Fraud Becomes A Problem For Warehouse Lenders As
Business Dwindles
As borrowers become more desperate, pressure builds
to exploit perceived weaknesses in lenders’ processes.
By Neil J. Morse
Most of Paul Eilbacher’s colleagues know he works in mortgage banking,
but few probably know he also toils in law enforcement. Although he does
not wield a nightstick or cruise a beat, Eilbacher’s work in warehouse
lending does require him to act “like a benign cop,” he says.
As first vice president in the warehouse lending department of China Trust
Bank USA, Eilbacher says he sees a growing amount of fraud that requires
him to be vigilant in transactions with brokers and bankers.
The root problem appears to be thinning originations. With volumes off
as much as 40%, warehouse lenders are fishing deeper depths for loans
and, as a result, they are drawing some undesirable catches to their nets.
That means warehouse lenders must be more careful. “Our customers
have to know that we’re always there watching,” says Eilbacher.
China Trust’s 30 customers maintain an average warehouse line of
$5 million to $7 million. The company, which operates from offices in
New York City and Torrance, Calif., has commitments totalling $150 million
from its bi-coastal locations.
What the company watches for are unscrupulous or desperate borrowers willing
to exploit “a perceived weakness in a lenders’ processes.”
That might include double warehousing without a single collateral agent
or diversion of retainment funds from the investor, says Eilbacher, listing
just two nefarious activities.
Gaining more control
Warehouse lending involves interim, short-term funding that allows a mortgage
banker to create a funded loan asset meeting the criteria of the secondary
market as a closed loan asset. In this way, a bank can sell the loan in
the secondary market as opposed to brokering it. Bottom line is control,
since it frees a broker from being at the mercy of the funding department.
For the most part, there are two types of warehouse lines: affinity and
non-directed. The former are primarily warehouse programs that investors
provide to their key originators. The latter are pure warehouse credit
facilities which tend to offer more flexibility. Non-directed lines also
tend to be more efficient, though they may cost a bit more.
Talk of fraud has spread lately because it is starting to affect more,
and more prominent, players, says Mike McAuley, managing director, mortgage
banker finance at Bank United in Houston. McAuley says problems experienced
by top players like Bank of America and First Union are reverberating
loudly throughout the industry.
It is a stark contrast with traditional encounters. McAuley says warehousing
has been viewed as a “sleepy part of the credit portfolio at banks,”
one without huge returns, featuring relatively low risk secured by mortgage
loans.
In this low return and low margin cycle, says McAuley, banks are “taking
hits on principal - something they never expected.”
It is a “rude awakening” for them.
Bank United has $2.5 billion in warehouse commitments, $1.3 billion outstanding,
McAuley tells SME. The company maintains business relationships with 125
customers, and 115 are direct borrowers.
“We’re also one of only two or three banks directly handling
collateral and back-office funding,” he says, adding that Bank United
ranks “about fourth - although we’re probably closer to second
in size for such transactions.”
A warehouse line of credit can be an attractive option for brokers because
they don’t have to disclose back-end points, they can receive better
pricing and they gain the label of lender. It adds up to greater business
control.
It also means more profit per loan and a ticket into the secondary market.
Warehouse funds typically flow from:
- commercial banks,
- specialized non-banks,
- investors, and
- Wall Street sources.
Exposure to smaller players
Current problems with fraud and losses in the warehouse lending marketplace
come as no surprise to Jim Croft, executive director of the Mortgage Asset
Research Institute (MARI), Reston, Va.
“There are some players in the industry faced with pressure to try
and push loans through the pipeline that under ordinary circumstances
wouldn’t be acceptable,” he says.
As warehouse lenders try to expand their markets, Croft suggests, they
are forced to do business with “smaller players in the lending food
chain who are ‘less well capitalized’.”
That means exposure to “fraud, material misrepresentation or serious
misconduct,” according to Croft, whose organization specializes in
developing and sharing information through cooperative databases within
the mortgage industry.
One of the databases is MIDEX, the Mortgage Industry Data Exchange, which
gathers public and non-public information on fraudulent and other less
serious misconduct.
According to Croft, 12-15% of the inquiries to MIDEX result in associating
a company name with a problem. In half of those cases, there is a public
record - a fine, action, etc.
That number is “a lot higher than I ever thought it would be,”
Croft remarks, and he levels a serious charge of complicity against mortgage
industry participants. In today’s complex mortgage system, he argues,
“there has to be complicity by a professional for (fraud) to occur.
With most fraud, we see someone looking the other way or actively participating.
People can do a significant amount of rationalization in a market like
this,” Croft maintains.
Trying to determine the extent of these problems draws one into a deep
gray area. There are no reliable figures, according to MARI. “The
FBI tried a couple of years ago (to quantify it) and threw up their hands,”
says Croft, who describes the figure as “unknowable” and offers
an explanation.
Many firms “do not know how much mortgage fraud they have in their
own portfolio, and others are not willing to comment on it because they
don’t want to publicize the fact that they are victimized by fraud.”
If you’re looking for safer, “plain vanilla” investments
in the warehouse lending arena, you will not find much business - or profit,
says China Trust’s Eilbacher.
The company does get requests for subprime, second mortgages, and similar
non-conforming products which offer “some margin, but some of the
product characteristics are not as desirable,” says Eilbacher, noting
that “there is an issue of the general quality of borrowers.”
As the number of warehouse lenders has dwindled, there remains significant
opportunity, he notes, spelling out the necessary qualifications.
“You need to have prudently administered controls in place,”
says Eilbacher. “The whole objective is to totally control the collateral
process and avoid back office slippage.”
No white knight
Losses stemming from fraud have “sucked up a lot of liquidity in
terms of warehousing facilities,” says Bank United’s McAuley,
noting that this time the usual white knight did not come to the rescue.
“Traditionally Wall Street would step in but even those guys got
exposed,” to losses.
Problems in warehousing also are coming from a change in the overall customer
base, says Paul Eilbacher of China Trust Bank.
“You’re not really dealing with full service mortgage bankers
(anymore) as much as brokers who are trying to emerge as bankers.”
Eilbacher says this proliferation of broker/bankers is further complicated
by too many companies “carrying multiple warehouse lines.” Then
there are all the new lenders coming into the market while others disappear.
The net result is “inadvertent and intentional manipulation with
multiple facilities, different funding sources, different documentation
standards, and the fact that individual lenders don’t talk to each
other,” says Eilbacher.
This article was previously published in the November 2000 Issue of Secondary Marketing Executive.
