Mortgage warehouse lending can be highly profitable for banks. With many of the market’s incumbents heading for the exits, it would seem like an attractive time to get in.
The question is how: buy one of the operations that have been put up for sale, such as those of Bank of America or MetLife, or start a warehouse division from scratch?
To purchase a major warehouse lender, a bank must have a liquid balance sheet and be ready, at a minimum, to support the established warehouse line commitments, which can be significant (MetLife’s are estimated at $1 billion). These calculations will not include the potential for vertical integration – such as the opportunity for the bank’s correspondent mortgage arm to buy closed loans from warehouse clients – which would increase returns substantially.
Bank of America had about $12 billion of outstanding warehouse line commitments and $7.2 billion to $8.4 billion in outstanding loans as of Sept 30, 2010. Those commitments had dropped to $5 billion a year later. To consider buying the warehouse business from the $2.5 trillion-asset Bank of America, an institution would need the capacity to hold these loans on its balance sheet for 15 to 20 days.
No interested bank would be large enough to absorb this business. That is why B of A has been shrinking the outstanding commitments and shifting some portion of the business to its Merrill Lynch unit. Many warehouse lenders have been expanding their portfolios as mortgage bankers have been scurrying around to replace their B of A lines.
To absorb a large warehouse facility would require purchasing the whole bank, not just the warehouse business. During this cycle, two banks have done this, and only one of them wanted any part of the warehousing operation it got as part of the deal.
More than a decade ago, PNC shut down its warehouse facility. It inherited another one with the takeover of National City. Keeping with its business model, it shut down the Nat City warehouse facility even though it was very profitable. (Interestingly, Kevin Rost, who headed sales at PNC’s warehouse division, is now at the $3.2 billion-asset Republic Bank in Louisville, Ky., where he put together a warehouse operation in 2010 from scratch. His former cohort at PNC, Paul Best, put together a similar operation that year at Peoples United Bank, the largest regional independent bank in New England with $27 billion of assets. Today, Republic has $500 million of warehouse commitments outstanding and Peoples has $225 million.)
BB&T already had a small regional warehouse operation and a strong balance sheet when it took over Colonial Bank from the FDIC, so it was able to absorb part of the failed bank’s warehouse business. It decided to keep only the portion serving areas where BB&T is established, the Southeast and Mid-Atlantic. The $168 billion-asset bank now has about $2 billion in commitments.
The MetLife situation is a bit different. MetLife has about $1 billion in commitments and at least $500 million of outstanding loans. The insurance company has $535 billion in assets and has stated that its want out of the mortgage origination and warehouse businesses (though not reverse mortgages … yet).
Aside from Republic Bank and Peoples Bank, a few community banks have started warehouse operations, such as Silvergate Bank in San Diego, which opened its division in April 2009. The bank has $434 million of assets and its warehouse arm has funded, as of Sept. 30, $2.4 billion of mortgages for clients. It’s extremely profitable. Another de novo that has been started by an experienced warehouse manager is at Community Trust, a regional in the Southwest with assets of $1.9 billion that now has $288 million in commitments within 12 months of operation.
Let’s take a look at the simple arithmetic of a de novo operation. You’re funding mortgages with Federal Funds that cost at least 13 basis points, and the rate of interest on the mortgages is 4%. Your spread profit for the time you hold the loans on the warehouse line is 3.87%. Let’s round that up to 4%.
You warehouse the loans for 15 days before they are purchased. The average size of a loan headed to Fannie Mae, Freddie Mac, or Ginnie Mae is roughly $250,000. Your per-day profit would be around $30, so for the 15 days your gross would be $450. Assuming you did $100 million for the month, your gross would be $180,000. If your cost of funds using deposits only is 1%, then your profit still would be 3% per loan or $135,000 for the month. This would amount to $2.2 million to $1.6 million per year gross.
That’s not counting the fees collected for each loan file. Nor does it take into account a side benefit of having the warehouse client deposit cash in noninterest-bearing accounts. Typically there’s a pledge account that serves as collateral for the warehouse line and an operating account that funds a small portion of each mortgage. These accounts are there to protect the bank, but they also lower its cost of funds, since they do not bear interest.
The core strategy is to operate at a low cost. The costs of a de novo are processing and variable costs of technology (one basis point); provision for losses (five basis points); compensation (seven basis points); and interest expense, which can run up to 31 basis points (assuming the operation is funded entirely with deposits, not Fed Funds). Total tab: a mere 44 basis points per loan. It should not take any longer than 120 days for a brand new warehouse lender to fund its first loan.
So why would a bank want to purchase an existing operation? The only way it might be cost effective is if the bank, like BB&T, had an infrastructure already in place and balance sheet capacity and the cost was nil.
If a warehouse facility is for sale, the mortgage bankers are already in the process of finding a new home, as B of A’s clients are doing. Those relationships may not be there by the time the deal closes. So what are you buying?
Barry Epstein is a mortgage industry consultant in Los Angeles.