Restoring the productivity of the U.S. mortgage marketplace is a critical, perhaps linchpin, element of both domestic and global economic recovery. Despite conditions ripe for our industry to experience resurgent and restorative volume, independent mortgage bankers have been restrained by a massive retreat from warehouse-line lending.
Some warehouse lenders succumbed to insurmountable losses on subprime and nonperforming loans of defunct mortgage bankers, while others made hard choices on balance-sheet allocation and the ‘perceived’ risk of warehouse lending before exiting the market. As a by-product of a shrinking pool of warehouse-line funds, independent mortgage bankers are being competitively marginalized.
This marginalization translates into borrowers not having access to competitively priced loan options. ‘Big Bank’ lenders saved by Troubled Asset Relief Program (TARP) allocations are gaining market share, which poses a dangerous imbalance to our recovery and long-term financial sustainability.
Like the true entrepreneurs they are, independent mortgage bankers must come together and create their own solutions. They do not have the luxury of waiting for the government to move or TARP funds to come along to bail them out.
Over the last four to five years, the number of financial institutions offering warehouse lines of credit to independent mortgage bankers declined from nearly 115 at its peak to fewer than 25 today, representing an 80% reduction in warehouse lending facilities for the industry. Lenders that utilize warehouse lines of credit originate approximately 41% of all U.S. residential mortgage loans and nearly 55% of all Federal Housing Administration (FHA) loans.
By the end of the first quarter of this year, it was clear from discussions we were having with lenders nationally that they were deeply concerned about the dwindling availability of warehouse lines and the possibility that a lack of liquidity would curtail or close their business.
The loss of a warehouse line for an independent mortgage banker is, in many cases, a business-ending event. As of May, less than $25 billion in warehouse-line capacity was available to independent mortgage bankers – a figure that stood in stark contrast with the Mortgage Bankers Association's (MBA) estimates for anticipated demand of $2.78 trillion in originations for 2009, up from a $1.6 trillion in 2008. It is conceivable that there will be a $630 billion shortfall in home mortgage financing availability caused by a lack of warehouse lending capacity.
As dictated by the rules of economics, scarcity in warehouse-line liquidity is driving up costs for non-depository lenders and borrowers. During the MBA's Secondary Marketing Conference in April, we encountered several lenders that were actively renegotiating renewal of their warehouse line at previously unheard of terms defined as note rate plus 300 basis points (bps) with a penalty of 50 bps for every dollar not utilized at least once within a 30-day timeframe, up to the line limit.
Nonrefundable application fees in the amount of $1,500 have been the norm, but some lines have been trending upwards to around $5,000, and correspondents have been paying in the hope of getting a line to meet rising origination demand.
[b][i]Stymied at origination[/i][/b]
Fueled simultaneously by growth in first-time residential purchases and refinance activity due to historically low interest rates, mortgage demand has swelled in the first and second quarters of 2009. From a demand standpoint, public policy of low rates and tax credits seems to be having the intended effect. However, for the small-business arm of mortgage banking, there is evidence that a portion of that demand is being stymied at origination due to severely limited liquidity.
In combination, these circumstances threaten the survival of independent, community-based mortgage businesses. The risks inherent to a shrinking marketplace of independent mortgage bankers will have a ripple effect, creating a less cost-competitive environment for purchase borrowers of all kinds, dangerously limiting refinance opportunities for troubled homeowner households, and further eroding local economic vitality.
Unfortunately, warehouse lending is a more arcane facet of how the industry performs; it has been an ‘elephant in the room,’ as regulators and politicians try to hammer out stimulus policy focused largely on ‘reactionary’ measures related to toxic mortgage-securitized assets at the highest levels of finance. Arguably because of the virtual invisibility of this enormously important contributor to mortgage finance liquidity, opportunities to compress the duration of economic malaise at the local, community level are being squandered and misspent.
There is simply not enough money in the system to allow both independent mortgage bankers and correspondent lenders to service consumer demand in their communities. They must pick and choose which loans to fund at the end of the month. Liquidity issues have even moved some remaining warehouse-lines providers to suspend refinance transaction funding.
Independent mortgage bankers are finding themselves less competitive to the Big Banks, as they extend locks and absorb the increased costs to retain customers. Rather than being rewarded for the strength of a business model that exhibited sober and conservative growth through the industry collapse, they are being edged out of their markets and forced to turn away from less profitable business channels traditionally underserved by the Big Banks.
