Although warehouse lending is often referred to as a high-risk, low-return business, there are a limited number of warehouse lenders. Large national lenders have either left the market or restricted their lending to large customers with very specific products.
The majority of second-tier lenders are focused primarily on their product’s early purchase programs.
Banks in the community and regional areas are more sensitive to the needs and wants of customers and will not rush to enter a business line that has been dropped by long-term, large players. MHRA approved warehousing UK
Lenders are unlikely to be discouraged from the warehouse business because of high demand. The most likely reason for the shortage in providers is the perception of risk. However, risk can be managed and prepared for profitably.
What’s the danger?
Let’s take a look at the business to better understand the risk. The customer of the warehouse lender is a mortgage bank that makes consumer loans, closes loans under its own name and then sells the loans to takeout investors. This is done under pre-existing correspondent loans which allow for, among other things, the seller to repurchase loans with defects (including fraud) or that fail within a specified time.
The customer should identify the loans it wants to finance within 24 hours of closing. To do this, the warehouse lender must receive a funding request from the customer along with the required pre-funding documentation under the warehouse lending agreement. The warehouse lender has not yet closed and the money will be transferred to the closing agent prior to final documents.
The warehouse lender will receive the final documents necessary for the warehouse lending agreement after closing. The customer then assembles the remaining investor package and fulfills all conditions. Once the investor package has been received by the lender, the warehouse is notified and the package’s balance (principally the original Note), is shipped to the designated takeout investor.
The takeout investor receives packages from the warehouse lender and mortgage lender. It gives them a cursory look and then wires funds to the warehouse representing the correct purchase price. It sends a Purchase Advice detailing the amount wired into the warehouse to the mortgage lender via e-mail or fax, and also provides its website.
The wired funds are applied by the warehouse lender to the mortgage lender’s obligation, as stipulated in the warehouse lending contract. The principal outstanding on the item will be reduced and associated charges will either pay or be billed according to the warehouse lending agreement.
As a generalization, I use the term “warehouse loan” to describe transactions that include pure lending transactions, purchase-and-sale transactions, and repurchase transactions. Although there are some differences between the three options, the basic scenario is the following: The customer selects a buyer and enters into an agreement. Once the product has been delivered and inspected, the buyer pays the seller.
This sounds like factoring. This sounds like factoring, but warehouse lenders aren’t as familiar with asset-based lending.
As such, they tend to focus on the customer’s P&L, balance sheet, and credit history, just as they would for any commercial customer. It seems that warehouse lending is a case where the primary source of repayment, and, realistically, the only, is liquidation of collateral. This is a backwards analogy to a cash flow lender.
Not only liquidation of collateral is the primary source of repayment, but also consistent and timely liquidation at or above the pricing necessary to generate a net operating profit out of net sale proceeds is the primary source of repayment. After the warehouse lender’s fees are paid, the net sale proceeds is what the customer receives.
Look at any mortgage banker’s financial statements and determine how much you can subtract from loans that are being sold to trigger insolvency. Divide this number by the average loan amount of that customer. This is the average number of unsaleable loans that it will take to get the customer into the tank. It is usually not a large number.
Although it is possible to offset the loss by finding another buyer for every loan that has been rejected, this will take time. A holdback is common for the alternative buyer. It is usually 20% of the agreed sale price for one year. A holdback and extra time required to close a “scratch-and-dent” sale can have significant liquidity implications.
The egg packer was my first customer who used assets other than the garment industry. Although the plant was kept clean and tidy, you wouldn’t want it to get downwind on a cold day. According to a worker, “the more eggs that you put through, then the more they hit the floor.” In this regard, the mortgage origination industry is similar. It has a very small percentage of loans that reach the floor and a high odor.
Any more than a few bad loans can have two consequences for the originator: the cash effect of having the loan rescinded and the possibility of the buyer completing more QC. This will increase the time it takes to complete the purchase, as well as increasing the chance of finding more loans that could be rejected. Future pricing could also be affected by rejected loans. They reduce the seller’s pull through rate and cost the buyer review time.
Even if a few loans are rejected, it doesn’t mean that the customer will die. If the loan conditions that led to the rejection are not cured, it is likely that the customer will lose the loan and the warehouse will take over loans with a lesser value than the amount financed.