As the number of warehouse funding competitors dwindled over the past year, TierOne Bank in Lincoln, Neb., got a little picky.

Some of the smaller lenders that had revolving lines at the $3 billion-asset bank were shown the exit when TierOne began welcoming in bigger mortgage banks that came knocking to replace lost lines-of-credit. "We've had some borrowers who are just very small, and haven't adapted to the changes of the times," says a TierOne executive who asked not to be named. "So we sort of ease them out, and replace them with somebody who has a far bigger, more robust line of business."

If it's not one thing (scarcity), it's another (selectivity) for mortgage lenders that have been scrambling to find new warehouse lines, a vital cog of temporary funding that ferries loans to the eventual owners and clears the pathway for new originations. The sources of warehouse lines have shrunk so much that a consortium of mortgage bankers has warned of a $32 billion shortfall in bank warehouse lending this year. That means a $630 billion funding gap in a projected home mortgage demand of $2.8 trillion this year, according to the Warehouse Lending Project, whose estimates come on the heels of an approximate $200 billion decline in warehouse lines in 2008.

"Things can get pretty dire," says Glen Corso, a principal with the organization, which in concert with the Mortgage Bankers Association has asked the U.S. Treasury and federal agencies to launch new efforts at replenishing short-term bank credits.

Those proposals (still under discussion with the Treasury) are running parallel to new ideas for building up alternative private-market resources for lenders, including luring smaller and mid-tier firms into handling more warehouse lines.

Since 2007, many of the primary warehouse lenders in the country such as Washington Mutual, Banco Popular, Credit Suisse, UBS, and Guaranty Bank left the business or were taken over by institutions that pulled the plug - reacting both to the collapse of secondary market investing and the implosion of major mortgage companies like New Century Financial that left warehouse lenders stuck with loans. Many of those that have stayed in warehouse lending, like JPMorgan Chase and GMAC LLC Residential Capital (ResCap), restrict lines to a closed pool of approved lender partners who provide a captive line of correspondent activity in return. ResCap has actually expanded its correspondent and warehouse business this year, hiring former Bank of America managing director Adam Glassner as its lead executive. The company is looking to use more third-party brokers to help drum up more business after the closing of 200 subsidiary GMAC Mortgage branches in 2008, but it will still be highly selective about choosing partner banks.

ResCap is taking a "very critical look at both the existing relationships and new relationships that we were interested in, in order to maximize the benefits to the firm," says GMAC financial services spokeswoman Jeannine Bruin. "With our dollars, we went to leverage the credit where it makes the most economic sense."

Even the good news in April that Wells Fargo has re-entered the business is tempered by the reality it is only a net gain of what was lost in Wachovia's former capacity, says Corso. "The need is far greater than that," he notes.

Many of the warehouse lines left standing are filled to capacity, according to Corso. The demand is resulting in higher rates with more stipulations and conditions, despite the fact many of the loans are government-backed, thus posing less risk than the subprime and option ARM loans than fed warehouse line activity in years past. Today's warehouse line deals might include higher fees, minimum levels of loan commitments, penalties for unused capacity, correspondent business agreements and even personal guarantees to buy back loans.

"The remaining warehouse lenders have gotten extraordinarily tight in the way they underwrite, and the way they view [wholesale] lenders," says Ruth Lee, vice president of Denver-based mortgage fulfillment outsourcer Titan Lenders Corp. "Mortgage bankers are having to ration their services...they're eating the rate locks and many of the extension fees because they're trying to remain competitive."

More recently, the market grew cloudier when PNC Financial Services Group Inc. decided in May to discontinue the $2.3 billion warehouse line business it inherited from its acquisition of National City Bank. The height of panic may have been this spring when wholesale mortgage lender Taylor, Bean & Whitaker made plans to head up a $300 million investment into struggling Colonial BancGroup in Montgomery, Ala. - all in hopes of staving off an FDIC seizure that threatened the Florida lender's own primary warehouse source.

