Innovative Funding StrategiesInnovative Funding Strategies

Michele PerrinMichele Perrin

MBA National Convention, October 26, 2004MBA National Convention, October 26, 2004

Mortgage Banker FinanceMortgage Banker Finance

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Funding StrategiesFunding Strategies

Warehouse lines of creditWarehouse lines of credit

Traditional repurchase (repo) linesTraditional repurchase (repo) lines

Gestation linesGestation lines

Early purchase facilities – similar to Early purchase facilities – similar to gestation with some new twistsgestation with some new twists

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Comparison of Funding Strategies:Comparison of Funding Strategies:

DescriptionWarehouse

LinesRepurchase

FacilitiesGestation

Repos Early Purchase

Provided primarily by Banks Wall Street Wall Street Banks, Investors

Line Sizes Limited Large Large Large

Accounting Treatment

On balance sheet

On or Off balance sheet

Off balance sheet

Off balance sheet

Non-use fees Yes Usually not No Usually not

Takeout Commitment Required? Usually Yes Yes Usually

Will it fund wet? Yes Some No Yes

Will it fund to closing? Yes Some No Yes

Require Personal Guaranty? Yes Some No Some

Advance Rates Usually 98% Up to 102% Up to 102% Up to 100%

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Warehouse LinesWarehouse Lines

Offered by BanksOffered by Banks

Accounted for as a borrowing Accounted for as a borrowing

Increases leverageIncreases leverage

Limited line sizesLimited line sizes

Not bankruptcy remoteNot bankruptcy remote

Carries a non-use feeCarries a non-use fee

Requires personal guaranty of ownersRequires personal guaranty of owners

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Traditional Repurchase LinesTraditional Repurchase Lines

Offered by Wall Street brokeragesOffered by Wall Street brokerages

May use financing or purchase languageMay use financing or purchase language

Often won’t fund wetOften won’t fund wet

Usually requires a takeout commitment Usually requires a takeout commitment

Offered to broker’s active sellersOffered to broker’s active sellers

Not committedNot committed

May fund over 100% of parMay fund over 100% of par

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Gestation RepoGestation Repo

Always requires a takeout commitment, often in the Always requires a takeout commitment, often in the form of an agency forwardform of an agency forward

Does not fund wet or to the funding tableDoes not fund wet or to the funding table

Usually off-balance sheetUsually off-balance sheet

Generally does not require guaranties or Generally does not require guaranties or commitment fees (not committed)commitment fees (not committed)

May fund over par May fund over par

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Early Purchase Facilities (EPFs)Early Purchase Facilities (EPFs)

Off-balance sheet Off-balance sheet

Some providers require that the loan be sold Some providers require that the loan be sold to themto them

May or may not be committedMay or may not be committed

May have no personal guarantyMay have no personal guaranty

Generally carries no non-use fee or Generally carries no non-use fee or commitment feecommitment fee

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Other Features of EPFsOther Features of EPFs

Will fund wet and to the closing tableWill fund wet and to the closing table

Available in larger amounts than warehouse linesAvailable in larger amounts than warehouse lines

Some do not require that the loans be sold to the Some do not require that the loans be sold to the provider as investorprovider as investor

May be committed for up to one yearMay be committed for up to one year

May not require takeout commitment at time of May not require takeout commitment at time of fundingfunding

May allow funding of Alt-A and subprime loansMay allow funding of Alt-A and subprime loans

May fund up to 100% of par valueMay fund up to 100% of par value

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Off-Balance Sheet TreatmentOff-Balance Sheet Treatment

Recorded as sale when funded by providerRecorded as sale when funded by provider

Reduces leverageReduces leverage

Improves liquidity ratio by decreasing Improves liquidity ratio by decreasing current liabilitiescurrent liabilities

May reduce the required net worth by May reduce the required net worth by keeping the leverage lowerkeeping the leverage lower

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Why Off-Balance Sheet Treatment?Why Off-Balance Sheet Treatment?

