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A perfect union.

GMAC Residential Funding Corporation seized an opportunity to enter the warehouse business by acquiring American Security Bank's successful unit--lock, stock and barrel.

Waves of new, so-called nontraditional investors have been coming into the servicing side of the mortgage banking industry for more than a year now. And in years past we've seen major coporate investors enter the field of mortgage banking for the first time with major acquisitions of whole companies.

Seeing new players enter specific niches of the mortgage banking business is not all that surprising or noteworthy. Yet, certain moves by companies still can generate considerable interest--particularly when the acquisition implies a strategic edge for the company in its existing business line.

Such is the case with Bloomington, Minnesota-based GMAC Residential Funding Corporation (RFC), an indirect subsidiary of General Motors Acceptance Corporation (GMAC). RFC acquired the mortgage warehouse lending unit of Washington, D.C.-based American Security Bank (ASB), a subsidiary operation of Maryland National Bank, Baltimore, in March 1991. A little more than a year later, the warehouse lending unit is a thriving, fully-integrated division of RFC. The 70 percent increase in warehouse lines since the acquisition is evidence of a successful integration.

Warehouse lines are used by mortgage bankers during the period between the funding of mortgages and their sale into the secondary market or their securitization. After it was decided to purchase the ASB warehouse unit, the chief financial officer of RFC had direct responsibility for the acquisition and integration process to an RFC-supported warehouse unit. It was evident from the beginning that a project of this magnitude was best handled by one person as opposed to a committee.

The purchase of the warehouse unit representd RFC's entry into a new line of business, separate from its primary business of investing in jumbo residential mortgage loans. The loans are privately securitized and sold to institutional investors worldwide. For the past several years, RFC has been a leading issuer of private-label mortgage-backed securities (MBS).

The prevalent need for additional warehouse resources and the excellent opportunity to purchase a well-established lending operation catapulted RFC into the warehouse lending business. To outsiders it may seem as though RFC became a strong player in the warehouse lending arena overnight. "Although the warehouse lending division was integrated in less than 90 days, it's been part of our strategic growth plans for more than four years," says Mark Korell, president and CEO of RFC. "The addition of warehouse lending is an extension of our basic business and reaffirms our commitment to the mortgage finance industry," Korell explains.

Demand up...supply down

The acute need for additional sources of warehouse financing came in 1990 when the mortgage banking industry hit a pivotal point. During the past few years there has been an increase in production for mortgage bankers. According to HUD statistics, mortgage bankers' share of single-family originations totaled $50.1 billion, more than 50 percent of the total $99.8 billion single-family originations for the first quarter of 1991. This represents a 20 percent increase in originations over the same period in 1990. (Real Estate Finance Today, December 2, 1991).

As illustrated in Figure 1, in 1989 mortgage bankers' share of originations exceeded that of S&Ls for the first time in the history of mortgage lending. This has been attributed to both increased regulatory concerns and a favorable fixed-rate market environment.

In 1989, the mortgage origination market became a much more level playing field as the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA) and other regulatory pressures shrunk S&Ls' portfolio capacities, due to higher levels of capital required. This forced competitive secondary market pricing for all mortgage originators. At the same time, interest rates began dropping, which fueled fixed-rate originations and played to the strength of mortgage bankers.

While S&Ls' origination share decreased, banks' share of the market increased, because those banks with mortgage banking subsidiaries could compete in an environment not dominated by $&Ls. Although banks reaped the benefit of weakened competition from S&Ls, they could take only a portion of the extra volume in the market because regulatory constraints--particularly risk-based capital rules--affected banks as well as S&Ls.

All these variables led to a substantial increase in mortgage bankers' share of the market. This trend continues today, and it is a watershed time for the mortgage banking industry. But, as the opportunity for volume increases, so does the challenge of finding alternative sources of warehouse lines.

Entering the warehouse market

The traditional sources of warehouse lines were banks. But these institutions have been enduring increased pressure to reduce assets and/or raise capital.

Banks' reasons for tightening up or withdrawing althogether from warehouse lending are twofold.

First, warehouse lines have historically been a secondary business for banks, and with regulators putting this type of lending in the 100 percent risk-weight category for capital purposes, banks are choosing to invest in more traditional, retail-generated assets. Second, selling real-estate-related assets is one way many banks have chosen to offset increased bank regulatory pressures and the scrutiny of all their real-estate-related loans.

