Warehouse financing is critical to the mortgage delivery chain because the majority of mortgage loans today are made by mortgage bankers. The secondary market has proven to be the lowest cost way to produce mortgage credit. Without warehouse financing, mortgage bankers are unable to make mortgage loans and thus, the mortgage delivery chain to homeowners breaks down.
We believe bank and thrift regulatory agencies should cooperate with the industry and lower the risk weighting for warehouse credit lines and loans secured by residential single-family mortgages to 50 percent (or 20 percent for FHA/VA) from 100 percent. This will help ease the credit crunch problems facing many mortgage companies and allow homebuyers to continue to benefit from competitively priced mortgages. As the following discussion indicates, there is both an economic and common sense rationale for the lower risk weighting.
The principal objectives of the Basle Accord and the U.S. risk-based capital regulations are to establish capital requirements that are sensitive to differences in risk profiles among banking organizations thereby minimizing disincentives to hold liquid, low-risk assets. In general, risk-based capital requires a minimum ratio of total capital-to-risk-weighted assets of 8 percent. Assets are assigned a risk weighting based on their relative credit risk. The amount of capital needed for each type of asset is represented as a percentage of the 8 percent minimum capital required. The risk weightings range from 0 percent to 100 percent.
Our recommended treatment of warehouse lines reflects the limited risk to banks and thrifts associated with warehouse loans. A warehouse lender usually has three layers of loss protection. First, is the financial capacity of the mortgage company to repay the loan after the sale of the mortgage or the securities. Second, is the mortgage collateral backing the warehouse loan. Third, is the protection afforded by third-party guarantees.
Levels of protection - The warehouse loan is secured by the mortgages closed by the mortgage company. The warehouse bank takes mortgage notes as collateral for its line. The collateral, i.e., the mortgage note, is secured by the real property. The loans are underwritten according to prudent standards which reduce the risk of homeowner default on the mortgages. Even in the event of a homeowner default, FHA and VA guarantees and private mortgage insurance on conventional mortgages protects the owner of the mortgage against losses.
Collateral is valuable and marketable - The collateral for the warehouse line is generally made up of FHA loans, VA loans and conventional mortgages. These mortgages have value and can be securitized or sold in a liquid market in the event that the warehouse bank must take ownership of the collateral.
Possession of collateral - The warehouse lender takes physical possession of the collateral at the time it is created in order to "perfect" the bank's security interest under the U.C.C. The bank maintains possession until the loans are sold to investors or pooled into mortgage-backed securities. The bank eliminates its risk of having to seize the mortgages if there is a default. Moreover, banks generally loan mortgage companies an amount less than the face value of the mortgage collateral.
Direct repayment of funds - Warehouse loans or lines of credit are short-term loans fully secured by closed residential mortgage loans. The risk to a bank is minimal because the mortgages serving as collateral are usually pre-sold to a government-sponsored agency that is obligated to purchase them pursuant to a commitment. Funds are usually repaid to the bank in 90-180 days or less. When the loans are sold in the secondary market, funds are usually wired directly from the agency investor to the warehouse lender.
We believe that our recommendation to lower risk weighting for warehouse lines to 50 percent is consistent with the Basle Accord. The Federal Reserve (the Fed) has used its discretion to address assets that technically would call for a higher risk weighting but, due to the effects on the credit market, resulted in a decision to classify the asset in a lower risk weight group.
Although the Basle Accord does not address the treatment of mortgage-related securities, the Fed has provided preferential treatment for these assets because the credit risk associated with any mortgage-backed security is essentially no greater than that of the collateral backing it. In particular, the Fed treats privately issued mortgage-backed securities and CMOs/REMICs as "indirect holdings of the underlying assets." As a result, a holder of these assets receives a 50 percent or lower risk weighting depending on the makeup of the underlying pool. The FRB's preferential treatment of MBS and CMOs/REMICs deviates from the Basle Accord strict risk-based capital frameworks but, nevertheless, makes sense from a public policy perspective.
Warehouse lines and CMOs/REMICs have several similarities that justify a lower risk weighting. A bank that owns a warehouse obligation and an investor that owns a privately-issued CMO/REMIC obligation both have a claim on the underlying assets in the event of a default of the borrower. Consequently, it would be appropriate for warehouse lines to have a similar risk weighting to CMOs/REMICs.
Finally, it seems illogical for risk-based capital rules to require 8 percent capital for a performing warehouse loan, but would reduce this capital requirement to 4 percent or less if the mortgage company defaulted on the warehouse loan and the bank took ownership of the mortgage loans. This treatment is inconsistent with risk-based capital because it effectively requires a higher risk weighting on a performing loan than on a non-performing warehouse loan.
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|Title Annotation:||lowering the risk weighting for warehouse credit lines and loans|
|Author:||Taliefero, Michael S.|
|Date:||Jan 1, 1992|
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