer of Bear Stearns.
Freddie Mac is pledging to purchase the mortgages that might be “left hanging on the mortgage line” provided by NattyMac if the two mortgage bankers in the pilot program should fail, according to Patricia McClung, vice president of offerings management.
While Freddie Mac has declined to identify the lenders that are participating in the pilot, warehouse lending consultant Reynolds identified one of the companies receiving warehouse lines from NattyMac--namely, Provident Mortgage Corporation, Libertyville, Illinois. Freddie Mac has indicated that the second company involved in the warehouse lending program is in the multifamily market.
While some observers believe Freddie Mac does not intend to expand its pilot program, a source at Freddie Mac says the GSE is “looking at other lenders and their needs,” but for the moment the program remains “still a pilot.”
“It is important to be aware that we are not a warehouse lender. We support our lenders’ ability to get warehouse lending,” says Freddie Mac’s McClung. Any future participating mortgage company would have to undergo a “rigorous approval process” and have multiple warehouse lines, she says.
Regulatory relief?
At the height of the warehouse lending crisis in March 2009, Mortgage Bankers Association President and Chief Executive Officer John A. Courson sent a letter seeking regulatory relief on capital standards for banks extending warehouse lines to facilitate more warehousing lending. The letter was sent to four key federal banking regulators: Federal Reserve Chairman Ben Bernanke, FDIC Chairman Sheila Bair, Comptroller of the Currency John Dugan and Office of Thrift Supervision (OTS) Acting Director Scott Polakoff.
Courson pointed out that for non-depository mortgage originators, the decline in warehouse lines capacity was 85 percent, falling from $200 billion in 2007 to approximately $20 billion to $25 billion in 2008.
In the letter, Courson recommended that the risk-based capital weighting be 50 percent for the portion of a warehouse line that is “dry-funded” and collateralized by loans conforming to Fannie Mae or Freddie Mac, FHA loans, Department of Veterans Affairs (VA) loans, U.S. Department of Agriculture (USDA) Rural Housing Service loans and FHA Home Equity Conversion Mortgages (HECMs). The dry-funded stage of the loan funding process is when the warehouse bank has the mortgage note and other collateral documents in its collateral vault.
The dry stage of warehousing funding follows the so-called wet-funded stage, which is designated “wet” because it refers to the ink not being dry on the closing documents. During that stage, the mortgage banker provides the warehouse lender with a Uniform Commercial Code (UCC) form that serves as collateral until the underlying collateral documents, including the mortgage note, are received by the warehouse lender from the closing table. In his letter, Courson did not recommend changing the 100 percent risk-based weighting for the wet stage of funding.
So far, the regulators have not indicated any willingness to change risk-based capital standards, as requested, and as prospects for the private market to provide more funding have improved, the outlook has dimmed for any regulatory intervention to incentivize more banks to do warehouse lending.
Warehouse lenders are adapting
Some warehouse lenders have been taking possession of loans temporarily in order to reduce the 100 percent risk-based weighting that goes with commercial lending. One such bank is Southwest Securities FSB, Dallas.
Southwest Securities has a $300 million warehouse lending capacity, which is seen by the bank as a “constrained resource,” according to David Frase, executive vice president at Southwest.
“This warehouse is a purchase facility,” explains Frase. “We own the loan while it is on the line,” an approach the lender has been taking since 2005. In fact, Frase says, most of the warehouse lenders that have remained in the business are those that temporarily purchase the mortgage.
Ownership of the loan while on the line has several advantages, according to Frase. For one thing, he says, “You get bankruptcy protection if the originator goes bankrupt.” The risk-based capital weighting is lower at 50 percent because the loan is classified as a residential loan for a one-to-four-family residence. In addition, Frase says, “The borrower is the customer, not the mortgage company”--which means that Southwest does underwriting for each loan on an individual basis.
By reviewing loans individually, Southwest avoided the problem of thinking it had pools of strictly prime loans but in actuality had a few subprime or low-doc loans in the pools.
Frase contends that there is no shortage of warehouse lines and that “demand has slackened” since the refi boom ended. Southwest has been adding new clients since June because its lines were not being used.
