REQUIRED READING: Warehouse Lending 2.0: The New State Of Affairs

Of the many mortgage banking dominos that tumbled in the aftermath of the subprime collapse, the warehouse lending sector's fall arguably came with the loudest thud. As of September 2007, according to the Atlanta-based Street Resource Group, 40% of all warehouse production volume was flowing through a mere 10 investors – and of that group, 60% of volume was concentrated among six investors.

‘It's been very rough,’ says Michael J. Kenny, senior vice president and director of the Quick$ale Warehouse Banking Division at Gateway FSB, San Leandro, Calif. ‘We've had an unprecedented year in mortgage banking. Warehouse banks suffered more than even the mortgage banks because they got stuck with a lot of problem loans. Two-thirds of our competition are out of the market entirely. The next 12 months will be very difficult and challenging for warehouse bankers.’

Today, however, warehouse lending is being realigned. The absence of nonprime lending, coupled with a radically increased focus on risk mitigation and due diligence, is laying a foundation to ensure there won't be a reprise of recent events. Even more intriguing is the arrival of a new class of warehouse lenders: the community banks, who are entering the arena without the scars and bruises that their money-center counterparts endured.

This is not to say that warehouse lending has bounced back to full health. ‘The state of warehouse lending, from a lender's perspective, is very precarious,’ observes Scott Stern, CEO of Lender's One, St. Louis. ‘Without warehouse lending, mortgage bankers simply can't make loans. I probably wake up every day and say that I hope this is not a day where a warehouse lender goes out of business.’

Still, this situation is not unique to the warehouse sector. ‘The state of all mortgage lending is precarious at the present time,’ says David Oser, senior vice president of investments at ShoreBank, Chicago. ‘As we see everything happening in the secondary market right now, there is no good news.’

Oser is also pessimistic about the effects of the reduced number of participants in the warehouse process. ‘The more sources and the more companies there are, the better it is for the industry,’ he says.

James E. Reynolds, managing partner with The Reynolds Group, Summit, N.J., is in agreement on the current scarcity of investors. ‘This is not a good thing, having it in so few hands,’ he laments. ‘The industry is still very fragmented, and having this in a few hands with a few investors who can control the ebb and flow of the product. More is better – it makes the business more competitive.’

Chuck Klein, managing partner of Mortgage Banking Solutions in Woodway, Texas, worries that a continuing of the fraying national economy could make the warehouse sector even smaller. ‘If we have a severe economic downturn, many investors handling mortgage-backed securities today would be even more leery of these products,’ he says. ‘This could be very difficult for our business if investors seek other avenues for their returns.’

But for Stanley Street, president of Street Resource Group, a low quantity of investors is not synonymous with a low quality. ‘Warehouse lenders depend upon the investor mortgage purchase commitment and price as primary criteria for funding individual loans,’ he says. ‘But they must also continually monitor and assess risk at the investor company level. While portfolio concentration risk might be higher with fewer investors, overall, those investors are much more stable and reliable.’

The morning after

Nonetheless, warehouse lending's state of health appears to be showing early signs of recovery.

‘As the dust settles and we get good, responsible lending, we will continue to see warehouse loans being made,’ says Edward Kramer, executive vice president for regulatory programs at Wolters Kluwer Financial Services.

Kramer points out that as part of this stirring, several regional banks have begun to present themselves as warehouse lenders. ‘This is a great opportunity for these banks to go into the business, which will increase their market share,’ he says.

‘I see great opportunity,’ says Clifford Shultz, senior vice president and director of mortgage warehouse lending at Sovereign Bancorp, Short Hills, N.J. ‘We have a lot of prospects concentrating on the government-sponsored enterprises and the Federal Housing Administration (FHA), and they're generating a lot of paper. The FHA business is alive and recharged, and it's creating a lot of opportunity for companies.’

Among the new regional banks entering the sector is Wachovia. ‘It's like any sort of lending,’ explains Ken Logan, director of Wachovia's residential mortgage and consumer group. ‘If we can keep the discipline in place and keep the right risk-based pricing concerns, it could provide Wachovia with a good, stable business.’

A new wave of warehouse lenders is making itself known. Stern points out that some community banks are beginning to expand into warehouse lending, and he feels their reputation for high-quality customer service makes them a natural fit in this environment.

‘The mortgage companies that will succeed in the years ahead will be the ones who treat their customers best,’ he states. ‘Community banks have relationships with their mortgage companies that sometimes span decades.’

Even the reverse mortgage niche is getting involved. Miami-based Amstar Financial Services recently announced plans to launch a reverse mortgage warehouse facility that will serve small correspondents originating FHA-insured home equity conversion mortgages.

‘We believe that we can fund and sell this production consistently and profitably,’ says Nelson A. Locke, AmStar's CEO.

And, of course, those warehouse lenders who remained operational through the recent turmoil are pressing ahead. ‘Our business production volume is up 400-percent since September,’ says Kenny. ‘We're benefiting, unfortunately, from the industry's demises.’
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The shape of things

As the industry recovers, warehouse lenders will be maintaining requirements that are far stricter than previously seen.

‘Underwriting criteria for approving mortgage bankers is extremely tight,’ says Mac Tatum, senior vice president of Town North Bank in Dallas. ‘Mortgage warehouse lenders who operate under strict funding guidelines to control risk are in good condition. However, those mortgage warehouse lenders who funded subprime mortgages are suffering. While a large portion of the investors were buying Alt-A and subprime loans, these 10 remaining investors focused on conforming and government production, thus avoiding the perfect storm in 2007. I think they will continue to focus on standardization and discipline that is needed in the mortgage industry.’

The tighter criteria has already been felt, and none too comfortably.

‘We're seeing a higher scrutinizing of net worth to justify the amount of a line,’ comments Steve Jacobson, CEO of Fairway Independent Mortgage Corp., Sun Prairie, Wis. ‘In February, we were given a couple of days to increase the net worth, in order to get our warehouse facility to raise our lines.’

However, Jacobson is not faulting the warehouse lenders for these tighter parameters. ‘Because of what happened last year, you can feel people are slammed,’ he adds. ‘It's just what happened in the industry.’

Warehouse lenders are also facing an increased pressure to adapt e-mortgage practices. However, many warehouse lenders appear to be pushing this pressure back.

‘With their core business of traditional delivery and current market conditions of massive demand and diminished supply, warehouse lenders see e-mortgages as an insignificant portion of the overall mortgage-production pie and are not warranting allocation of resources toward accommodating the technology,’ says Street. ‘There also remains significant debate on the issue of perfecting security interest in the note vis-Ã -vis the mechanics of purchase fund remittance in lieu of bailee letters no longer being applicable in the e-mortgage world.’

Tatum adds that warehouse lenders are also skeptical about the security aspects of e-mortgages. ‘Warehouse lenders are reluctant to embrace e-mortgages because of the increase in mortgage fraud,’ he says. ‘They are not confident that e-mortgage technology can prevent mortgage fraud. They are not confident that regulation pertaining to e-mortgages is good enough to secure their collateral.’

Plus, there is the lingering Luddite appeal of flipping through paper. ‘Warehouse lenders haven't overcome the preference of having the documents in their hands,’ says Klein, who believes that an all e-mortgage warehouse sector is possible within five years.

However, Shultz believes that e-mortgages and other high-tech issues will remain a low priority for the immediate future. ‘With the state of the mortgage industry, I don't see a lot of people interested in technology,’ he says.

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