Warehouse Lending in the Post-Recession Era
Thursday, 12 November 2009 10:19
The lifeblood of any healthy industry is the availability of credit. In the mortgage industry, that lifeblood is the availability of warehouse lending—short-term funding that enables mortgage bankers and mortgage brokers to sell their loans into the secondary market and thus compete with depository institutions many times their size.
Unfortunately, in the wake of the credit crisis and the ensuing recession, the warehouse lending market has virtually collapsed, contracting over 90% according to some industry experts. The reverse mortgage industry has been hit especially hard as a number of retail and wholesale lenders have experienced funding curtailments or ceased doing business altogether.
Thankfully, the warehouse lending environment is beginning to show signs of improvement. However, the reverse mortgage industry faces a new challenge in the post-credit crunch era—the inability of many warehouse lenders to fund reverse mortgages. Despite clear evidence that the reverse mortgage industry is in far better shape than the forward mortgage industry, some warehouse lenders are struggling to accept this reality and their refusal threatens to stunt the future growth of the industry.
Background
For almost two decades, from 1989-2007, the reverse mortgage industry led a relatively sheltered existence. Lenders who specialized in reverse mortgages toiled in near anonymity, impervious to the ebb and flow of interest rates and turmoil in the forward mortgage market. Capital was relatively cheap and plentiful as Wall Street investors and foreign investors gradually joined Fannie Mae in the reverse mortgage arena. The resulting burst of competition generated record profits for the industry, and the sky, it seemed, was the limit.
Not surprisingly, during that same period, warehouse lending was also quite accessible, enabling mortgage firms of all sizes to gain entry into the reverse mortgage market and grow as much as their profits dictated. At one time, according to the Warehouse Lending Project, mortgage firms that relied on warehouse lending were responsible for 41% of all loan originations in the country, and 55% of all FHA originations. More importantly, warehouse lending helped spur healthy competition and ensure that a few large lenders didn’t dominate the mortgage lending industry.
All of that changed in August of 2007 as the credit crisis spread through the economy like a plague, ravaging the balance sheets of corporate America; Wall Street investment banks that had invested aggressively in the U.S. real estate market were decimated and the resulting pullback drained liquidity for scores of mortgage products in just a matter of weeks. One by one, lenders and Wall Street firms who had engaged heavily in subprime or Alt-A lending fell victim to the onslaught.
As a result, many large and regional banks exited the warehouse lending space entirely. By January 2009, with interest rates at unprecedented low levels, the precious few warehouse lenders who remained were forced to handle an enormous volume of refinances, further straining their reserves. At the same time, hundreds of new warehouse line applicants were clamoring for new financing. Needless to say, when warehouse lenders inevitably exhausted their cash reserves, an already overloaded system officially achieved gridlock.
Meanwhile, many institutions that had received a transfusion of emergency TARP funds opted not to rush back into warehouse lending. Instead, the crisis gave pause for many of these lenders to reevaluate their entire lending strategies, with mostly inconsistent results.
Some institutions prohibited the funding of third party originations altogether, while some prohibited the funding of proprietary loan products. Some lenders merely trimmed the size of their warehouse lines or tightened the qualifying requirements for new applicants. Still others increased their transaction fees as well as their haircuts. Many warehouse lenders were forced to increase their margins as the LIBOR index continued to drop.
However, along the way, something more disturbing and insidious occurred. Somewhere in the midst of this mess, the FHA HECM reverse mortgage product was unfairly branded as a risky, unsafe loan product in a way that no other federally insured loan program has been before. It is this negative stereotype that the reverse mortgage industry must overcome in order for the industry to grow.
The Knowledge Gap
Most warehouse lending divisions are staffed with experienced professionals who possess a great depth of knowledge about the forward mortgage world. On the subject of reverse mortgages, however, there can be wide disparities in their working knowledge. A number of common misperceptions abound:
First, there is a widespread perception that Fannie Mae is the only investor that purchases HECMs. Few warehouse lenders are aware that there is a vibrant and rapidly growing market for GNMA HMBS securities. Even fewer lenders are aware that investment banks and private equity firms are in the process of reentering the HECM market to buy whole loans. What makes this misperception especially frustrating is that in the forward mortgage world there are many mortgage products that are purchased by just one investor. Yet, by comparison, the FHA HECM product is somehow seen as “unsafe” despite 20 years of consistently reliable performance.
Second, reverse mortgages are perceived as a growing liability on a warehouse line. Specifically, the negative amortization feature of a reverse mortgage means that any unfunded reverse mortgages on a warehouse line will burn through the available credit at an accelerated pace. On its face, this argument makes some sense but it’s still a rubber chicken. FHA HECM reverse mortgages are much easier to insure than forward mortgages and therefore, are much easier to fund. There’s virtually no credit, income or employment underwriting required. If a reverse mortgage lender produces a marketable, insurable FHA HECM, Fannie Mae will purchase that loan as part of a small commitment, or on a flow basis, with very few exceptions.
Third, some warehouse lenders are worried about the “headline risk” associated with reverse mortgages. Whether it’s the high fees, the litigation involving deferred annuities or just the bad press coming from Washington, some warehouse lenders are unnerved by the barrage of bad publicity surrounding reverse mortgages.