On June 30, 2009, at the tail end of the refi boom, Southwest had extended $295.8 million of its $300 million warehouse line. By Sept. 30, 2009, that had fallen to $208.3 million, according to Frase.
The typical client for Southwest is “on the smaller size,” says Frase--a mortgage banker who needs between $8 million and $15 million for its warehouse line.
Warehouse lenders and mortgage bankers have learned to work together to speed up turn-around times, according to Frase. In 2006, across the country warehouse lenders were provided $500 billion in warehouse funds. Now, there is only about $200 billion available. Warehouse lenders can, however, do more with that $200 billion today than they could in the past.
“In 2003, when there was a refi crush, we had turn times of 55 and 60 days. However, when we had a warehouse refi crush in 2009, the turn time was four or five days. That’s not even in the small ballpark” with the older, longer turnaround time, he says.
The process has also been made easier because virtually all of the origination is of “plain-vanilla agency” loans, making the product more standardized and one where it was easier to improve efficiencies. Frase agrees with claims by mortgage bankers that third-party brokers are being for
ced out of the industry as a result of tighter warehouse lines and the demands of lenders. “The quickest vanishing breed in the industry is the wholesale manager, the dinosaur of our era,” he says. Not that long ago, he says, “they were highly compensated people.”
Doing business with smaller lenders
Dealing with small-cap and mid-cap mortgage banking companies is different from the warehouse lending business done with large-cap mortgage companies, according to Frase. “It’s a lot more hands-on,” such as the individual file review. Plus, Southwest “maintains a high contact with customers, including frequent visits to customers,” he says.
Southwest also monitors the financial health of the take-out investors, the firms that take the loans once they leave warehousing. “Very few are delivering their loans direct to the agencies,” he says, referring to Fannie Mae, Freddie Mac and Ginnie Mae. Instead, they are delivering them to Chase Home Finance and Wells Fargo, for example.
Frase points out that the permanent investor wires funds directly to the title agent, and that proceeds back to the warehouse. Many of the permanent investors have exited in the last two years, making this an area of the business that requires constant vigilance by Southwest.
“You had to monitor that almost daily, whether to accept take-outs,” Frase says. This constant monitoring has allowed Southwest to build up a good track record in protecting originators from investors that might not be able to purchase the loans after they had made commitments, he adds.
Frase believes that the ability of warehouse lenders to improve their flexibility and work with mortgage bankers to speed up turnaround has allowed the private market to find a solution to the need for warehouse lines without intervention or assistance from the government in terms of regulatory changes or financial guarantees.
Frase says, “The typical warehouse lender says they have capacity and would not like to see the rules changed.”
He adds, “That’s what’s so great about mortgage banking. The industry adapts, adjusts and perseveres. It’s very creative.”
The impact on non-urban markets
Smaller communities were especially hard-hit by the collapse of warehouse lender Taylor, Bean & Whitaker, according to Street. Some of the commercial banks in smaller communities that were originating loans were selling them to Taylor, Bean & Whitaker, which had taken “a predominant share of the community business,” Street explains. “It was a blow to lending in smaller communities.”
Because many of the community banks that were selling to Taylor, Bean & Whitaker do not want to portfolio those mortgage loans, it creates an opportunity for independent mortgage bankers to expand their business into that niche, according to Street.
Once the investment banks decide they want re-enter the business as aggregators, they will be providing warehouse lines, Street predicts. “They have warehouse divisions to fund their correspondent or supplier network to ensure that they are the investor that buys the loan. It goes hand-in-hand,” he explains.
Both Street and Reynolds agree that being in the warehouse business is not a driving profit motive for Wall Street firms. Instead, it is viewed as part of their loan production business. Reynolds goes further, saying that this is a flawed strategy and a major reason why the Wall Street firms were unable to monitor loan underwriting--which is typically a function for warehouse lenders.
Flagstar seeing a surge in applications
Flagstar Bank, Troy, Michigan, a major mortgage banker and a warehouse lender, reports a surge in applications for its existing warehouse lending lines, which has remained pretty much at the same level of $425.8 million, according to Steve Brooks, executive vice president of wholesale lending at Flagstar, based in Jackson, Michigan. Flagstar has been in the warehouse lending business for 15 years. The lender does business with 1,500 correspondents and has 182 account executives.
