REQUIRED READING: In 2005, there were more than 115 active warehouse lenders. There are currently fewer than 30. Today's total aggregate capacity of warehouse lending is about $25 billion, representing a nearly 90% drop from the pre-recession period.
Those figures, compiled by the Warehouse Lending Project, a Washington, D.C.-based coalition of independent mortgage bankers, underscore the severity of the warehouse lending crisis. Although industry experts believe the crisis is showing signs of easing up, it seems that a return to pre-crisis levels is a long way off.
The good news, it appears, is that the worst of the crisis is moving behind the industry.
‘As of today, there is slight improvement from a year ago,’ observes Robert Engelstad, co-founder of the Warehouse Lending Project and a former senior vice president with Fannie Mae. ‘That is because there are two things going on: The credit situation improved slightly, and mortgage volume is down considerably. That made the situation much less critical.’
‘We're in a better place now than we were this past spring,’ concurs Tamara King, director of loan production for the Mortgage Bankers Association (MBA).
‘I do not know if warehouse lending in 2010 will return stronger than in 2007,’ says Scott Stern, CEO of Lenders One, based in St. Louis, and chairman of the Community Mortgage Lenders of America, a recently created lobbying organization for the independent mortgage banking sector. ‘I have reason to believe it will be stronger than 2009. In 2009, there was very little positive in the warehouse sector. We saw a dramatic reduction in capacity, and the people who depend on warehouse lines were very, very vulnerable.’
That's the good news. The bad news, though, is that the level of vulnerability has not evaporated.
‘There are still a lot of companies having trouble securing adequate warehouse lines of credit,’ King says.
Indeed, today's warehouse lines are anything but bountiful. According to the Warehouse Lending Project, there is a $630 billion shortfall in home mortgages available, created by limits in warehouse lending capacity. The organization estimates that an additional $32 billion is needed to close the gap and, thus, ease the restrictive nature of the sector.
So where is the sector going? According to Stern, the void in warehouse lending could be filled by four new market entrants: new banks – either de novo institutions or recently acquired banks looking for new business channels; Wall Street, which has not been a warehouse player before and needs to get up to speed on how the process works; private and venture capital funds that are seeking untapped markets for investment opportunities; and the banks that remained in this sector throughout the crisis.
If filling this crucial void is the goal, how can the industry achieve it? It appears that this year will see movement toward that result.
‘I hope and expect that as credit strengthens and banks improve capital and expand business leads, some expansion of warehouse lending will take place,’ predicts Englestad. ‘There are already some good signs, especially the takeover of Colonial BancGroup's warehouse business by BB&T last August. BB&T expressed satisfaction – if not enthusiasm – about the business, and they will stay in it for the mortgage banking operations within BB&T's footprint.’
Englestad adds that two existing warehouse leaders, Wells Fargo and Citi, are continuing to push ahead in the sector. However, MBA's King notes that another sector force, National City's warehouse lending division, is slated for closure this spring – its fate was sealed following the October 2008 acquisition of National City Corp. by PNC Financial Services Group, which already closed down its warehouse division.
If the sector's existing entities are sending mixed signals, many industry experts believe the opportunity is ripe for new players to step in.
‘I'm sure that at least one entrepreneurial banker will see the compelling opportunities to this space,’ says Barry Epstein, a Los Angeles-based independent warehouse banking consultant and a former senior vice president of Ocwen Financial Services. ‘Once one does it, it is follow the leader – others will jump into the space.’
Epstein believes a quick way for new warehouse lenders to emerge is through a takeover of insolvent or underperforming banks. ‘Smaller equity firms are looking to buy controlling interest in independent community banks or national banks,’ he continues. ‘They will find a compelling area with a return on equity that is risk mitigated. This gets the cashflow – the return on equity is substantial, based on amount of leverage that banks use.’
During the course of 2009, a number of industry leaders began talking the concept of community banks creating warehouse lending divisions. Mike Larssen, president of Larssen Consulting Group, based in Clearwater, Fla., and a former executive vice president of Mortgage Investors Group, believes this could be a win-win situation for all parties.
‘I'm hoping the small independents jump in,’ he says. ‘I'm expecting the banks with $100 million to $400 million asset size will start to commit to local warehouse lines. The independent banks realize that there is less stock value risk and an opportunity for them to make some fairly respectable margins on safe products.’
Mary Kladde, president of Denver-based Titan Lenders Corp., has been a leading proponent of this strategy, and her company has been working with community banks to explore this possible business channel.
‘We have six community banks in the final stages of coming out and supporting local lenders,’ she reports. ‘I think there is some loosening. There is an opportunity for them to invest in something that is not so risky. Right now, there are five loan programs left in the market, and they are either fixed-rate or the government is backing them.’
Kladde acknowledges that this strategy may require some time to develop. ‘It is taking so long to bring them to the table, because they were never part of the mortgage side, much less the warehouse side,’ she adds. ‘The biggest concern revolves around risk. But today's loans are not as risky as they once were – there is a lot of caution in play.’
Kladde notes that if community banks are hesitant about venturing solo into the sector, there is the opportunity to team with private equity groups that are circling the market. King adds that mortgage bankers seeking warehouse lines could also create their own cooperative network by arranging multiple small to midsize lines from a number of community banks.
Gibran Nichols, CEO of the CMPS Institute, based in Ann Arbor, Mich., notes that this situation offers pros and cons to community banks. On the plus side, the closure of many independent mortgage brokerages has enabled community banks to bring in industry veterans who can help expand their residential mortgage operations, thus negating the argument about the lack of in-house experience. However, he adds, there is a significant obstacle to consider.
‘If the secondary market is not buying, the loans will stay on the warehouse line for a while,’ he says.
The secondary market was also pegged as a possible warehouse lender, although the government-sponsored enterprises (GSEs) are not chartered for such input. One way around that situation emerged in October, when Freddie Mac announced it was conducting a pilot program designed to help its seller/servicer affiliates obtain warehouse lines of credit with participating warehouse lenders. The initiative was aimed at single-family and multifamily lenders in finding adequate warehouse lines of credit to fund loans for sale to Freddie Mac.
The GSE is working with warehouse lender NattyMac, a Guggenheim Partners company, in the pilot program, which will provide participating warehouse lenders with standby commitments to purchase qualifying loans in the event a Freddie Mac seller/servicer cannot meet its contract obligations or fails.
The pilot program is still relatively new, and results have not been formally announced.
‘It is my understanding that the pilot is going well for sellers and servicers who could participate,’ says King. ‘I anticipate it to expand, but that is not known right now.’
Stern agrees, stating that federal intervention would rate a two on a one-to-10 scale. ‘Two being only slightly worse than the worst possible outcome,’ he says. ‘If the government was not involved in the past year when we really needed them, they do not need to get involved now.’
In his conversation with Washington officials, Stern noted that many people in the government were being introduced to the sector.
‘It is fair to say they weren't aware of warehouse lending,’ he says. ‘I think warehouse is not an obvious business – it's a complicated business with operations behind the scenes in the mortgage industry. Asking lawmakers and regulators to understand a part of the industry that even mortgage bankers don't understand is a complicated issue.’
But, on the other hand, Stern admits that maybe some mortgage bankers need to be more aware of the issues. He recalls a conversation he had with a financial services executive on the subject. When Stern asked the executive if his institution was involved in warehouse lending, the executive affirmed, ‘Yes, we make loans to warehouses.’