Lenders usually require the leverage ratio (liabilities Lenders usually require the leverage ratio (liabilities divided by net worth) to be greater than 15:1divided by net worth) to be greater than 15:1

Lenders want to see a liquidity ratio (current assets Lenders want to see a liquidity ratio (current assets divided by current liabilities) of no less than 1.03:1 divided by current liabilities) of no less than 1.03:1 to 1.05:1to 1.05:1

Cash as a percent of assets: Lenders would also Cash as a percent of assets: Lenders would also like to see cash of about 1.5-2% of total assetslike to see cash of about 1.5-2% of total assets

Off-balance sheet facilities help reach these goals Off-balance sheet facilities help reach these goals as shown in the following example.as shown in the following example.

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Off-Balance Sheet Treatment EffectOff-Balance Sheet Treatment EffectBefore After Target for

Description EPF/Repo EPF/Repo Lenders

Cash 1,200,000$ 2,000,000$ Loans Held for Sale 90,000,000$ 50,000,000$ Fixed Assets 2,000,000$ 2,000,000$ Total Assets 93,200,000$ 54,000,000$

Accounts Payable 1,000,000$ 1,000,000$ Warehouse Lines Payable 88,200,000$ 49,000,000$ Total Liabilities 89,200,000$ 50,000,000$ Net Worth 4,000,000$ 4,000,000$ Total Liabilities & Net Worth 93,200,000$ 54,000,000$

Leverage Ratio 22.3 12.5 15Liquidity Ratio 1.02 1.04 1.03Cash as % of Assets 1.3% 3.7% 2%

Amount of EPF/Repo Used -$ 40,000,000$

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Why Does a Repo or EPF Get Sale Why Does a Repo or EPF Get Sale Treatment?Treatment? The legal document is a Purchase and Sale The legal document is a Purchase and Sale

AgreementAgreement

The transaction must not require repurchase The transaction must not require repurchase by the Seller—the purchaser completes the by the Seller—the purchaser completes the pre-arranged sale to a third party investorpre-arranged sale to a third party investor

Must be bankruptcy-remote—that is, it must Must be bankruptcy-remote—that is, it must meet the legal requirements for a salemeet the legal requirements for a sale

Must meet requirements of SFAS 140 for Must meet requirements of SFAS 140 for auditor buyoffauditor buyoff

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SFAS 140—Three Requirements to SFAS 140—Three Requirements to Get Sale TreatmentGet Sale Treatment

Transferred assets must have been isolated Transferred assets must have been isolated from the transferor—even in bankruptcyfrom the transferor—even in bankruptcy

The transferee must have the right to pledge The transferee must have the right to pledge or exchange the assets it receivesor exchange the assets it receives

No repurchase agreementNo repurchase agreement

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Caveats for Users of Off-Balance Caveats for Users of Off-Balance Sheet VehiclesSheet Vehicles

Must be monitored closely for stale loans just like a Must be monitored closely for stale loans just like a warehouse linewarehouse line

Maintain adequate net worth and liquidity to Maintain adequate net worth and liquidity to manage risks of all loans in the pipelinemanage risks of all loans in the pipeline

Some warehouse lenders will add these balances Some warehouse lenders will add these balances back to calculate covenantsback to calculate covenants

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ConclusionConclusion

Find out more about these facilities and see if one Find out more about these facilities and see if one of them is right for youof them is right for you

Ask your current lenders how they would treat such Ask your current lenders how they would treat such a facilitya facility

Check with your auditors about how they would Check with your auditors about how they would treat the facility you have in mind (they may need to treat the facility you have in mind (they may need to review the agreement)review the agreement)

Ask lots of questions—these facilities vary greatly in Ask lots of questions—these facilities vary greatly in what they will allowwhat they will allow

Then get ready to grow!Then get ready to grow!

Thank You!Thank You!