INVESTMENT BANKS are offering mortgage banks a new type of financing that is encroaching on turf traditionally held by commercial lenders.

"Wet gestation repos," as Wall Street has dubbed the new instrument, are repurchase agreements that allow mortgage banks to borrow against mortgages pending sale into the secondary market from the moment the loans are in the hands of the mortgage bank - in other words, while the ink on the mortgage bank - in other words,

Pioneered earlier this year by Donaldson, Lufkin & Jenrette Securities Corp. and now offered by PaineWebber Inc., wet gestation repos are the latest example of investment banks replicating the functions of mortgage warehouse lending.

"The investment banks are certainly moving earlier in the food chain," said A. Donald Pray, head of mortgage lending at Bank of New York.

Until recently, mortgage banks that wished to borrow against mortgages immediately after the loans closed could do so only through mortgage warehouse lines, typically provided by a syndicate of commercial banks. Generally, mortgage warehouse lines allow for a sublimit of such borrowings, usually between 10% and 35% of the entire facility.

Breaking Free of Limits

However, this year's furious pace of originations caused some mortgage banks to bump heads against these sublimits.

It was into this vacuum that investment banks stepped. "We wanted to provide the funding our clients needed," said Rod Enrico, senior vice president at Donaldson, Lufkin & Jenrette.

From a mortgage banker's perspective, wet gestation repos almost always carry lower coupons than the equivalent mortgage warehouse lines. However, the funding cost is not the only part of the economic equation. Unlike syndicated loans, which generally have collateral agents to keep track of the loans, users of gestation repos must undertake that function themselves or employ a third-party collateral agent.

Some industry observers are also concerned that so many mortgage banks are financing themselves through uncommitted investment bank lines, a situation that could prove perilous in the event of a downgrade. Mr. Enrico, however, has noted increasing numbers of mortgage banks seeking committed repurchase lines.

Highly Lucrative

For their part, investment banks finance mortgage companies because the banks can make money, a lot of it, securitizing the mortgages. "These guys don't exactly walk around wearing Santa Claus hats," said Bank of New York's Mr. Pray.

Wet gestation repos are the third type of repurchase agreement widely used by mortgage banks. Investment banks began by providing "gestation repos," which fund loans from the time they receive a guaranty from a secondary agency until they are sold in the market. Last year, the "dry gestation repo" developed, which allows borrowing against loans that have documents at a custodian but with funds not yet advanced.

Certainly, investment banks are a huge source of funds for mortgage banks. Estimates for the amount of gestation funding currently in effect range from $ 10 billion to $15 billion. By comparison, syndicated mortgage warehouse loans total around $24 billion, according to Mr. Pray.

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