The share of the mortgage market occupied by independent mortgage banks (nonbanks or IMBs) has grown substantially in recent years.
As traditional bank lending has receded, IMBs and the warehouse lenders that extend them credit have filled a void.
Yet misperceptions about the warehouse lending market and IMB liquidity persist.
According to the recent FSOC 2019 Annual Report, “Nonbanks often obtain liquidity from warehouse lines provided by banks, and these lines can be a significant portion of nonbank liabilities. In times of significant stress, warehouse lenders may face strong incentives to cancel the lines and seize the collateral as quickly as contractually permitted.”
Unfortunately, this narrative is misleading and must be addressed.
Warehouse lending’s role in real estate finance
Let us first acknowledge that warehouse lending is a critically important part of real estate finance. Over the last decade, the number and diversity of warehouse lenders have grown significantly to provide the liquidity needed for IMBs to support the housing recovery.
Warehouse lenders typically extend lines of credit to IMBs in order to fund the issuance of their loans, with the intent that these loans will be sold to the secondary market within a short amount of time – typically within two to three weeks.
In today’s market, the vast majority of these loans meet standards set by Fannie Mae and Freddie Mac or Ginnie Mae. IMBs today originate high quality, sustainable loans. As a result, the loans that serve as collateral for the warehouse line of credit are high-quality mortgages that have a deep and liquid “take-out” market should an IMB ever run into trouble.
Because of this business model, warehouse lenders manage risk from both a collateral standpoint as well as a counterparty credit standpoint.
Warehouse lending risk is substantially mitigated because the warehouse lenders control the collateral. The warehouse lender has possession of the loans and can quickly protect its interests.
Risk is also managed by tracking the number of days between funding and sale based on the delivery expectations (whole loan versus MBS trade). And typically, loans have curtailment provisions once the loan or collateral has aged on the warehouse line past a reasonable expectation.
Weathering the market cycle
This approach – short-term credit lines backed by high-quality collateral saleable into a deep and liquid market – is one of the reasons warehouse lenders can weather various market cycles.
The protection provided by the GSE and Ginnie Mae take-out gives warehouse lenders comfort that the loan will sell either by the mortgage banker or, in a worst-case scenario, by the warehouse lender.
More than likely, if a warehouse lender were to pull its lines, it would be because of fraud, a material and sustained warehouse line covenant violation, or bankruptcy/failure of the IMB. Pulling a line of credit for reasons other than these would create the very problem warehouse lenders seek to avoid.
So, what happens if an IMB goes out of business due to mismanagement or a lack of cash or capital?
When this happens, the warehouse lender assumes control of the loans through the agreements and/or possession of the collateral. Depending on the stage, the warehouse lender then delivers the loans to the investors through its own mortgage company or retains it for its own portfolio. With a diverse customer base and a liquid takeout market, it is highly unlikely that warehouse lenders would collectively pull all their lines of credit at the first sign of trouble or a market downturn.
Indeed, over the last decade, some IMBs have failed. However, they have not posed a systemic risk during this time given the large numbers and diversity of IMBs in the marketplace.
Much has changed since the 2008 recession. The multitude of new federal regulations and rules has created a lending environment that is safer than ever before. Warehouse lenders and IMBs are an important component to this new reality.
Policymakers, regulators and other housing stakeholders should look to both as a beacon of stability and strength in the financial markets – not a source of systemic risk.
Mike Dunlap is the president and CEO of Merchants Bank of Indiana and a member of the Mortgage Bankers Association.