Jul. 30, 2009: A good time to start a warehouse bank? Rates slide higher on poor auction results

Jul. 30, 2009: A good time to start a warehouse bank? Rates slide higher on poor auction results Rob Chrisman

Three friends from the local congregation were asked, “When you’re in your casket, and friends and congregation members are mourning over you, what would you like them to say?”   Artie said: “I would like them to say I was a wonderful husband, a fine spiritual leader, and a great family man.”  Tad commented: “I would like them to say I was a wonderful teacher and servant of God who made a huge difference in people’s lives.”   Robbie said: “I’d like them to say, ‘Look, he’s moving!’”

Why not get a bunch of friends together and start a book club? Or better yet, why not start a warehouse bank or a warehouse lending co-op? Although I have been accused of being simple-minded, it would seem to make financial sense: Fed Funds (the interest rate on overnight loans between banks, most often used to satisfy the reserve requirement) are .25%. This is about what a bank pays on deposits these days. And instead of earning .25%, a bank, or group of individuals, could loan them out at 4% to needy small mortgage banks who have a solid net worth and collect some fees along the way. It would appear that this segment of mortgage banker is of little interest to the existing warehouse banks who cater to larger clients and that aren’t already fully “loaned up”. Not only is warehouse lending less risky due to collateral requirements, but also the underwriting guidelines currently in place are more stringent than any time in recent memory.

Of course, the risk of setting up a warehouse line should be weighed against all of the stories about fraud that seem to appear every day. Yesterday included, “Florida’s Federal-State Mortgage Fraud Initiative announced charges against 41 defendants in six separate cases, resulting in more than $40 million in fraudulent loans. The cases feature many often-used fraud methods, such as use of false documents to secure a mortgage, payments to “straw borrowers” and multiple loans on the same property”, “9 indicted in Phoenix area mortgage fraud allegations – the alleged scheme involved at least 22 properties which were purchased by straw borrowers and at the closing of each one defendant Daniel Morar received cash-back from the loan funds even though he was not the borrower”, and “SEC charges 4 in $197 million Arizona lending fraud scheme – The SEC alleges four men who include two certified public accountants, a pharmacist, and a grade school principal — raised more than $197 million from investors nationwide primarily through word of mouth between their friends and relatives. Through their company, Radical Bunny LLC, they pooled investor funds to make loans to Mortgages Ltd., a Phoenix-based originator of high-interest, short-term loans to real estate developers.” (Headlines are from http://www.mortgagefraud.org//)

Yesterday’s interest rate movements toward the upside were caused by a poor 5-yr auction. As everyone knows, the Treasury sells bills, notes, and bonds in order to finance their activities. The maturity of these instruments is spread out over time, depending on their expected needs. This week, when the 2-yr auction did not go well many believed that it might have been a “fluke”, and were hoping that the demand for the 5-yr note yesterday would be better. Unfortunately, they were disappointed, and given the overall size of the government sales this week, and in the future, analysts are becoming increasingly nervous. On top of that, yesterday’s auction had “indirect bids” of less than 37%, which means that foreign entities bought far less than hoped.

Suddenly, as if this had ever gone away, economists are reminding us that rates can indeed go up not only because of a strengthening economy but also because of overwhelming supply. And although the Fed has been buying securities backed by mortgages, all rates may slide higher. Along those lines, the Fed released their “Beige Book” yesterday discussing the economy in their various districts. Up popped phrases such as “consumer spending below year-ago levels”, “regions report stable or weaker lending”, “soft labor markets”, and “sluggish retail sales”.

Returning to mortgage rates for a moment, since there is little in the way of investor news, astute observers have noticed that indeed mortgage rates are better, relative to Treasury rates, than they have been in the recent past. The yield on current coupon mortgage securities, backed by Freddie and Fannie loans, is about .875% higher than the yield on the 10-yr Treasury note. The lowest that we have seen occurred in May, when they got to about .7% higher, and the worst was in June when they were about 1.125% worse. And jumbo rates have been easing “a tad”, probably due to the stringent underwriting guidelines currently in place for these loans making them a decent investment for banks. Besides the 7-yr auction today, the only news out will be weekly Jobless Claims. So look for rates to move based on the auction results later this morning, along with movements in the equity markets. The current 10-yr is yielding about 3.68% and mortgages are roughly unchanged.

A man entered the bus with both of his front pockets full of golf balls and sat down next to a beautiful blonde.  The puzzled blonde kept looking at him and his bulging pockets. Finally, after many such glances from her, he said, “Golf balls”. Nevertheless, the blonde continued to look at him for a very long time, deeply thinking about what he had said.  After several minutes, not being able to contain her curiosity any longer, she asked, “Does it hurt as much as tennis elbow?”

Rob

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