What is a warehouse line of credit?

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WAREHOUSE LINES OF CREDIT

To close a mortgage loan, the mortgage lender will request funds from its warehouse lender and deliver the associated mortgage note to the warehouse lender to be held as security for the warehouse line. Most mortgage lenders are not owned by banks, thrifts, credit unions, or insurance companies. Instead most mortgage lenders are public or privately held corporations which originate loans and sell them to "investors" who then retain or resell those loans, often in the form of mortgage-backed securities.

To close a mortgage loan, the mortgage lender will request funds from its warehouse lender and deliver the associated mortgage note to the warehouse lender to be held as security for the warehouse line.Usually a warehouse line of credit is a revolving line secured by 1) the mortgage loans originated by the mortgage lender, and 2) the promise to repay the line by the mortgage lender and the guarantors on the warehouse line.

The two agreements which can be used are 1) the "Warehouse line of credit Loan and Security Agreement", and 2) the "Warehouse Participation Agreement" (sometimes called a "Purchase/Re-purchase Warehouse Agreement" or a "TPO" Warehouse Agreement). From a day-to-day operating perspective, there is virtually no difference between the two. However, there are technical differences which can be important. There are two basic types of warehouse lines, best distinguished by the type of warehouse agreement used between the warehouse lender and the mortgage lender.

LOAN AND SECURITY AGREEMENT

Generally accepted accounting principals usually call for a loan-type warehouse line to be disclosed as a liability on the balance sheet of a mortgage lender, and the corresponding mortgage loans to be disclosed as an asset, usually "Mortgage Loans Held for Resale". Anticipated revenue on the pending sale of the mortgage loans is not recognized until the investor actually purchases the loans, regardless of whether firm commitments to purchase exist. A line extended under a "Warehouse Loan and Security Agreement" (loan-type) is a commercial loan between the warehouse lender and the mortgage lender. The warehouse lender takes a security interest in each mortgage loan originated with the warehouse line, and the mortgage lender owns each mortgage loan from the day it is disbursed until the day it is purchased by an investor.

WAREHOUSE LINE PARTICIPATION AGREEMENT

The mortgage lender has the right to re-purchase the mortgage loan, and the re-purchase price is higher than the price "paid" by the warehouse lender, effectively providing the warehouse lender with "interest" on his "loaned" funds. Purchase-type agreements are popular for several reasons. A line extended under a "Warehouse lines of credit Participation Agreement" (purchase-type) is actually not a loan at all, but rather a purchase agreement between the warehouse lender and the mortgage lender. The warehouse lender usually purchases a 100% participation interest in each loan originated under the warehouse line, thereby actually owning the mortgage loan.

Therefore, warehouse lenders owned by smaller financial institutions can extend larger lines without violating their "loans-to-one-borrower" restrictions. First, the only "borrower" is the borrower on the underlying mortgage loan.

Also, the business of purchasing and selling loans is usually more appealing to managers of credit risk and boards of directors than is the business of extending large, highly-leveraged lines of credit. Second, many warehouse lenders recognize that the risk drivers associated with warehouse lending largely parallel those associated with correspondent lending. By using a purchase-type agreement, a corporate mortgage group may be better able to manage its warehouse unit with existing talent.

This treatment allows a mortgage lender to have substantial warehouse capacity without appearing to have extremely high leverage ratios. (The notes at the end of a mortgage lender's audited financial statements will usually disclose the existence of this type of warehouse lines of credit facility). Third, purchase-type agreements provide off-balance sheet financing to the mortgage lender. Most agreements contain terms which cause GAAP treatment to recognize the warehouse transaction as a sale, thereby eliminating the need for disclosure on the balance sheet of the mortgage lender.

While the lack of repurchase requirements keeps purchase-type agreements from being classified as "financing arrangements", the mortgage lender will virtually always repurchase the warehoused mortgage loans because he/she will get better execution in the secondary market than obtainable under the Warehouse Participation Agreement. Most Warehouse Participation Agreements give the mortgage lender the option to re-purchase warehoused loans, but not the obligation to do so unless certain repurchase events occur.

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