Brooks agrees that increasing demand has led to tighter guidelines and restrictions on mortgage bankers with less competitive fees. “We believe in strong risk controls,” he says. “This allows us to know our customers a lot better.”
The warehouse lines feed into Flagstar’s mortgage business. Anything that is not a Flagstar loan, we’re still putting in through our engine, he says, where it is scored, collateral is checked and borrowers are screened for possible fraud.
Flagstar has not changed its fee structure a lot in response to growing demand, according to Brooks. Further, he says, Flagstar continues to have low London interbank offered rate-based (LIBOR-based) rates on its lines.
The role of community banks
In the past year, increasingly mortgage bankers have turned to community banks to provide warehouse lines.
To the extent independent mortgage bankers have success in getting warehouse lines, it will give them a chance to capture or regain more of the origination market from the big banks, according to Street. He estimates independent mortgage bankers are funding 20 percent to 30 percent of mortgage volume, while the big investors and big banks are funding 70 percent to 80 percent.
Independent mortgage bankers are also looking toward community banks because other warehouse lenders have tightened their requirements for mortgage bankers so much that some are unable to qualify, according to Street. For example, existing warehouse lenders are requiring an increase in tangible capital for mortgage bankers.
Indeed, MortgageAmerica’s Johnson reports he has been able to obtain warehouse lines because “we’re well capitalized.” Further, he adds, the company has “a long track record of success and reliability.” And, finally, he says, “We have a higher degree of liquidity in our own right than [does] the typical company our size.”
But there are limits to the role that community banks can play in helping to resolve the warehouse-lending problem. “There is counterparty risk on all sides,” Frase notes. “If you are getting into this business, you need to bring on veteran mortgage bankers with warehouse background to install the proper procedures.”
Things can go terribly wrong, such as what happened in August 2007 when the secondary market seized up. Loans that were in the warehouse at the time were suddenly worth 70 cents on the dollar.
Street divides the warehouse lending market into three tiers: the top institutional, Treasury-financed partner business, which is making loans to large mortgage production shops. The size of these warehouse lines run from $250 million to $500 million. The middle tier of the business is for warehouse lines of $25 million to $100 million to relatively well-capitalized successful mortgage banking companies. Street believes these two segments of the business are being adequately served by existing warehouse lenders.
Existing lenders can increase volumes for clients that lost major lines from Colonial and National City. “It’s easy to expand business for a company that is already your client rather than bring on a new independent mortgage banker. So, existing warehouse lenders are increasing their volumes by absorbing higher limits,” Street says.
The third tier of the business, however, faces some challenges. This tier, according to Street, comprises warehouse lines under $25 million extended to smaller, independent mortgage lenders that are not as well capitalized as those in the second tier.
Out in the cold
The cutback in warehouse lines, then, “leaves smaller independent bankers out in the cold in terms of being approved for new lines,” Street says. “Therefore, mortgage bankers are going to local community banks, with whom they may already have a banking relationship, and asking for a warehouse line,” he explains. In response to this demand, Street says he is seeing “increasing interest” from the commercial banking industry across the country in providing warehouse lending.
Community banks are requiring mortgage bankers to have a banking relationship with them and, in lieu of capital, they are requiring compensating balances on deposit. Those demands range from 5 percent of the warehouse lending commitment to a flat amount, such as $500,000 or $1 million. “What this does is add a layer of risk mitigation to the community bank,” Street explains. “Because it is a deposit relationship, it is not solely a credit relationship.”
Helping new entrants
One reason community banks are interested in warehouse lending is that it provides “an incredibly high yield and high fee-income base,” says Street. The return on equity is good compared with other commercial lending; it is secured by real estate mortgages; the duration is short-term--15 to 30 days; and there is a high rollover of funds, explains Street. Warehouse lending can also provide Community Reinvestment Act (CRA) benefits to commercial banks if they structure it as a purchase-sale agreement.
