In a case that could set a precedent for participants in warehouse loans that go sour, a subsidiary of Chase Manhattan Corp. has been sued for allegedly poor monitoring of a $185 million line of credit to a failed Michigan mortgage company.

Guaranty Federal Bank of Dallas claims that Chase Bank of Texas "failed in a number of respects to fulfill its duties and obligations" as warehouse agent and collateral custodian in the syndicated warehouse line for MCA Financial Corp. of Southfield, Mich.

The suit, filed in U.S. District Court in Texas, accuses Chase of gross negligence and willful misconduct, breach of contract, and breach of fiduciary duties. It seeks unspecified damages. Warehouse bankers say they will be watching the suit closely because of the implications for other deals that have blown up in the last 18 months.

Warehouse lenders supply interim financing while mortgage banks wait to sell loans in the secondary market. The lines are usually secured by home loans held for sale. Such arrangements are often the lifeblood of small, independent mortgage bankers, many of which ran into liquidity problems last year.

National Mortgage News, a sister publication of American Banker, ranks the Chase unit, formerly Texas Commerce Bank, No. 2 in this activity, with $3.3 billion of commitments as of Dec. 31, 1998.

MCA set up the $185 million warehouse line with Chase as the lead bank in October 1997. In the suit, Guaranty Federal said it committed $25 million to the facility and had advanced $22 million by the time MCA defaulted.

Bank One Texas, LaSalle National Bank, and Bank of New York also participated in the line, the suit says.

As agent, Chase was required to make sure every loan financed under the warehouse facility was eligible collateral that complied with procedures outlined in the credit agreement before disbursing any funds, the suit says.

On Dec. 30, 1998, MCA defaulted on certain provisions of its warehouse line. The company was under several financial difficulties, as the fall 1998 liquidity crisis had made subprime loans - a major part of its business - difficult to sell in the secondary market without taking losses. MCA also had extended loans to an affiliated property management company, Rimco, which was losing money.

In January, Guaranty Federal's suit says, it learned that a number of loans pledged as collateral to the warehouse lines "did not comply with the standards and procedures set forth in the credit agreement and therefore should not have been funded."

MCA failed in January. A conservator now has a plan to liquidate the company's assets.

After MCA closed its doors, state officials found evidence that MCA had double pledged some collateral to the warehouse lenders. The extent of the problem is still unclear, said Timothy Skillman, principal of BBK Ltd., the turnaround firm that has taken over MCA. In March, Patrick Quinlan Sr., MCA's former chairman, told American Banker that the double pledging was accidental.

Brad Johnston, general counsel for Guaranty Federal said it is the bank's policy not to comment on pending litigation. Chase also said it does not comment on matters under litigation.

MCA is one of several mortgage companies to have caused major headaches for warehouse lending banks recently. United Companies Financial Corp. and Harbor Financial Group went bankrupt this year, and PNC Bank Corp. - which had exposures to both companies - decided in October to exit warehouse lending.

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