The entities that rely most heavily on warehouse lines, mortgage bankers, make up a large part of RFC's core business clients. Day-to-day contact with these customers convinced RFC there was a need for funds in the market. The next step was to conduct a feasibility analysis to research what it would take to successfully compete in the marketplace. Four basic components came to the forefront: * Supply and demand--Ability to

define the supply and demand for the

lines while effectively and

efficiently serving customer needs; * Risks--Competence to manage the

risks involved: * Competitive pricing-- Capability of

tapping an economical source of

borrowings in order to price

competitively to attract business; and * Tapping nontraditional

investors--Experience and proficiency in

tapping nontraditional investors

through securitization or other

creative vehicles.

Using these four key components as a guideline to what was required for a successful warehouse lending operation, each was evaluated in light of what expertise was needed and how entering this market would complement the current core business of RFC.

In addition to meeting customers' needs, it became apparent that entertaining the lending business would allow RFC to penetrate new markets by offering financing for products not necessarily tied to jumbo loans.

Supply and demand

As detailed earlier, it did not take a rocket scientist to conclude the demand was steadily increasing for warehouse lines as mortgage bankers originated more of the total share of home loans. And, at the same time that demand was climbing, the available supply of warehouse credit was substantially decreasing. This basic demand/supply imbalance elevated the need for warehouse credits. Through various vehicles such as the RFC Advisory Board and phone calls from individual clients, RFC heard a resounding need for lines, RFC decided it was important to bring the service to existing clients at a time when other suppliers of warehouse credit were leaving the business. The next step was to pinpoint the risks.

Risks

Three risk categories were defined, the first being the relationship risk or the risk of fraud. Having been a leading private mortgage conduit for more than nine years, RFC has spent its resources establishing and maintaining good customer relationships. The focus on relationships is a key in battling the risk of fraud in RFC's core business and now with its warehouse lending unit.

Jim Noack, president, Monument Mortgage, Inc., Walnut Creek, California, concurs with RFC's focus. He explains, "In a warehouse unit, the two most important things are first to have employees who understand warehouse lending processes and the collateral, and second, to be sure you know [with whom] who you are doing business.

"There's a great need to stay on top of that, to not let your credit deteriorate. These two things override everything else. Without them, you open yourself up to fraud, and nothing else matters."

RFC's relationship focus was a welcome one for Lawrence Pendleton, former senior vice president of ASB's warehouse unit and current senior vice president of RFC's warehouse unit, "It was pleasing to see the firm so relationship-oriented; this philosophy fit with well our business."

Terrance Hodel, president and CEO of IMCO Realty Services, Santa Rosa, California, comments, "As an RFC seller and a warehouse credit customer, I like the idea of a relationship which is multidimensional. Our personnel can develop working relationships with their counterparts throughout RFC. This is a strength RFC and other nontraditional warehouse lenders can bring to the market."

The second risk RFC defined was in evaluating collateral, or credit, risks. These risks are different in some ways but are similar, overall, for a lender versus a buyer of loans. For a lender, it is critical for collateral to be properly managed, mitigating the risk of loss, mishandling, non-delivery, or inability to secure a first lien on the collateral.

The third risk was the management risk. The ability to properly manage the business of lending and recognizing and taking advantage of market opportunities in order to grow the business is imperative. Without proper management a lending organization opens itself up to allocating resources to areas representing more risk than reward.

In the final analysis, RFC concluded that the risks involved in the lending business, although somewhat different, closely resembled those it already effectively managed on a daily basis in the purchase and securitization of jumbo loans. Furthermore, purchasing a warehouse unit such as the ASB unit, which was already functioning and properly managing risks, meant RFC could look to ASB's experienced staff to continue to manage the risks that were unique to warehouse lending.

Bruce Paradis, executive vice president of marketing of RFC, explains, "The business of warehousing is a natural extension of our core business. There are, however, unique differences that require the talents of experienced lending personnel." Having concluded that the risks involved were manageable, RFC focused on the next component: competitive pricing.

The key to competitive pricing in the warehouse lending business and RFC's core business is having access to a viable source of borrowings. Backed vy the strength of GMAC, with assets of $102 billion and a net worth of $8.6 billion, RFC as a subsidiary has the ability to price competitively.

With strong financial backing, RFC assessed what additional value the warehouse lending unit could bring to RFC's core business. RFC's management realized that by combining the individual strengths of both entities, the company could enhance the warehouse process.

Tapping nontraditional sources in capital

Currently, there are no means of effectively tap investors for financing warehouse lines. RFC intends to bring to this business the same securitization skills it brings to the jumbo mortgage market.