The biggest obstacle facing community banks that want to enter the business is frequently their own board of directors. Board members are often reluctant to approve this new line of business, according to Street. “When they hear the words ‘mortgage’ and ‘mortgage warehouse lending,’ typically their ears go deaf,” he says. “The challenge is to help educate boards of directors of banks as to the true nature of warehouse lending.”
To help community banks get into the business, efforts are under way to provide back-office operations for co-op warehouse lending, “so banks can be in this business and provide the credit, but the centralized operations provide the expertise,” he says.
“We believe that commercial banks have at least until 2011 to enter this business before Wall Street firms conveniently forget what happened and re-enter this business, as they do historically,” Street says.
As noted above, Titan Lending Corporation launched a new service in March 2009: a mortgage warehouse lending services platform for community banks. “We take a loan from the time it is underwritten all the way to the sale to end investor,” says Kladde, the firm’s chief executive officer. Titan does not do underwriting, but provides back-office support for the closing and financing of the loan from warehouse lender to investor, she explains.
Titan got involved with “the warehouse lending conversation” in late 2008, as the number of players began to shrink dramatically and mortgage bankers were scrambling for warehouse lines, according to Kladde. Late 2008 was the first time Titan was able to facilitate what Kladde calls a “buddy line” of $3.5 million to kick in at the end of the month when their mortgage banker client might need a little extra warehouse funding above and beyond the lines it has.
Titan has facilitated two private-equity lines for its clients. Further, Titan has been in conversation with several community banks as potential warehouse lenders, and expects them to enter the business in the next few months.
Profits and pricing
Reynolds, who advises warehouse lenders, sees the present “as the best time ever to be in the warehouse business.” For one thing, he says, those in the business presently are able to turn their lines more often because of increased demand for the lines (coupled with improved processes and technology). Typically, a warehouse lender can turn its line twice a month. If it’s a $100 million line, multiply that by 24 and the lender is lending out $2.4 billion a year. “The small banks [that are in the business] are making a fortune,” Reynolds says.
The return on investment (ROI) is normally 20 percent for the warehouse lending business, and “many times it can be as high as 40 percent,” Reynolds says. “It’s off the charts.”
The return on assets (ROA), which is the measurement used by banks to measure profitability, is 2 percent minimum, he says, with most of the banks in the business earning 3 percent ROA.
Reynolds contrasts the current ability to price warehouse lines to the situation that prevailed a few years ago, when big Wall Street firms were very active in the business. At that time, Wall Street firms were charging small-cap mortgage bankers LIBOR plus 1.5 percentage points. That gave small mortgage bankers the same pricing benefits that were available to big mortgage lenders. Wall Street firms were willing to offer favorable pricing because they were focused on the money to be made underwriting the mortgage bonds, according to Reynolds.
The gain in pricing power by remaining warehouse lenders is translating into lower margins for mortgage bankers and a wider spread between Treasury rates and mortgage rates than otherwise would be the case, according to Street. Reynolds explains why. “A big part of mortgage banking income has been the arbitrage” between the interest rate at which the mortgage banker can obtain funds for and the average coupon on mortgages provided to homeowners. For every day the loan is on a warehouse line, often the mortgage banker can make between 1 and 1.5 percentage points, according to Reynolds.
Now, however, warehouse lenders are charging LIBOR plus 2.5 percent to 4.5 percent. Some of the warehouse lenders have minimums and floors. In some cases, if mortgage bankers are not careful, they can end up with negative arbitrage, he warns. “That means from the minute I borrow from the warehouse lenders, it’s costing more to borrow than I can earn,” explains Reynolds.
While mortgage bankers may be losing some of their arbitrage with warehouse lines, they are, in turn, making up for it by raising mortgage rates higher to compensate, according to Reynolds.
As warehouse lending improves, it will help improve the arbitrage for mortgage bankers, making the business more attractive. No one, however, is even contemplating celebrating that potential outcome because it seems so far away at this point.
Instead, most independent mortgage bankers, such as Johnson at MortgageAmerica, are “all working hard at getting worked hard,” as he puts it. This is no time to slack up. Got to keep the big wheels of those hard-to-get warehouse lines turning and churning. Rollin’ out those mortgages.
MB
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