If you ask almost any mortgage banker what the biggest issue is in mortgage banking these days, you will probably get the same response from 98% of them: The crisis is, quite simply, the lack of warehouse lines.
The situation is serious enough that this crucial but normally ignored form of commercial lending has drawn the attention of regulators and Congress.
Only two years ago there might have been well 30 to 35 banks or Wall Street firms offering credit lines that allowed independent mortgage bankers to hold (i.e., "warehouse") mortgages for the two or three weeks between their closing and their sale to permanent mortgage investors. Today we can think of only half a dozen lenders offering new warehouse lines.
Over the past several months we've seen announcements from Banco Popular, UBS, Credit Suisse, JPMorgan Chase, National City Bank and Guaranty Bank that they are exiting the business. Washington Mutual and Citigroup had once been the two biggest warehouse lenders. Wamu is gone, and Citi closed down this division about a year ago.
Why is this happening?
First, the word "mortgage" has become a four-letter word. Boards don't want to have anything to do with mortgage lending, even if warehouse lending is different from mortgage lending.
Second, banks are desperate for or stingy with capital, and warehouse lines compete with other forms of lending for that precious capital.
Third, though warehouse lending is generally a very safe business, it can incur some losses if the lender does not have proper controls and expertise.
Interestingly, the banks that have exited the business recently have strong track records of profitable warehouse lending, so it's more likely that they have exited because warehouse lending is not strategic for them, or because they want to preserve capital.
If a bank must increase its capital ratios and cannot raise enough new capital, the only real alternative is to shrink assets.
And with warehouse lines typically being written for no more than one year, letting them run off without issuing new ones is perhaps the quickest way to shrink.
On the other hand, warehouse lending is a great business. Demand is currently very strong from high-quality independent mortgage bankers, whose shareholders typically provide personal guarantees.
But warehouse lending is a specialized business best managed by experienced commercial bankers. Mortgage bankers are subject to numerous origination, secondary marketing and other financial risks, and the warehouse lender needs to understand them thoroughly.
The lender must strike the right balance between prudent credit guidelines, solid counterparty risk analysis, tight operational controls, vigilant collateral monitoring and attractive pricing.
Banks who do this properly will earn some of the best risk-adjusted returns and consistent borrowings available in all of middle-market lending.
The future of warehouse lending is tied to the future of the independent mortgage bankers. Observers have predicted their demise for the past 30 years. However, we believe that independent mortgage bankers are here to stay, and that they will get the funding they need.
We expect large mortgage investors and the agencies to buy loans faster from the mortgage bankers, allowing them to stretch their remaining lines further.
We expect quality mortgage bankers to arrange for forward sales of, say, $100 million over three months with small depository institutions such as credit unions or community banks, which can fund the mortgage banker's originations at the closing table.
Perhaps most importantly, we expect new commercial bank entrants — primarily regional banks and small community banks — to seize the opportunity to enter a business long dominated by the largest banks in the nation. If they do, they'll be entering one of the most attractive niches remaining in the entire middle-market lending business.