The ability to tap nontraditional sources is exactly what brought RFC to the dance. RFC was created in 1982 out of a need in the secondary mortgage market. The need was for a major investor conduit that could provide originators with an alternative, ongoing source of funds for jumbo home mortgages. RFC's core business today remains the purchase, aggregation, credit enhancing, securitization and distribution of securities backed by these jumbo mortgage loans.

Having pinpointed the four basic capabilities--defining supply/demand needs, managing risks, pricing competitively and tapping investors for warehouse lines--RFC began looking at how best to attain a warehouse unit.

Buy versus build

In determining the best way to actually enter the warehouse business, the buy-versus-build question was evaluated according to the availability of people, systems, operational groups and office locations. From this fact-finding process came several opportunities to purchase firms already in existence. Due negligence teams were sent in to each of these firms of evaluate the operations.

RFC quickly concluded that building a warehouse division from scratch would not be the most efficient plan. CEO Korell says, "With the opportunities present in the market, the firm could quickly and effectively enter the business and be more proactive toward customer needs by purchasing a division already in operation.

"Acquiring the assets, operations, and experienced personnel from ASB satisfied the goals of size and outstanding assets. The purchase represented a commitment to current customers and to the mortgage finance industry overall."

Integration

Integrating ASB's warehouse unit into an RFC unit was a challenging assignment, especially when it involved severing dependencies from the former parent corporation, establishing independent computer systems, affiliating personnel from three regional offices and blending the efforts to two sales forces; all while trying to keep the process transparent to the customers.

While the deadline for complete integration was six months, essentially all work was completed in the first 60 days from the date of purchase agreement. Many projects such as the transfer of payroll, benefits, wire transfer procedures, cash management and collateral management systems were complete in the first 30 days.

Making matters more challenging, RFC did not move the operation to Minnesota, its home office location. Instead, all of the services and support such as payroll, benefits, cash management, etc. that the warehouse lending units formerly received from ASB had to be replicated by RFC from an off-site location. The Walnut Creek office in California and the Sunrise office in Florida stayed in the same location, but the Washington, D.C. office moved to a new location in the same area.

To make the transition go as smoothly as possible and keep both parties directed toward a common goal, RFC and the warehouse executives and staff established and maintained a hit list addressing and resolving more than 700 transitional points. Each item on the hit list detailed additional items to be completed, the timeframes and who was accountable for completion. Highlights included: * a new Washington, D.C. RFC office

location; * leases and purchases of equipment; * transfer and document follow-up of

current mortgage agreements; * third-party notifications; * credit policy/loan approvals; * deposit arbitrage; * legal agreements with outside

business entities; * custodial agreements; * operating issues related to loan

accounting transfers; * office administration; * RFC lines of credit; * post-closing insurance matters; * operational concerns; * human resource issues.

Even with the short timeline and the huge integration process, Pendleton says the transition went quite well. "there was tremendous collaboration from everybody: ASB, Maryland National Bank, employees and customers. Everyone worked together and got it done. There wasn't any fighting the system. It was a win-win situation; ASB was able to downsize, RFC bought a division that was operational on the first day, clients' line were transferred smoothy...all in all, we were terribly lucky with the diverse cast of players. to make it work as smoothly and quickly as it did."

Gaye Beasley, president of Patrician Financial Company, Bethesda, Maryland, agrees that for her firm, the transition was transparent. "We've had a long-standing relationship with ASB and Larry Pendleton; we almost didn't feel the transition. The staff stayed intact and it was really painless."

Noack comments on the transition as it affected Monument Mortgage, saying, "When ASB notified us they were putting the warehouse unit up for sale it caused a great deal of concern for us. With another of our warehouse lenders looking to scale back, we stood to lose 80 percent of our credit lines. As history played out, we've been very fortunate with the outcome.

"There were a few fits and starts during the transition period, like |tell us yesterday what you're going to fund tomorrow,' and some wire- and cash-management changes that could have put us at a competitive disadvantage. We soon discovered, however, how aggressive RFC is in customer service and accommodating the client. We were one of the first to go through the new RFC credit committee as our line was up for renewal and increase. There was some trepidation on our part--compounded by the fact that we'd just lost our line with another firm pulling out of the business. Our line was approved and increased. This sent a clear message [to us] that RFC is a committed player and [that it] valued our relationship."

Having spent almost four years researching the possibility of entering the warehouse business, the firm was prepared for the acquisition and knew it had the personnel and technology to enhance the new unit's systems.

