Many bank warehouse operations have been closed (PNC Financial Services) or have been “listed” for sale such as Bank of America and MetLife. For a bank to purchase a major warehouse lender the bank must have a liquid balance sheet and be able to support at a minimum of carrying the established warehouse line commitments of at least $1 billion (the estimated size of MetLife's operation).
These calculations will not include correspondent purchases/vertical integration that would increase returns substantially.
Bank of America had approximately $12 billion in outstanding warehouse commitments and $7.2 billion to $8.4 billion in outstanding loans. For a financial institution to consider buying the warehouse sector from Bank of America the balance sheet of the institution would have to have the capacity to hold these loans on its balance sheet for 15 to 20 days. No bank would be large enough to absorb this business. That is why Bank of America has been deceasing the outstanding commitments and shifting, maybe, some of the business to Merrill Lynch.
Many of the current warehouse lenders have been increasing their business that fits their model, as mortgage bankers have been scurrying around to replace their Bank of America lines.
To be able to absorb a large warehouse facility the purchaser, like PNC buying National City, would need to purchase the bank, and not only the warehouse sector to be able to absorb the warehouse volume.
In this case a few years before the purchase of National City, PNC shut down its warehouse facility, and keeping with its business model it shut down the National City warehouse facility even though National City's warehouse facility was very profitable. Interesting that Kevin Rost who headed sales at PNC warehouse division is at Republic Bank ($3.2 billion in assets) in Louisville, Ky., and put together a de novo warehouse operation in 2010 and his cohort at PNC, Paul Best, put together a de novo in 2010 at Peoples United Bank, the largest regional independent bank in New England with assets of $27 billion. Current warehouse commitment outstanding are $500 million with $225 million outstanding.
In the case of MetLife the situation is a bit different as MetLife has approximately $1 billion in commitments and at least $500 million in outstanding loans. MetLife has $535 billion in assets and the company has only stated that they want out of the mortgage origination business (not reverse mortgages…yet), and the warehouse segment, as it does not fit their present model as an international insurance company. What would a prospective buyer pay for a mortgage warehouse division, and what would they be buying or would it be more cost effective to do a de novo?
Let's just discuss a de novo the way Republic Bank and Peoples Bank performed, and a few community banks that began as a de novo such as Silvergate Bank in San Diego that opened in April 2009 with current assets of $434 million and has funded, as of Sept. 30, 2011 $2.4 billion since inception and is extremely profitable. Another de novo that has been started by an experienced warehouse manager is Community Trust, a regional in the southwest with assets of $1.9 billion that now has $288 million in commitments within 12 months of operation.
The decision to purchase an ongoing warehouse operation from an established bank versus a de novo is what are you buying and the cost. History tells us, to date, the only major warehouse lending purchase transaction, other than BB&T “gift” from the FDIC of Colonial Bank's warehouse operation was the purchase by PNC of National City and eventual closing of the warehouse operation.
BB&T had a small regional warehouse operation, and a strong balance sheet so they were able to absorb part of the warehouse business, and decided only to keep the regional portion where they, BB&T was established. They currently have about $2 billion in commitments. The assets of BB&T are $168 billion and bank covers the mid-Atlantic and Southeast regions of the country.
Let's take a look at the simple arithmetic of a de novo operation. Funding mortgages with fed funds that cost from 13 basis points, and the rate of interest is 4%. Your spread profit for the time you hold the loans on the warehouse line is 3.87% (using 4% to round off) and you warehouse the loans for 15 days before they are purchased.
Average loan size for GSEs, FHA and VA would be approximately $250,000 (this will go up or down depending on the area of the country and not include jumbos). Your per-day profit would be approximately $30, therefore for the 15 days your gross would be $450. Assuming you did $100 million for the month your gross would be $180,000. If your cost of funds using deposits only is 1% then your profit still would be 3% per loan or $135,000 for the month. This would amount to between $2.16 million to $1.62 million per year gross. This does not include fees per loan file and the benefit of pledged and operating DDA to offset cost of funds.
The core strategy is to operate a low cost platform. The costs of a de novo are processing and variable costs of technology, 1 basis point, provision for loss 5 basis points, compensation expense 7 basis points and interest expense up to 31 basis points (this is based on deposit cost of funds and not fed funds) for a total expense of approximately 44 basis points.
It should not take any longer than 120 days to fund your first loan of a de novo. Why would a bank want to purchase an already existing warehouse operation? The only way it might be cost effective is if they, like BB&T, had an infrastructure already in place, had balance sheet capacity and the cost was nil.
If a warehouse facility is for sale the mortgage bankers are already in the process of finding a new home like the Bank of America exit, so what are you buying?
Barry Epstein is managing director, Warehouse Banking Consultant, Los Angeles.
