When Does a Warehouse Advance Actually Come Due?

A warehouse advance actually comes due on the earliest of five events, and only one of them is the sale the originator planned. In one older, public example, a 2006 warehouse loan and security agreement filed with the Securities and Exchange Commission (SEC) between a regional bank and three affiliated originators of a public homebuilder, each advance, with its fees and interest, is payable on the earlier of “Forty-five (45) days from the Funding Date of the Eligible Mortgage Loan,” the purchase date, “The earliest date on which the Eligible Mortgage Loan becomes past due 60 days or more,” the date the borrower itself “assigns, sells, transfers, conveys, or commences foreclosure upon” the loan, and “Termination of this Agreement.” In our view the sale is the one originators plan around. The first one is the clock that turns a slow-moving loan into a demand for cash, and it runs whether or not anything has gone wrong.

The 2006 agreement is a $30 million facility: a $20 million committed line and a $10 million uncommitted line the bank “may in its sole discretion provide” and is “under no obligation to honor.” It is an example of the secured-loan warehouse form rather than a statement of current market terms, and every figure below is that agreement’s rather than the market’s.

What is actually being advanced?

What is actually being advanced is at most the loan, and the formula has three ceilings rather than one. The 2006 agreement defines the advance amount as “the unpaid principal balance of the Eligible Mortgage Loan minus” the amounts on the settlement statement “which are to be disbursed to and retained by the Borrower.” The agreement’s settlement statement is the HUD-1 of that era. The commitment letter then caps the advance at the lesser of three figures: “100% of the net funding amount on the HUD-1,” the “unpaid principal balance of the mortgage loan being originated,” or “99% of the Market Value of the mortgage loan being funded.” The bank has “no obligation to make any advance” against a residential loan whose original principal amount exceeds $1,000,000.

In our view the third ceiling, 99 percent of market value, is the one that behaves like a haircut, and it is the same idea the collateral maintenance covenant runs on.

Is there a margin call, or something that works like one?

There is something that works like a margin call, drafted as a demand right. The 2006 agreement has no margin call mechanism in the sense a repo trader would recognize. What it has instead is a collateral top-up covenant. Whenever the collateral’s value, “as determined by Bank with reference to objective secondary market criteria such as, for example, the FHLMC posted rate” (FHLMC is Freddie Mac), falls below the advance on that loan, the borrower must, “upon demand of Bank, deliver to Bank additional collateral or other Eligible Mortgage Loan documentation or related papers as may be deemed necessary by Bank.”

Three things follow. The bank determines value. The example given, the FHLMC posted rate, is illustrative and not binding, because it is introduced with “such as, for example”; what binds is that the bank determine value “with reference to objective secondary market criteria.” And the obligation runs on the bank’s demand once the bank finds the value short; the covenant sets no other trigger. A borrower reading this provision as the equivalent of a repo margin call is reading in a discipline the words do not impose. The remedies clause of the same agreement adds a second edge: “in case of any depreciation in the value of said Collateral below the market value agreed upon,” the debt becomes due “at the absolute option of the Bank,” so a value shortfall can be an acceleration trigger as well as a demand. We cover the formulaic version in how a warehouse margin call is calculated.

What makes a loan eligible, and who decides?

The bank decides what makes a loan eligible, and it reserves the right to change the answer. In the 2006 agreement an eligible mortgage loan is a residential loan that meets every criterion on a schedule attached to the agreement, a schedule “which may change from time to time at the sole discretion of the Bank.” The agreement splits eligible loans in two. An eligible prime loan is one that conforms to the guidelines of the Federal Housing Administration (FHA), the Department of Veterans Affairs (VA), Freddie Mac, or Fannie Mae, with an express tolerance for a loan that “conforms to all FNMA guidelines except maximum loan size and debt ratios” (FNMA is Fannie Mae). An eligible sub-prime loan is any eligible loan that is not prime. The schedule, in the version filed, requires a loan “no more than 30 days old on the Advance Date,” secured by a one-to-four family property that is “ready for immediate occupancy” and located in the United States. It caps non-conforming loans by a grade the bank assigns from a grid of credit score against combined loan-to-value ratio, with no more than 5 percent of the line in the weakest of its five grades, and it excludes loans “previously warehoused” or “re-purchased by the warehouse borrower” outright.

