what now?
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O Avoid the LTOB limitations. Because the bank is not extending credit to the mortgage banker and is relying solely on the individual loans and the loan sale takeout proceeds for retirement of the loans, the LTOB limits apply to the individual mortgage borrowers and not the mortgage banker. This allows the bank to fund a large mortgage banker that they might not otherwise be able to fund under their LTOB limits. In the last 10 years, Fannie, Freddie and several conduits have developed early purchase programs. These programs look very much like the Whole Loan Repo process. The takeout investor (Fannie, Freddie or the conduit) funds the purchase of the loan, or part of the purchase price, within two or three days of the funding by the mortgage banker. The mortgage banker then has a defined deadline by which it must deliver all of the required documentation, and receive the balance of the money due to them. If they fail to do so, they have to buy the loan back. This allows the mortgage banker to quickly get the loan off the balance sheet, reduce its warehouse line of credit and improve its debt-to-equity ratio.
Warehouse lending: Profitable and safe Without question, the risks of warehouse lending have increased. Nonetheless, for those who run it well, warehouse lending is a safe and profitable business. The lender’s yield on the warehouse line of credit, and the rapid repayment of amounts advanced, makes this lending a very attractive asset for a commercial bank. Those lenders who profit from this lending watch the things that always mattered: O O O O O O O O
The character and track record of their customer and its management The debt-to-equity and profitability of their customer The liquidity of their customer The speed at which their customer turns their loans, including aggressive paydown requirements for aged loans The timeliness, substance and quality of the takeout and the takeout investor to which their customer is selling their loans The advance rate under the line, versus the takeout price Careful oversight and control of the mortgage collateral, including use of the Mortgage Electronic Registration Systems (MERS) Careful control over the funding of the loan and the proceeds of the loan sale
MAY 2009 O
NEW YORK MORTGAGE PROFESSIONAL MAGAZINE
O www.NationalMortgageProfessional.com
Mortgage bankers: Challenge and adaptation
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Mortgage bankers also have challenges. When I started in this business, the prevailing debt-to-equity requirement for warehouse lines of credit was 10 to one. In other words, the mortgage banker needed GAAP capital of $1 million for every $10 million of warehouse line outstanding and, in most cases, for the amount of line committed. Additionally, warehouse lenders looked at working capital (GAAP current assets minus GAAP current liabilities) as an important ratio. We tried to maintain positive working capital equal to at least 75 percent of GAAP capital. We did not capitalize, nor did we often sell, servicing. Most warehouse lines of credit advanced the lesser of 98 percent of par or the loan sale takeout price. In summary, the industry operated with much less leverage than today. As we began to capitalize and sell servicing, things got more complicated. A more competitive and permissive credit environment led to higher advance rates and debt-to-equity ratios. In the last 10 years, I have seen warehouse deals with debt-to-equity ratios as high as 25 to one and advance rates as high as 102 percent of par. As to working capital, “What’s that?” has often graced the tongues of lenders and borrowers. Mortgage bankers are also at the mercy of the institutions to which they sell their loans. For many mortgage bankers, that is a conduit, and the conduits have their own funding challenges—whether it is the funding capacity of the bank that owns them or the capacity of their own warehouse lines. The mortgage business is very volatile. When business volume spikes, the speed at which institutional investors buy loans slows dramatically. This slows down the turnover of the mortgage banker’s warehouse inventory and increases the size requirements of their warehouse credit needs.
Warehouse lending: Solutions Now let’s look at some possible solutions. Some are more dramatic than others. I believe that they can all have a positive impact on the challenge. If you are a mortgage banker: O If you have a warehouse lender, treat them with the same respect you treat your wife (or spouse). O Manage your aged inventory. If you have a problem, call it to the attention of your warehouse lender before they call it to your attention. When you call them, offer a reasonable and achievable plan for resolution of the specific problem. O Prepare and model your business for higher capital requirements—a lower debt –to-equity ratio. O Carefully monitor the liquidity (working capital) of your business, and maintain adequate levels to safely run your business. O Don’t defer problems. Hoping is not a plan.
O Visit your community bank(s) and explain the business to them. Ask them if they will consider providing warehouse financing to you and/or other mortgage bankers. If they will, contact your current warehouse lender and see if they will sell them a participation in your line of credit. If you are a successful warehouse lender: O Thank you for supporting our industry! O Please consider using your operations platform and expertise to expand your lending program by selling participations to other banks that need loans and are willing to consider warehouse financing. Charge a fee for this extra service. If you are a bank that is willing to consider warehouse financing: O Please consider the purchase of warehouse line participations from experienced banks O If you have the resources, consider forming a unit to provide warehouse financing. It can be a very lucrative and safe business channel. If you are a Wall Street firm: O Do you or can you still offer repos? O Do you or can you still offer Gestation Repos? If you are a federal home loan bank or “banker’s bank:” O Please consider creating an operational platform to serve your member banks that would like to invest in mortgage warehousing. This can increase your fee income, and help your member banks invest in a profitable asset. O Consider using your resources to be a clearing house for sale of warehouse line of credit participations to your member banks. O To the extent your charter permits, consider investing in warehouse lines of credit that are secured by loans eligible for sale to Ginnie Mae, Fannie Mae or Freddie Mac. If you are a federal regulator: O Please consider allowing risk-based capital treatment, for qualifying warehouse lines of credit, to be based on the risk-based allocations for the underlying mortgages that secure the line of credit. That will eliminate the disparity between bank-owned and independent mortgage companies. The Mortgage Bankers Association has recently made a similar request. O Bank-owned mortgage companies that are funding their loans “on balance sheet” can already use this capital treatment. O Banks using a Whole Loan Repo process are also already using this capital treatment. By definition, Whole Loan Repo agreements are not supposed to have specific recourse to the mortgage banker. Traditional warehouse lines of credit, backed by agency loans, afford the same collateral protection to the bank, and have the added credit enhancement of specific recourse to the mortgage banker. If you are Fannie Mae, Freddie Mac or Ginnie Mae: O Please consider the purchase of warehouse line participations from experienced banks. As this article goes to press, Ginnie Mae has announced that they are considering some type of warehouse support for Ginnie Mae issuers. O Thank you for your years of support of and collaboration with our industry! Mortgage banking was created to transport mortgage lending capital from capital surplus areas of the country to growing, capital starved regions of the country. Independent mortgage bankers are vital to the sustenance of our country’s mortgage financing. Without adequate and affordable warehouse inventory financing, independent mortgage banks will become scarce. For many years, banks and independent mortgage bankers have enjoyed a symbiotic relationship. We are all aware of the challenges that banks face. The provisions of warehouse financing are good for the banks, mortgage bankers, the availability of mortgage loans and the cost of mortgage loans to the consumer. For many years, this industry has contributed to the American dream of homeownership. Our industry needs some help and some compromise. The cost of that compromise is affordable and, when properly managed, safe. We must all work together for prompt resolution. The tools are available, and the requisite compromises are tolerable. It’s time for a solution! James Hinton is chairman of Hinton Mortgage & Investment Company in Dallas, and is a 37-year veteran of the mortgage and banking industries. His company provides consulting and advisory services to the financial services industry. He may be reached by e-mail at james@cfhinton.com or via his company’s Web site, www.cfhinton.com. Visit author James Hinton’s blog at blog.cfhinton.com for tips and tricks on how to de-mystify and conquer the home loan process, and make the best deal for your loan.