While there are estimates that the warehouse business still has around 30 lenders providing services, Titan Lenders found fewer than eight were taking new applications not tied to correspondent relationships. And of those, some were tenuous: Colonial is reportedly unable to expand its $4.1 billion in commitments due to the capitalization requirements of its cease and desist order. At press time, analysts were skeptical that even Taylor, Bean's infusion - which would ostensibly restore enough funds to qualify Colonial for Troubled Asset Relief Program funds - would be enough to get Colonial out of hot water.

The market is "still weak and tenuous at best," says Craig Focardi, a TowerGroup research director in consumer lending. "There are concerns about loan quality as well as regulatory concerns about the business line and essential impact on the warehouse lender's capital."

To that end, the MBA and other groups trying to spark a warehouse lending revival are seeking remedies with temporary federal government intervention. One idea put forth by Corso's group and the Mortgage Bankers Association is increasing participation of Fannie Mae and Freddie Mac. Their plan is to protect warehouse lenders with purchase-and-sale agreements whereby the original lender has a guarantee of Freddie Mac or Fannie Mae placement if an open-market buyer isn't found. Another request from the MBA asks the Treasury to set up Government National Mortgage Association (Ginnie Mae) financing for warehouse lending - although that task might seem a tall order given that agency's recent costly spate of having to pick up the pieces (and liabilities) of troubled servicers.

In recent months, efforts have moved forward to get more small and mid-tier banks involved on the provisioning end. One big spark could be changes to the Mortgage Electronic Registration Systems' (MERS) e-registry that could prompt more warehouse lenders to move closer to an electronic-mortgage environment. Flagstar Bank of Troy, Mich., is one of the pioneers in this area, and is providing incentives for warehouse borrowers to adopt e-mortgage solutions that shorten the period of warehouse line holds. Flagstar first vice president Joe Lathrop says the bank intends to increase its $1.3 billion in current monthly commitments to $2 billion thanks to this innovation.

Of course, Flagstar's efforts are also aided by a $350 million private-equity investment and $266 million in funds from the Treasury's TARP. Many smaller banks don't have the cash or existing market contacts to quickly or effectively launch warehouse lines, so they are turning to service providers. For instance, a startup mortgage solutions provider in Houston - Mortgage Warehouse Network - launched a turnkey service to small banks to set up an outsourced warehouse line business in under two months. Titan Lenders itself is in discussions with six community banks to help them organize new warehouse business operations that would allow the banks to serve local lenders. By opening up as little as a $5 million line, Lee says, banks can produce healthy fee and interest income - perhaps $3,500 total for each loan - through low-risk, government-backed loans while offsetting rising defaults in auto and credit-card portfolios. There's also the potential to receive Community Reinvestment Act credit, says Lee, giving banks the "tangential benefit that if you are supporting the housing industry in your community, you're doing a good thing right now."

There are smaller and mid-tier banks already making hay out of warehouse lending. TierOne has built up its warehouse line-of business to $250 million in commitments among two-dozen lenders. The $238 million-asset Allegiance Bank Texas has stated plans to fill 20 percent of its total loan portfolio with warehouse lines.

George Jones, the chief executive at the $5 billion-asset Texas Capital Bank in Dallas, told an investor crowd in June that warehouse lines have become a major profit center, with $1 billion worth of loans being processed each month. "If we took the lid off of it, it could be twice as big," says Jones. "We're not going to let it grow that much, but that's how much demand there is."

Corso says these efforts are important to recovery of the warehouse line market. "But that's going to take awhile to get done," since most of the mortgage group's members are red-lining at 90 percent or more capacity on their lines, he says. Getting big-bank lenders and the GSEs more into the picture will be needed long-term for the health of independent mortgage bankers, who produce 40 percent of current originations. "Without warehouse lending, it's really disruptive both to homebuyers and people's lives," he says. "That's what we're trying to avoid."

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