Fourth, some banking professionals who are considering warehouse lending feel that the relatively low interest rates of reverse mortgages could skew their cost of funds. In other words, in the world of short-term lending, there really isn’t much profit to be made on a loan that yields such a low rate of interest. However, many times these lenders don’t realize that the margins
on reverse mortgages have increased substantially and that transaction fees in the warehouse lending market have increased as well.
Fifth, and perhaps most widespread, is the lack of knowledge about reverse mortgages in general. The complaints of “we just don’t know enough about the product” or “that’s not a core product for us” or “we’ve never funded those before” are commonplace. In today’s environment, it’s incredibly difficult to persuade an institution to fund reverse mortgages or any other new loan program when there is such a palpable fear of the unknown.
The Industry Response
Beginning in 2009, the mortgage banking industry actively tried to bring the warehouse lending issue to the forefront of the public’s attention. As liquidity in the warehouse lending sector rapidly evaporated, major trade publications and trade organizations promptly sounded the warning bells to Congress and the media. MBA President John Courson frequently commented on the dearth of warehouse lending in his appearances on Capitol Hill, as did other industry leaders. Mortgage trade publications, especially the National Mortgage News, regularly featured articles on the warehouse lending crisis. The Warehouse Lending Project, a coalition of mortgage lenders dedicated to providing expert commentary and statistical data on the issue, worked to engage policymakers and industry experts on all levels and continues to do so.
The intense lobbying effort has generated some interesting policy ideas, including a proposal to have Ginnie Mae provide short-term guarantees for loans that are packaged into Ginnie Mae securities. In a more recent development, policymakers are debating whether to have Fannie Mae and Freddie Mac provide similar short-term guarantees, or participations, directly linked to warehouse lenders funding GSE-backed loans. Unfortunately, no major policy initiatives have yet been implemented. More importantly, while the recent lobbying effort has certainly helped raise awareness about warehouse lending in the forward mortgage world, virtually none of the lobbying has addressed the lack of liquidity in the reverse mortgage sector.
Next Steps
At some point, the U.S. economy will rebound and many of the problems in the credit markets will heal themselves. However, unlike any recession since 1973-1975, the recession of 2008-2009 has brought about major structural changes to our economy, especially in the area of residential real estate lending. It’s a brave new world and the warehouse lending environment is but a microcosm of our new reality.
Without adequate warehouse capital to fund reverse mortgages, new lenders will find it much more difficult to enter the market. Existing reverse mortgage lenders who are not depository institutions or not well-capitalized will have difficulty sustaining real growth. The worst-case scenario is that the industry collapses down to a small group of lenders, sapping itself of political and financial strength and dramatically reducing competition in the marketplace.
Ensuring a healthy future for our product requires that our industry adopt a new paradigm, one in which comparisons to the forward mortgage world are made at every step, such as:
First, the banking industry must be made to understand that reverse mortgages are much safer than forward mortgages. For starters, reverse mortgages have a much lower foreclosure rate
than forward mortgages. Reverse mortgages also require borrower counseling, and thus have much lower suitability and steering risks. Owing to the additional credit, employment and income requirements, forward mortgages have a much higher incidence of fraud. In the area of proprietary lending, most reverse products have closely mimicked the sound lending principles of the FHA HECM, whereas scores of flawed proprietary products in the forward mortgage world were responsible for the collapse of the mortgage industry. Finally, forward mortgages have a far less regulated fee regime—junk fees and mark-ups are practically routine. That reverse mortgages are much safer than forward mortgages should be plainly self-evident.
Second, we must reach out to the banking community in general, and the warehouse lending sector specifically, and engage them about the realities of today’s reverse mortgage market. After all, the FHA HECM program is a 20-year old, federally insured program. It’s anchored by a government sponsored enterprise and supported by a number of investment banking and private equity firms, as well as a rapidly growing GNMA market. HECMs are heavily regulated and safe, and they contain a number of innovative, borrower-friendly features that are unique to the mortgage world. Congress has added its endorsement, significantly expanding the HECM program by enacting a higher national loan limit and adding the HECM for Purchase feature.
Third, the “headline risk problem” facing our industry must be addressed. Here again, from a pure social justice perspective, a reverse mortgage is far more compelling than a forward mortgage. The FHA HECM Reverse Mortgage Program has significantly enhanced the retirement security of thousands of senior citizens, many of whom would otherwise have been forced out of their homes. That critical message cannot be drowned out by media coverage of isolated incidents that occur on the fringes of our industry. Forward mortgages may allow families to purchase their first home or refinance to a lower rate, but reverse mortgages allow our seniors to remain independent and keep their homes. We owe them this program.
Final Thoughts
Even the most cynical observer would agree that healthy competition is a prerequisite for good business. The reverse mortgage industry is certainly no exception to this rule. However, healthy competition can only exist when small to medium-sized companies with strong balance sheets are able to compete alongside much larger institutions. The accessibility to warehouse lending continues to be a major challenge for our industry. To maintain and expand warehouse credit facilities in the post-recession era is going to require a concerted effort. The rewards for this effort are right in front of us--in the final analysis, seniors are better served by a vibrant and robust reverse mortgage industry.
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