Avoiding the pitfalls of warehouse lending

January 10, 2023

In the mortgage warehouse lending and repurchase space, risk can never be fully removed – but it can be mitigated. Learn how the right document custodian can help you manage your warehouse lending facilities and effectively sidestep a variety of obstacles.

 

Risk management, by necessity, should be top of mind for finance professionals. In this article, we’ll discuss how partnering with the right custodian can help you bypass many of the potential risks associated with mortgage warehouse and repurchase operations.

 

What does a custodian do?

The duty of a document custodian is to receive, verify, store and release documents that act as underlying collateral for some form of debt encumbrance or instrument. Custodians operate by an overriding “golden rule” taken from the laws of physics: just as no two particles of matter can occupy the same space, no single collateral file can have more than one owner.

While a custodian’s role may sound basic, it’s critical to the market. For scale, Ginnie Mae mortgage-backed securities (MBS) issuance totaled more than $360 billion through July 2022, and each one of those loans is backed by a mortgage note held in a custodian’s vault. 

Warehouse and mortgage repurchase obligation facilities rely on custody services but require more intensive daily interactions than many other clients. Large securitization platforms and agency sale conduits typically manage their business in days, whereas warehouse and repurchase facilities do it in hours. Custodial document reviews accommodate the necessary certification requirements. They can also drive borrowing base calculations and interest payments between “wet” loans, where funds are disbursed before document completion, or “dry” loans, where the mortgage documents are received and reviewed after the loan closing.

Custodians provide daily or more frequent reporting on their activities to all counterparties associated with warehouse lending transactions. They ensure collateral is delivered to third parties under the possession of a bailee to avoid jeopardizing a lender’s or purchaser’s security interests. They may also act as the certification agent for loans being sold to an agency under their cash or MBS purchase programs.

 

What should you look for in a custodian? 

Your custodian is one of your most important strategic industry partners. They should thoroughly understand where your business is today and – more importantly – where it’s heading in the future.

A strong partner draws on the full resources of its organization to work with you toward a common goal for success. Skillful communication is key to this relationship, and it’s an attribute you should expect them to prioritize.

In the U.S., most custodians are regulated by a federal body, such as the Office of the Comptroller of Currency. This regulatory oversight requires the organization to apply certain controls and maintain policies and procedures to adhere to rules and regulations for operating in this capacity. Customers that work with top-tier custodians can benefit from the strong control infrastructure, rigorous training and comprehensive risk practices they apply to their entire organization.

“Custodians operate by an overriding 'golden rule' taken from the laws of physics: just as no two particles of matter can occupy the same space, no single collateral file can have more than one owner.”

How do custodians differ?

Not all custodians provide the same services. Many focus primarily on servicing the portfolio of their internal loan department – and maybe, on occasion, moonlight as a service provider to third parties.

While it’s easy to obtain a list of approved agency custodians, few listed usually have experience servicing the specific needs of a warehouse or mortgage repurchase provider. Although many of the baseline functions seem the same, the purpose, impact and cycle-time requirements for a warehouse or repurchase facility are unique. Your custodian must understand those requirements and demonstrate their understanding through their approach.

Usually, warehouse custodians also offer a broader complement of services, such as disbursement agent and administration services, for deeper back- and middle-office coverage.

 

How can custodians help manage risk?

Borrowing base monitoring and pipeline management provide the lifeblood of warehouse and mortgage repurchase facilities. As such, the risk of fraud (e.g., document, counterparty, wire) is a constant variable through the lifecycle of a transaction.

While risk can never be fully removed, it can be mitigated. Warehouse custodians specialize in other services that help reduce those risks:

  • Systematic and operational controls can prevent double pledging of collateral within single or multiple facilities.
  • Disbursement agent services can direct wires to closing agents for wet funded loans. Typically, this will also include depository oversight and controls when the custodian is also the account bank (i.e., OFAC testing).
  • Dedicated document custody professionals have experience with warehouse custody transactions.
  • Serving as the MBS settlement agent can facilitate agency take outs and gestation repurchase trades.
  • Administrative services can supplement and enhance borrowing base mechanics through collateral pricing, concentration reporting and margin maintenance.
     

Not all programs or facilities require all services, but they do all need a trusted partner. Due diligence is important to ensure you have the best fit for your needs. When your warehouse custodian serves as your strategic partner, they can help you position your business for success today and into the future.

 

At U.S. Bank, we’re committed to serving as your trusted partner by offering a variety of products and services that help you mitigate risk while adding value to your business. Learn more about our document custody solutions and the services we offer.

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Loan approval is subject to credit approval and program guidelines. Not all loan programs are available in all states for all loan amounts. Interest rates and program terms are subject to change without notice. Mortgage, home equity and credit products are offered by U.S. Bank National Association. Deposit products are offered by U.S. Bank National Association. Member FDIC.