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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!