Herb Tasker, president of All Pacific Mortgage Company, Concord, California, agrees that for his organization, it was the ASB staff who made the transition easy. "When we heard RFC was going to enter the warehouse business, we were concerned they would not know warehouse lending or there would be different requirements. Our fears, however, were unfounded, as RFC purchased the ASB unit and kept the same staff in place--[and it is] one of the best staffs in warehouse lending. This really made the transition smooth."

RFC is no stranger to change, as it has been part of four different parent companies since its inception in 1982. RFC has long been known as an innovator in the mortgage-backed securities market, having brought to the market many new products and services. The ability to learn quickly, be flexible and be proactive to the market were assets in this integration process. Warehouse lending is another such service.

Prior to its purchase, ASB's warehouse unit was an innovator in its own right. For example, the group made a strong maket impact in the multifamily market, supplying funding to loans where financing is not readily accessible. In addition, the unit streamlined fundings of conforming loans, which currently account for about 65 percent of lines used. (See Figure 2.) One of the best innovations that ASB brought to the table was its decentralization, due to its location in three major markets. "These multiple locations are something no other player has," says Pendleton.

Having been in the warehouse lending industry almost 16 years, Pendleton has seen his share of newcomers enter the industry who are hungry for assets, then make mistakes and get out quickly. "This kind of competition is difficult to deal with," says Pendleton, "It's like competing with a cobra, you don't know when its going to strike and when its going to pull back."

What's next?

The innovations of the former ASB group are just a taste of what RFC would like to see done with the lending unit and the warehouse lending industry itself. "RFC expects to work closely with other warehouse lenders to assist in broadening the market of lending credits. In addition to the participation process going on in warehouse lending today, RFC expects to bring the lines to a larger market of investors. RFC can tap into the international pool of investors having nurtured them for the past several years. These investors are hungry for these types of investments," comments Korell.

He explains, "RFC would like to see the securitization of lines using creative financial mechanisms that attract global investors--European and Asian investors--in assisting the lending market. Just as RFC brought many innovations to the mortgage-backed securities market, it expects to create operational efficiencies, streamline procedures and apply new technology to enable lenders to lower costs, thus bringing in a broader spectrum of investors."

Hodel says he thinks "RFC and other larger nontraditional players have a commitment to the overall mortgage market. There are so many things these players do and can do to help customers. They have an advantage over banks this way."

Warehouse lines are good assets and there are other nontraditional institutions tapping the market. Several investors are toying with a myriad of vehicles to enhance the lending practice. Some Wall Street firms have stepped in with gestation repos. Although these do not meet all of the needs lenders have, it is a creative mechanism for meeting some credit demands.

Other efforts to decrease dependencies on former sources of credits and to tap investors directly have included mortgage banking entities trying to issue their own commercial paper. In this financing, a lender would buy letters of credit and use them as backing for their fundings in place of a warehouse line.

As players begin to securitize, it will force the process to become streamlined and standardized, and hence, expedite the flow of funds from the capital markets to mortgage bankers.

These are just a few of the methods being explored to deliver capital-market funds to the mortgage banking industry. "We're using many of the options available such as gestation repos, table funding, etc. The current fear now is with the refinance glut, we'll roll right over the top of our lines," adds Tasker.

Entering the warehouse lending business was a springboard for RFC in establishing a secured-lending and operations division commisioned to explore further means of tapping sources of capital to fuel mortgage originations. Comments Korell, "Our basic business is buying and selling loans. RFC believes there are opportunities in the lending and financing area. It's a whole other dimension. Warehouse lending is the first step but there are plenty of other things that need to be financed such as operating loans or financing to fund servicing purchases. RFC is a wholesaler, credit enhancer, master servicer and now a lender. Gregory B. Schultz is executive vice president in charge of Secured Lending and Operations, a recently formed division of RFC specializing in bringing alternative sources of financing to mortgage lending. Schultz was responsible for heading the warehouse lending unit acquisition.
COPYRIGHT 1992 Mortgage Bankers Association of America
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1992 Gale, Cengage Learning. All rights reserved.

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Title Annotation:Strategic Planning; GMAC Residential Funding Corp.'s acquisition of American Security Bank's mortgage warehouse lending unit
Author:Schultz, Gregory B.
Publication:Mortgage Banking
Date:May 1, 1992
Words:3519
Previous Article:Compensation strategies.
Next Article:Lurking liability.
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