Regulators: Take Steps to Recognize Warehouse Lenders’ Important Role in Today’s Housing Finance Market

This is a difficult time for the housing industry, and those challenges extend to all corners—not only mortgage lenders but also the warehouse lenders, vendors, title companies, and real estate agents that support the housing and mortgage finance ecosystem. Over the past 24 months, there has been a sharp pivot from historically high origination volume—spurred by record-low interest rates—to a rapid slowdown in home sales and origination volume driven by higher interest rates and tight inventory.

According to MBA’s data, total origination volume was cut in half from an all-time high in 2021 of $4.436 trillion to $2.245 trillion in 2022, and we expect the number to be even lower in 2023. For better or for worse, real estate finance remains a cyclical business. But it’s also a resilient business.

Over the last couple of years, we have seen some necessary “right-sizing” of the industry to reflect the dramatic shift in production volumes. Consolidation in the housing and mortgage industries is ongoing. Some 600,000 real estate agents have left the business. New mortgage insurance written (NIW) and title insurance revenues are down sharply. We have seen a number of lenders merge or exit the mortgage origination business, and we are now seeing some institutions exit the mortgage warehouse lending business.

Concerning warehouse lending, observers and policymakers should see this for exactly what it is—market forces at work, part of a necessary and predictable recalibration in the face of declining transaction volumes and revenues. This will likely continue until we achieve market balance, and we shouldn’t be surprised to see similar shifts in bank business models or product lines.

Warehouse lending is an essential and irreplaceable form of liquidity for the mortgage market—connecting Wall Street to Main Street to provide broad mortgage credit access for borrowers across the country. It’s the oil in the engine of our housing finance system and a critical source of liquidity for the IMBs that provide more than 60% of mortgage originations today. Warehouse lending is a safe, attractive business, secured by high-quality, well-underwritten mortgage loans as collateral, and has shown resilience through changing market cycles.

Due to the precipitous drop in origination volumes, there is today excess capacity in the warehouse finance market, which is why some are choosing to scale back or exit. It makes sense, therefore, that the players who remain in the space should see higher usage levels and, over time, increased profitability as a result of the reduced competition.

Some observers may point to the recent exit of a handful of warehouse banks from the market as evidence of some fundamental instability in the independent mortgage banking business model. While it is important to remain vigilant, a fairer reading of the situation suggests this is a natural response to declining demand for warehouse funding that should reverse when mortgage market demand returns. Even today, some new entrants see opportunities in the warehouse lending space.

As demonstrated in 2020, the warehouse market is capable of responding to sudden shifts in market demand in both directions. Warehouse lenders and their clients stood together to keep credit flowing for borrowers during the chaotic onset of the COVID-19 pandemic, and during the boom in originations that followed.

This is not to say that there aren’t actions that policymakers should take to ensure the stability of the warehouse funding market. Current risk-weighting requirements in bank capital rules greatly exceed the level of risk represented by warehouse lending and the underlying mortgage assets that collateralize the lines. This clearly has a punitive impact on banks that choose to remain in the warehouse business, as well as a chilling effect on potential new entrants to the space. Moreover, larger regional banks—a critical source of liquidity for warehouse financing—could be subject to further capital charges as part of the forthcoming Basel 3 “endgame” capital rules, making the problem even more severe.

An indiscriminate increase in capital charges for mid-sized and regional banks, particularly without fine-tuning for key assets in the mortgage finance sector, could exacerbate already challenging conditions in the housing and mortgage markets. Two key regulatory changes should be considered:

• Reduce the risk weighting on warehouse lending facilities to align with the risk weighting on the underlying collateral. Under current rules, a warehouse line secured by single family loans is assigned a 100% risk weight. If those same loans were taken on balance sheet by the bank in the event of default by the mortgage company, the risk weighting would be cut in half. This makes no sense—for single-family mortgages that meet agency and GSE guidelines, regulators should reduce the risk weighting from 100% to 50%.
• The Federal Housing Finance Agency (FHFA), as the regulator of the Federal Home Loan Banks (FHLBs), should ensure that advances from the FHLB system remain available to support warehouse lenders through all market cycles. Some FHLBs do not permit advances against warehouse line of credit, even though the collateral directly supports housing finance activities.

Even in this challenging market, millions of new mortgages will be originated this year. The warehouse lending community has more than enough capacity to fulfill that demand. Regulators can help by taking steps that recognize the important role warehouse lenders play in today’s efficient housing finance market.

Editor’s Note: This article was originally published by the Mortgage Bankers Association at: https://2thepoint.blog.