Eligibility is not the only gate; the funding conditions and the lock covenants add several more. Before funding, the bank “may require” evidence of a lock and may require that it “be satisfied that Borrower can meet the requirements of each such Lock.” Closing documents other than agency or investor forms must reach the bank at least 10 business days before closing, and the borrower warrants that their use “will not violate the Lock” and will not “adversely affect the marketability” of the loan. If the advance documents do not arrive within two business days after closing, the bank may fund anyway, and its decision to do so “shall not be deemed to be or construed as a waiver” for any other loan; it “still may, in its sole and absolute discretion, declare an Event of Default.” A canceled lock, or an investor’s threat to cancel one, must be reported to the bank in writing immediately.

A schedule the bank alone may rewrite is the same structural problem correspondent sellers face with a seller guide. The 2006 agreement puts the power in the definition itself, where the criteria “may change from time to time at the sole discretion of the Bank.” What happens to loans already in the pipeline when the criteria move turns on the particular agreement’s own words.

Who is holding the note while it is in transit?

A bailee is holding the note while it is in transit, under a letter the bank attaches to the note before it ships. In the 2006 agreement the bailee letter is a form the bank attaches “to the front of every Mortgage Note,” addressed to the investor. It tells the investor the notes “are to be held by you as a bailee in possession on behalf of and for the benefit of the Bank, for the purpose of perfecting the security interest of the Bank in such Mortgage Note(s), and subject to the Bank’s direction and control.” Notes held under it “shall at all times be segregated from other property owned or held by you.” If the investor buys, the proceeds are to be wired to the bank “within twenty-one (21) calendar days after the date of delivery of this letter”; if it does not buy, the notes go back by overnight delivery within the same 21 days. The investor may not deliver the notes to anyone but the bank, or otherwise deal with them, “without the prior written consent of the Bank.” The bank’s security interest “shall be deemed to have been released only upon the receipt by the Bank of the full amount of cash proceeds from the purchase.” And the investor is told not to honor the borrower’s instructions about the notes without the bank’s consent “or until the Bank has received the applicable proceeds.”

Wet funding runs on the same trust theory at the front end. In each advance request the borrower “agrees to hold all documents related to the Mortgage Loan funded hereby in trust for and on behalf of Bank until delivered to Bank.” The security agreement says the pledge “may be perfected by the delivery of the Mortgage Notes to a third party as bailee,” and that the bank’s lack of physical possession “shall not in such event invalidate this pledge or its perfection, if such bailee is given notice of this assignment.”

For an originator, the bailee letter governs its shipped note, and in this form the originator does not sign it. The bank signs the letter, the investor countersigns it, and the originator’s signature is on the advance request.

What counts as a default?

What counts as a default is a longer list than the payment covenant, and one entry on it is not a standard at all. The 2006 agreement lists 10 events of default, lettered (a) through (j). They run from the failure of any obligor “to perform any agreement hereunder,” through insolvency events, “a materially adverse judgment,” “any materially adverse lien,” a governmental authority taking possession of “any substantial part of the property of any obligor,” and “the dissolution, merger, consolidation or reorganization or change in control of any obligor,” to “the reasonable determination by the Bank that a material adverse change has occurred in the financial condition of any obligor,” an unconsented assignment of any right in the collateral, “the Bank deeming itself to be insecure,” and any default “on any other indebtedness owing by the undersigned to Bank.”

The financial covenants sit next to that list. Tangible net worth “will at all times remain above $3,000,000.00,” net worth must “meet or exceed 5% of Borrower’s total liabilities,” and liquidity must “meet or exceed $1,500,000.00.” Merger, consolidation, a sale outside the ordinary course of “all or a substantial part of its assets,” and a change of management or a substantial change of ownership each take the bank’s prior written consent, “which consent shall not be unreasonably withheld.” The consent covenant carries a reasonableness standard, and so does the default event for a material adverse change. The default clause also lists a merger or change in control among its events.

Acceleration is immediate and at the bank’s option. On any of the 10 events the borrower’s liabilities “shall, without further notice, at the sole option of the Bank, become immediately due without demand for payment thereof.” The only notice the remedies clause provides for is the notice the Uniform Commercial Code (UCC) requires before a sale of the collateral, which the agreement deems satisfied by five days’ mailed notice.

