Mortgage Warehouse Lending Background

The recent turmoil in the capital and credit markets has resulted in a significant, yet avoidable, "bottleneck" in the funding channels for real estate finance. Many in the industry believe this problem stems, in part, because the mortgage warehouse lines of credit from banks to independent mortgage lenders to fund residential mortgages incur a significantly higher capital requirement than the underlying mortgages themselves.

Therefore, industry leaders have requested the Board of Governors of the Federal Reserve System (Fed), Federal Deposit Insurance Corporation (FDIC), the Office of Comptroller of the Currency (OCC) and Office of Thrift Supervision (OTS) study the current risk weightings for mortgage warehouse lines of credit for real estate financing and make appropriate changes to better reflect the risk associated with lines backed by Fannie Mae, Freddie Mac or Ginnie Mae eligible loans and related servicing advances. The proposal does not extend to other single family mortgage loan types such as non-agency subprime or Alt A loans.

Recently, the industry has identified a growing threat to a source of capital for many mortgage lenders – mortgage warehouse lenders going out of business, terminating or adding restrictions to their mortgage warehouse lines of credit causing independent (non-depository) mortgage lenders to struggle to maintain their ability to lend. Mortgage warehouse lenders serve as crucial short term lenders for mortgage bankers. According to National Mortgage News, in 2007 there were approximately 90 warehouse lenders; today there are very few mortgage warehouse lenders.

Mortgage warehouse lending is a line of credit provided to a mortgage banking company to fund the closing of mortgages. It is a short term revolving credit facility that funds a lender's pipeline from the closing table to sale in the secondary market. The mortgage note is used as collateral for interim financing until the mortgage is sold and delivered to the permanent investor. The loans have to be pre-committed to an approved investor takeout, and those takeout commitments are part of the collateral pool for the mortgage warehouse line of credit. Mortgage bankers draw upon the mortgage warehouse line of credit to fund a mortgage at closing or to purchase a closed loan from another originator. The mortgage warehouse line of credit is paid down when the loan is sold to the permanent investor.

The decline in mortgage warehouse lending capacity has outpaced the decline in overall mortgage originations. The 2008 residential mortgage originations of approximately $1.8 trillion were 20.9 percent, or $483 billion, less than in 2007. For the mortgage warehouse lenders, the capacity of the mortgage warehouse lines of credit to serve non-depository mortgage originators is declining at a much faster rate - from over $200 billion in 2007 to approximately $20 to $25 billion in 2008, a decline exceeding 85 percent. For the originator that depends solely on mortgage warehouse lines of credit, this reduction could extinguish their lending business and will impact the consumers in their market.

Recently, several commercial banks have purchased other institutions that are active in the warehouse lending business. While it is uncertain what the future of institutions' engagement in mortgage warehouse lending will be, many banks have pulled-back on mortgage warehouse lines of credit, ceasing to issue new mortgage warehouse lines of credit or increase existing lines, or have closed down lines altogether. These actions have left many non-depository lenders without adequate and viable sources of capital.

Other mortgage warehouse lenders may not continue to extend mortgage warehouse lines of credit to lenders for various reasons, including it is a simple means of reducing a balance sheet, the perceived risk is too high, or headline risk of products associated with mortgages is too great despite the fact that underwriting is extremely rigorous today. Mortgage bankers that rely on mortgage warehouse lines of credit will be unable to maintain their businesses and cannot serve their local communities if their sources of mortgage warehouse lines of credit are not maintained.

Industry leaders have held recent meetings with representatives of the Department of Treasury, the Fed, Federal Housing Finance Agency and Ginnie Mae pursuant to working out a short term solution to the mortgage warehouse lending problem that would help the industry through this time of crisis. Industry leaders, however, believes that some permanent improvements in risk- based capital (RBC) rules should be made to better reflect the risks inherent in mortgage warehouse lending for single family (1-4 units) and multifamily mortgages eligible for sale to Fannie Mae or Freddie Mac, insured by the Federal Housing Administration (FHA), guaranteed by the Department of Veterans Affairs (VA) or Rural Housing Service (RHS). This would provide a longer term solution to part of the problem.

Currently, RBC rules for banks and savings and loan associations treat mortgage warehouse lines of credit as commercial loans by assigning them to the 100 percent risk-weighted asset category, along with other commercial loan exposures. Industry leaders believe that mortgage warehouse lines of credit, if properly managed, have risks comparable to conventional and government-insured mortgage exposures, and, in the final few days in warehouse, the risk is comparable to holding a government or government agency mortgage-backed security (MBS). Banks are exiting mortgage warehouse lending to shore up their risk-based capital positions. As a result of the fast turn of loans in mortgage warehouse lending (generally less than twenty days) and given the 100 percent risk weighting assigned thereto, winding down mortgage warehouse lending is a quick way for a bank to improve its capital position. Further, banks can replace mortgage warehouse assets by holding the same types of mortgages in whole loan form, which has a more favorable RBC treatment.