The Big Banks, on the other hand, are overwhelmed with demand but are unconstrained by supply. They are definitely enjoying the opportunity to shore up their margins. This core imbalance in the infrastructure of the industry illustrates how well-intended policy may have unintended consequences that must be addressed simultaneously.
After analyzing the problem with the help of groups like the Warehouse Lending Project, the MBA sent a recommendation brief to the Office of the Comptroller of the Currency, the Federal Reserve, the Federal Deposit Insurance Corp. and the Office of Thrift Supervision.
This brief acknowledged that ‘warehouse lending contributes to the financial capacity the industry provides for originating loans for first-time homebuyers; refinancing troubled borrowers into new mortgages; assisting other borrowers in securing credit for residential mortgage transactions; and originating loans for the purchase, refinance or repositioning of rental properties.’ The MBA further proposed that federal banking regulators cut the capital requirement on warehouse lines of credit by as much as 80% to alleviate a funding crisis facing non-depositories.
Unfortunately, for many independent mortgage bankers, the need for solutions is immediate. While motivating regulators and legislators to address the problem is a means to resolution, it will not be timely or address the situation currently at hand today.
Calls for government-sponsored enterprise intervention are constrained by charter limitations that require legislative intervention. Lowering risk-based capital requirements will not alleviate balance-sheet allocation concerns. Clearly, we need to entice new warehouse lenders into the market.
Motivated and inspired by its necessity, independent mortgage lenders must seize the day and become the driving force behind an inventive transformation of warehouse lending – expanding beyond its traditional embodiment as a peculiar type of lending for a single type of institution.
Warehouse lending is neither so complex nor so risky that regulated depository financial institutions cannot manage it. It also currently delivers a return on investment that makes it a desirable private equity tool in today's market. Independent mortgage bankers must – individually and as a group – work to persuade their community financial institutions on a grassroots level to create warehouse facilities that will allow them to facilitate mortgage financing in their communities.
Some independent mortgage bankers have already discovered the option of establishing a warehouse line through private equity. Wall Street's volatility and a general degradation of quality in the bond market could be offset by the relative security of warehouse lending, which offers a solid return on an extremely low-risk investment.
Considering that residential real estate loans today are of the highest caliber in 15 years, with a product mix limited to agency- and government-backed loans, the stage is set for private equity investment into mortgage warehouse-line lending.
Private equity funds can fill the gap between loan origination and ultimate investor with minimum start-up and operating costs by outsourcing the technology infrastructure and process management. They can pilot programs on a smaller scale, taking their capital to market in a highly structured, process-driven environment. When these processes are refined and perfected, funds can scale up, down, regionally, nationally, conforming or niche.
Another approach is keeping it local. Community-based lending for community-based businesses is a natural combination. Independent mortgage bankers can target, educate and entice their community financial institutions to fill the gap that threatens their localized mortgage economy. They should urge those financial institutions to advocate for the modification of some capital requirements for community banks and credit unions on warehouse-line lending.
Community financial institutions know the mortgage business well enough to be both originators and warehouse-line lenders. Both are profitable models, both are sustainable for today's lower-risk lending and both promise consistent growth.
According to industry sources, credit union originations were up 17% in 2008, while overall mortgage originations fell 39%. The result was that the credit union share of total mortgage lending jumped from 2.5% in 2007 to a record-high 4.7% in 2008. Nearly a quarter of credit unions' 2008 originations came from five institutions – Navy Federal in Virginia, State Employees in North Carolina, Pentagon in Virginia, Boeing Employees in Washington, and Alaska USA in Alaska.
Clearly, the current recession and declining consumer confidence in large banking institutions has created a great opportunity for credit unions and community banks to grow their customer base. As many reports have highlighted, despite the struggles of Big Bank institutions, smaller banks, community banks and credit unions have not experienced the same issues, because they did not engage in risky investments.
Although they account for less than 10% of total U.S. banking assets, community banks' traditional, values-based approach is a model not only for their larger Wall Street mortgage lending counterparts, but for traditional warehouse lenders. Most community bankers know their customers – both consumer and commercial.
George Bernard Shaw once said, ‘Progress is impossible without change, and those who cannot change their minds cannot change anything.’ In the vacuum created by the demise of traditional sources of capital liquidity, independent mortgage bankers have an opportunity to redefine the future and character of warehouse-line lending. It is their opportunity to regain a greater sense of control and predictability, allowing them to make more meaningful contributions to the health and economic self-determination of their communities.
[i]Mary Kladde is president and Ruth Lee is vice president of sales for Titan Lenders Corp. in Denver. They can be reached at (866) 412-9180.[/i]