Internal Warehouse Lending Profitable for Community Banks

Have any of you thought about why we refer to the day after Thanksgiving as Black Friday?  

The term "Black Friday" was originated in Philadelphia  during the 1960's.  It was used to reference the unusual amount of traffic that was observed on the day after Thanksgiving.  More recently, merchants and the media have used it, instead, to refer to the beginning of the period in which retailers go from being in the red (i.e., posting a loss on the books) to being in the black (i.e., turning a profit).

We get a fair amount of calls from brokers and small mortgage bankers about the idea of partnering with a community bank.  Early in my career, I had the opportunity to partner with several banks.  My team and I contributed the knowledge, systems and relationships.  The bank provided the capital, liquidity and warehouse lending.  The best thing of all was I didn’t have to provide a personnel guaranty on the warehouse facility. 

From the late 70s through the mid-90s, small to mid-size banks and thrifts were active in residential lending.  Many institutions had internal mortgage banking divisions and others had wholly owned subsidiaries. We’re starting to see community banks poking around mortgage banking and warehouse lending as a business opportunity. 

Looking at the environment today, why would a community bank do this?

Banks currently have a low cost of funds, but only a handful of low risk/high return investment options (borrow short and lend long) with which to put those cheap funds to work.  Construction lending is dead, small business loans are perceived as too risky, and consumers are paying off debt rather than using their credit cards. While banks have indeed been lending to the US government via purchases of Treasury debt securities,  there is an opportunity to be profitable from lending via residential lending.

An internal residential lending operation provides two opportunities for banks:

1.The bank can fund the internal mortgage operation's loans during the warehouse period itself and earn a competitive spread.  The spread is the mortgage note rate less their 30 days cost of funds.   Today, that might amount to a 4% annual return...or more.

2. The bank can generate additional earnings from operating a mortgage banking division.  Today, we are seeing small mortgage banks earning 30 to 50 basis points in pre-tax profits.  The caveat is the bank probably needs to hire or partner with an experience mortgage banker to oversee the lending division. 

Consider a bank originating, warehousing and selling $10M per month based on the margins noted above and holding the loans for 30 days.  The warehouse spread is $33K and the mortgage banking profit is $30K to $50K, with a combined profit of $63K to $83K. 

If you are a mortgage banker and little worried about the current environment, consider calling your local community bank about partnership.  It might be a great opportunity for both of you.