By way of background, mortgage warehouse lenders define three stages of the mortgage warehouse process:

1. Wet Funded Stage: Mortgage warehouse lenders frequently send money to the closing table on the day of loan closing. The closing agent, simultaneous with the closing, assigns the mortgage to the mortgage warehouse lender. This is generally governed by closing instructions from the mortgage warehouse lender to the closing agent. The mortgage banker provides the mortgage warehouse lender with a Uniform Commercial Code (UCC) form that serves as collateral until the underlying collateral documentation is received from the closing table. Such documentation includes the mortgage note. According to the UCC, the UCC document is valid collateral for up to 20 days.
2. Dry Funded Stage: This stage represents the period that the mortgage warehouse lender has the mortgage note and other collateral documents in its collateral vault.
3. Gestation Repo Stage: Prior to delivery of a Ginnie Mae, Fannie Mae or Freddie Mac security (government MBS) to the secondary market, the mortgage banker will obtain an initial pool certification. Often, the certifying agent is the mortgage warehouse lender itself. Upon initial pool certification, the pool is said to be "in gestation" awaiting delivery to the takeout investor upon security issuance. Fifteen years ago, Wall Street firms would take delivery at this point and provide gestation repo funding from initial pool certification date to trade settlement. During the last ten years, commercial banks have added a gestation repo tranche to the typical mortgage warehouse line agreement in order not to lose this segment of the mortgage warehouse business.

Industry leaders believe that the following RBC rules should be promulgated to more properly risk- weight these assets:

1. Wet Funded Stage: The current RBC weighting of 100 percent should be maintained until a" collateral documents are received from the closing table.
2. Dry Funded Stage: Dry funded loans provide as collateral to the mortgage warehouse line of credit bank the mortgage note endorsed in blank. This allows the mortgage warehouse line of credit lender to step into the shoes of the mortgage lender and own these loans if the mortgage lender defaults. The mortgage warehouse line of credit lender also has a perfected interest in a" forward sale agreements. So, not only does the mortgage warehouse line of credit lender have the ability to own the loan, it can deliver that loan into the secondary market within weeks at a pre-determined price. Thus, the mortgage warehouse line of credit lender has collateral that is perfected, has little credit risk (since newly originated), and has little market risk (since pre-sold into the secondary market). Present RBC rules for mortgage loans held by a bank require from 50 percent to 100 percent RBC weighting, depending on the mortgage's loan-to-value (L TV) ratio. For FHA and VA loans, the RBC weighting is 20 percent. Proposed Basel" "standardized approach" provides for RBC weightings from 20 percent to 150 percent depending on the L TV and whether the loan is current. Industry leaders propose that RBC weighting of 50 percent be accorded that portion of a mortgage warehouse line of credit that is dry funded and is collateralized by loans conforming to Fannie Mae or Freddie Mac requirements, FHA loans, VA loans, Rural Housing Service loans, and Home Equity Conversion Mortgages (HECM's)
3. Gestation Repo Stage: Upon initial pool certification, a new government MBS will be issued in a matter of days. Since the warehouse lender has a blanket lien on all forward sale commitments, these MBS are pre-sold. Present RBC rules call for zero percent capital on Ginnie Mae MBS and 10 percent on Fannie Mae and Freddie Mac MBS. Industry leaders recommend a RBC weighting of not more than 20 percent for that portion of a warehouse line that is backed by gestation collateral.

A much smaller yet very important piece of a typical mortgage warehouse line of credit relationship is a working capital line to finance a mortgage servicer's advances required under Fannie Mae, Freddie Mac and Ginnie Mae servicing agreements for principal and interest passed through to certificate holders prior to receipt of a borrower's payment and for tax and insurance escrow advances. As the Treasury's recent loan modification and refinance initiatives are implemented, and as a result of the current moratorium on new foreclosure actions, these advances are expected to rise dramatically, resulting in further mortgage warehouse line of credit needs. The mortgage warehouse lenders appropriately require a discount for this collateral for amounts not directly receivable from Fannie Mae, Freddie Mac and Ginnie Mae. Industry leaders recommend an RBC weighting of 20 percent for this collateral.

Although this proposal provides a mortgage warehouse line of credit capacity shortage solution specifically tailored for loans with actual or effective government guarantees (GSE, FHA, VA and RHS-eligible residential and multifamily mortgages), it is not an appropriate solution for non-government guaranteed private label residential, commercial and multifamily loans. In order to address this issue, Industry leaders will work with industry members and the administration to craft solutions that provide for increased mortgage warehouse lines of credit capacity for private label residential, commercial and multifamily loans. By addressing both government guaranteed and private label loan categories, a complete solution to the capacity shortage for mortgage warehouse lines of credit can be developed.

Industry leaders commend the bank and thrift regulators for their concerted efforts to address the housing finance crisis while bolstering the safety and soundness of the institutions that they regulate. However, Industry leaders believe that the success of most of these efforts hinges on improving the liquidity and availability of mortgage warehouse lines of credit that are needed to support the recovery of the housing market.

Industry leaders look forward to working with government regulators and providing representatives of independent mortgage lenders and mortgage warehouse lenders to discuss more fully the mortgage warehouse lending process.