Warehouse Facility

A warehouse facility, in lending and structured finance, is a revolving credit line that a bank or other investor provides to a loan originator, secured on the loans the originator makes. The originator draws on the line to fund new mortgages, car loans, consumer credit or business loans, holds them for a period, and repays the line when the loans are sold or refinanced, most often through a securitization. The loans are said to be warehoused in the meantime.

Warehouse funding is the main source of finance for non-bank lenders, which have no deposits, including mortgage companies, auto finance firms, fintech lenders and buy-now-pay-later providers. It is also used by managers assembling the portfolio for a collateralised loan obligation. The providers are typically investment banks and, increasingly, a private credit fund or insurer. It is a form of secured wholesale funding.

In the most common structure, the originator sells or transfers eligible loans to a special purpose entity set up for the purpose. The entity borrows from the warehouse provider under a loan agreement or by issuing variable funding notes, and uses the money to pay the originator for the loans. The provider's security is over the loans and the collections on them, held apart from the originator's other assets so that they are protected if the originator fails. The originator usually continues to collect payments as servicer.

In the United States, mortgage warehouse lines are often documented instead as a master repurchase agreement, under which the lender buys the loans and the originator agrees to buy them back when they are sold on to a permanent investor, typically within days or weeks. Economically this is a secured loan, the same idea as a repurchase agreement in securities markets.

• Commitment and availability period. The provider commits to lend up to a limit for a set period, commonly one to three years, during which drawings can be made, repaid and redrawn.
• Advance rate. The provider lends only a percentage of the value of the eligible loans, for example 85%. The originator funds the remainder with its own equity or with a junior lender, which gives the senior provider a cushion against losses, a form of credit enhancement.
• Eligibility criteria. Each loan must meet conditions on borrower quality, size, term, interest rate, documentation and arrears status. Loans that cease to qualify, for instance by falling into arrears beyond a set number of days, are removed from the borrowing base.
• Concentration limits. Caps on exposure to any one borrower, region, product type or risk band guard against concentration risk.
• Performance triggers. If arrears, defaults or the excess spread on the pool breach set levels, the facility stops revolving and collections are used to repay the provider.
• Pricing. Interest is charged at a margin over a reference rate on drawn amounts, with a commitment fee on the undrawn portion and often an arrangement fee.

The amount that can be drawn at any time is the borrowing base: the balance of eligible loans, adjusted for concentration excesses, multiplied by the advance rate. It is recalculated regularly from data supplied by the servicer and checked by the provider or an independent agent.

A warehouse is temporary by design. Once the pool is large enough, usually a few hundred million in the relevant currency, the originator arranges a public or private securitisation. The special purpose issuer sells notes to investors, uses the proceeds to buy the loans out of the warehouse, and the line is repaid and becomes available again. Alternatively the loans may be disposed of through a whole loan sale or a forward flow agreement with an institutional buyer.

For the originator, the central danger is refinancing. If securitisation markets close or investors lose confidence in the asset class, loans cannot be moved out of the warehouse, the line fills up and new lending must stop. If the provider declines to renew, or performance triggers end the revolving period, the originator may be unable to fund its business at all. This happened widely in 2007, when warehouse lenders withdrew lines from US subprime mortgage originators and many failed within months.

For the provider, the risks are the credit risk of the loans, the possibility that they cannot be sold for enough to repay the line, fraud such as pledging the same loans to two lenders, and weaknesses in the originator's servicing. Providers protect themselves through the advance rate, verification of loan files by a custodian, regular audits of the pool, backup servicing arrangements and, in mark-to-market facilities, margin calls if the value of the collateral falls. Interest rate mismatches between fixed-rate loans and floating-rate funding are normally hedged with an interest rate swap.

A warehouse facility with tranched credit risk is generally a securitisation position for the purposes of bank capital rules, and in the European Union and United Kingdom the securitisation rules on risk retention, due diligence and reporting can apply to private warehouse transactions as well as to public deals. Because warehouses connect banks to non-bank lenders, supervisors monitor them as a channel through which stress in shadow banking can reach the banking system.