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Secondary market.

SECONDARY MARKET

The mortgage banking industry has been feeling the effects of the current credit crunch in the areas of warehouse financing, servicing acquisition financing, residential construction lending and commercial lending. Over the past two years, we have increasingly witnessed instances where credit lines to mortgage companies have been terminated. This typically has happened to small and mid-sized mortgage companies and residential builders as well that have credit relationships with small and medium-sized thrifts. We estimate that hundreds, perhaps several thousand, credit lines have been terminated as a result of approximately 1000 thrift/bank failures occurring over the last two years.

Many companies had just a single credit line with a bank or thrift. When the bank or thrift failed, the mortgage company eventually failed unless it miraculously obtained another credit line. Unfortunately, these companies are out shopping for new lines at a time when banks/thrifts have "real" and "perceived" disincentives to lend. There are also structural problems in the banking/thrift industry that impede even capital-rich firms from making loans to mortgage companies.

Real disincentives to lend - Capital requirements fall into this category. The fully phased-in risk-based capital requirement will be an 8 percent capital to risk-weighted assets ratio. Leverage capital ratios are 3 to 5 percent or more for banking organizations. One way for a depository institution to enhance its capital position is by reducing assets, i.e., loans. Moreover, under the risk-based capital framework, capital position can be enhanced if lower risk-weighted assets are substituted for higher risk-weighted assets. For example, capital position is improved when the institution substitutes Treasury or Ginnie Mae securities for the warehouse lines or commercial loans it has on its books. Another real constraint is the loans-to-one-borrower limitation of 15 percent of the institution's unimpaired capital. This constraint is the basis for the new Fannie Mae program whereby the agency provides construction financing to home builders through financial institutions that have reached their lending limit with respect to a particular borrower.

Perceived disincentives to lend - Regulatory scrutiny and the economic climate for real estate lending fall into this category. There are over 1,500 bank and thrifts that fail to meet current minimum capital requirements. Although these institutions have not been seized by the U.S. government, they are probably under some kind of government scrutiny. With regulators watching their every move, these institutions are likely to be very impatient with borrowers and certainly not likely to take on new business.

Larger banks that meet minimum capital requirements continue to lend to the mortgage banking industry for warehousing purposes, but even these do not appear to be taking on new clients or expanding in the area of servicing-acquisition financing. This is partly explained by the fact that warehouse financing groups tend to be situated within the real estate lending department of commercial banks. Real estate lending has been blamed for the mounting losses experienced by the banking industry. Thus, the corporate focus of the banks tends to be one that is moving away from anything to do with real estate.

Another perception that affects both under-capitalized and well-capitalized financial institutions is the threat that regulators will require increases in loan loss reserves, thus depleting capital further, perhaps below the minimum. In addition, institutions fear that regulators will force them to reappraise commercial loan collateral and write down values. Still another perception impeding servicing acquisition lending is the fear that regulators will classify them as "highly leveraged transactions" (HLT) even though regulators have indicated verbally that they would not classify them as such so long as there was 20 to 30 percent equity in the deal.

Structural Impediments - One would expect that with the great demand for bank financing, banks not currently involved would seize the opportunity. Unfortunately, mortgage company lending is highly specialized and very backroom-intensive. This effectively creates a barrier to entry for new firms.

The Mortgage Bankers Association of America (MBA) has not developed formal positions on these issues but it has begun to consider a number of alternative courses of action including the following: * GNMA's approval of MBA's proposed pledge of servicing

agreement and enhancements to the existing Freddie

Mac agreement; * use of the secondary market agencies to provide warehouse

financing through commercial banks in a manner

like Fannie Mae is doing for homebuilders suffering

from the effects of the loans-to-one-borrower limitation; * use of bankers' banks to provide warehouse financing; * encourage mortgage companies with capital-rich parents

to help the parent develop warehouse financing capabilities

(Unregulated companies may also get involved in

the warehouse business as GMAC Residential Funding

Corporation (RFC), Bloomington, Minnesota, has done

as a complement to its correspondent lending program.); * find a way to get the RTC and FDIC to keep good credit

lines in place when they seize institutions; * make sure the secondary market agencies' custodial depository

eligibility requirements do not negatively affect

warehouse lending relationships; * lobby against the concept of market-value accounting as

it relates to the writing down of commercial loans; * lobby for more favorable risk-based capital treatment for

warehouse lines (i.e. place in 50 percent category instead

of 100 percent, since lines are secured by first

mortgages); and * lobby for a longer phase-in period for risk-based capital

with the idea that the current economic climate is not the

time to require higher levels of capital.

Michael S. Taliefero Staff Vice President Government Agency Relations
COPYRIGHT 1991 Mortgage Bankers Association of America
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1991 Gale, Cengage Learning. All rights reserved.

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Title Annotation:the credit crunch and the mortgage banking industry
Author:Taliefero, Michael S.
Publication:Mortgage Banking
Article Type:column
Date:Mar 1, 1991
Words:893
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