PERSON OF THE WEEK: Barry Epstein And The Warehouse Banking Dilemma

of the more challenging aspects of today's mortgage banking industry is the precarious state of the warehouse lending sector. [/b]This week, MortgageOrb speaks with Barry Epstein, an independent warehouse banking consultant and a former senior vice president of Ocwen Financial Services, on where the sector stands today and what the near future holds. [b]Q:[/b] How would you categorize the current state of warehouse lending? [b]Epstein: [/b]The current state of warehouse lending is best described as almost non-existent. Many articles have been written highlighting almost the demise of the warehouse banking sector for the small- and medium-size banker (net worth of $500,000 to $20 million) – the remaining mega warehouse lenders have little appetite to expand for these type of mortgage bankers. The Wall Street firms would entertain warehouse lines for the much larger mortgage banker with a net worth of $50 million-plus, and they would only consider the smaller bankers on an exception basis. This leaves many originators with limited choices, as the liquidity crisis in this sector is evident. Only about 10 warehouse lenders of any size remain, down from over 100 a few years ago. Less than $20 billion is available, down from over $200 billion. Some of the smaller warehouse lenders, such as Texas Capital and Southwest Securities, are pretty well ‘loaned up’ and have little room to expand, due to their asset and capital size. [b]Q:[/b] Do you see any movement of new warehouse lenders entering the market? [b]Epstein:[/b] I have spoken to many financial institutions, and there is currently very limited movement by banks to enter this space. As an example, Scott Stern, the CEO of LendersOne, a co-op of over 120 mortgage bankers, has been seeking warehouse lines for the co-op's members, and they have found very limited interest to date from small, medium or regional banks, even though this would have the potential of a captive market. The only way I believe any movement can be created in motivating banks to enter the warehouse banking space is by communicating about the compelling reasons for bank(s) to enter warehouse banking. The return on equity (ROE) is well above norm for a bank in comparison to other types of lending, including C&I, CRE, multi-family, consumer and any other type of asset-based lending. In reality, warehouse lending is basically divided into two separate sectors. The lending portion is no more than short-term commercial loans – two to 15 days – and using the residential mortgage as collateral. If structured as repurchase agreements, these loans do not affect capital ratios and are structured as true sale of underlying loans. They can also be hypothecated and resold, which provides leverage opportunities. The ROE in the warehouse lending sector alone shows at least a 30% ROE within 12 months, depending on the leverage used by the bank. The second part of warehouse banking is correspondent purchasing of Federal Housing Administration (FHA)-insured loans from banks' warehouse clients and selling Ginnie Mae securities. The ROE will then exceed 70% within 12 months, whether the securities are sold or released. Not only is warehouse lending to FHA Full Eagle mortgage bankers extremely profitable and risk-mitigated, it also creates a strong relationship type of business, as the mortgage banker must deposit 5% or more as non-interest-bearing compensating balances against the line. It also creates Community Reinvestment Act (CRA) credits. [b]Q:[/b] Some potential warehouse lenders may not wish to enter the market because they feel it is a risky business to get into. Is that a correct assumption? [b]Epstein:[/b] It is a false assumption and a total misconception that warehouse banking is a risky business in today's marketplace. Many of the shortcomings of the past no longer exist in today's mortgage market that created this illiquid market. Today's warehouse banking is very transparent. There is a very specific process for both the mortgage banker and investor approval – plus very detailed underwriting guidelines are in place. Desktop software is used both for the warehouse bank and client, so most documents are online. Errors and omissions and fidelity coverage is set at a minimum of $1 million, and each mortgage banker must have an approved quality control plan, compliance and audit guidelines. The Department of Housing and Urban Development (HUD) has very specific guidelines for Full Eagle mortgage bankers before they are delegated. Additionally, risk mitigation engines such as MARI, Lexis Nexis, CoreLogic, SRG and MERS registration mitigates fraud, and all due diligence should be completed pre-funding, not post-funding. [b]Q:[/b] Do you feel the federal government is aware of the problems being created by the current state of warehouse lending? [b]Epstein:[/b] The government agencies are certainly aware of the problems created by the current state of affairs in the warehouse lending. The issue is that the government has enough on its plate right now, and the government-sponsored enterprises are not in a financial position to assist in the liquidity crisis in the warehouse lending sector. Ginnie Mae would have to jump through many legal hoops to enter the warehouse lending sector. Ginnie Mae can influence the expansion of warehouse lending by putting some pressure on the approved Ginnie Mae issuer banks that have the asset and liquidity base but that only issue its securities from the bank's own retail originations and don't offer warehouse lines. This confines Ginnie Mae's originations and securitizations to the mega banks. Presently, nondepository banks supply roughly 40% of loans, and the mortgage market will suffer substantially if warehouse banking is not offered to this shrinking market as the mega banks drive the HUD-approved mortgage bankers out of business as they eliminate competition. With decreased competition, the possibility of higher-cost mortgages certainly is a reality. Without a robust mortgage market, the economy will stay in the doldrums. [b]Q:[/b] If we were to revisit the conversation in 12 months, what do you think will be the state of warehouse lending at that time? [b]Epstein:[/b] As in any business, companies will follow the leader once it is known that the ROE is real and the business is risk mitigated. Who will be the first bank to reap the ric