The insecurity clause is the entry that is not a standard, and the same agreement writes the trigger twice and qualifies it once. The setoff clause lets the bank call every obligation “forthwith without notice or demand” should the bank “in good faith ever deem itself to be insecure.” The event of default reads “the Bank deeming itself to be insecure.” The UCC supplies a good-faith standard where it is enacted. Its uniform text provides that a term letting a party accelerate when it “deems itself insecure” means the party “has power to do so only if that party in good faith believes that the prospect of payment or performance is impaired,” and that “[t]he burden of establishing lack of good faith is on the party against which the power has been exercised.” So the bare clause is not unreviewable. Where the uniform text is enacted, the borrower, as we read it, carries the burden of proving a lack of good faith under both. In our view an unqualified trigger sitting in the same list as objectively testable events converts every other negotiated threshold into a floor rather than a test.

Is your warehouse a loan or a sale?

Whether your warehouse is a loan or a sale depends on the document, and this one is a loan; the agreement is careful about it. We searched the 2006 agreement and its exhibits for a borrower repurchase obligation, a price for one, or any true-sale wording, and there is none. The word “repurchase,” in one spelling or another, appears twice in the agreement and its exhibits: in the commitment letter’s promise not to use the line “to repurchase any mortgage loan,” and in the eligibility schedule’s exclusion of re-purchased loans. The structure is a secured lending facility. The borrower “pledges, assigns, conveys, mortgages, transfers and grants to Bank a security interest” in the notes, the locks, the mortgages, the servicing rights, the sale proceeds, its deposits at the bank, and “any and all other properties and assets of Borrower of whatever nature.” The grant says what it is for: “this assignment is made for the purpose of securing an indebtedness of the Borrower to the Bank,” and if the borrower performs, “this assignment shall be void.” The collateral assignment provision confirms the pledge is cumulative with the separate collateral assignments, so that the bank’s security interest “shall be construed and expanded to the fullest extent possible.” Where a loan goes unsold past the lock’s time limits, the borrower must “immediately reduce its indebtedness under this Agreement by the amount of the Advance,” with interest, unless the bank “in its sole and absolute discretion, should determine to allow otherwise” or agrees to a workout. The result is a mandatory prepayment, not a repurchase at a price.

In our view the distinction decides how the facility is treated if your counterparty fails, and what the borrower’s estate looks like if you do. It is the same question as whether the transfer is a true sale or a secured financing when a counterparty is in a workout. It decides whether the lender’s remedies run through Article 9 of the UCC or through a contractual repurchase. On this form the remedies are the UCC’s: on default the bank has “all of the rights of a secured party under the Uniform Commercial Code” of the governing state and may sell the collateral “at public or private sale, at the sole option of Bank.” In our view, where an originator carries more than one facility, the facilities do not behave the same way under stress, and the answer is not on the cover page.

What to take from this

The clock bites in five places, and the maturity schedule itself is only the first of them. Two of the others are a collateral top-up that runs on the bank’s demand and an eligibility schedule the bank alone may rewrite. The last two are an insecurity default and a pledge structure that puts the bank’s remedies under the UCC. Each is set by the agreement’s own words. The 2006 agreement writes its insecurity trigger two ways, with a good-faith qualifier in the setoff clause and none in the event of default. It puts a reasonableness standard on its consent covenant and on one of its 10 default events. It runs its collateral maintenance on a demand, where the repo form we read for the margin call article runs on a calculated deficit. Terms that a drafter writes two ways in one document, and differently across forms, are terms the parties set.

In our view the default is the trap. In our view a facility signed on the form as filed leaves the calls with the bank, apart from what it qualifies with a reasonableness standard and whatever the governing state’s UCC reads in. In our view four of the five provisions are presented as boilerplate. The maturity schedule, the one that is not, is in our view the one originators read, and the 45-day dwell is this agreement’s number, not the market’s.

Which of the five a given bank will move turns on facts particular to the deal. Those are what the particular agreement says, whose paper it is on, what else the originator has signed, and what it is funding. That is the work.