Business Insights

Managing Liquidity: Insights and Advice from Our Resident Expert

This is the first in a three-part series on managing liquidity in mortgage banking, featuring Richey May’s Director of Mortgage Banking Seth Sprague. Part 1 looks at the state of liquidity and its impact on both mortgage origination and servicing. Part 2 dives deeper into the implications for servicing. And Part 3 explores industry best practices.

According to the National Association of Realtors, May 2023 saw home sales drop 20%. Little wonder the following month was an unsettling one for Seth Sprague, CMB.

The more the mortgage market cooled off, the more Sprague’s phone rang. In a typical week in June, he averaged a dozen calls from anxious CEOs and CFOs at independent mortgage banks (IMBs) across the country.

The topic of those conversations? Managing liquidity.

Sprague’s spike in call volume speaks not only to the current market situation but to his reputation in the mortgage space. As Richey May’s Director of Mortgage Banking Consulting, he’s more than our resident expert. He’s an industry authority, and frequently talks with industry trade groups and the DC regulators.

So what does the state of liquidity signal for IMBs? Sprague offers insights and five pieces of advice.

1. Keep a tight rein on risk. “IMBs live and die by the liquidity they’re getting from their warehouse lenders,” says Sprague. “So as stress and strain come into the banking space, the regulators are going to step in and change the capital rules for banks.”

As mortgage warehouse lenders like Comerica exit the business, IMBs in origination and servicing may need to think about more than just managing liquidity. Regulators may require mortgage banks to hold additional capital and that means banks are keeping a tighter rein on higher risk weighted assets on their balance sheets.

“As they have more capital rules thrown at them,” Sprague explains, “banks may have to get rid or reduce their mortgage servicing rights (MSR). A number of the large IMBs rely on their ability to sell servicing to help fund operations or servicing financing from banks. If that market gets oversaturated, values can come down, which would have a direct impact on the liquidity of IMBs trying to sell to that same space.”

2. Monitor the correspondent channel. Sprague points out that five of the top 10 correspondent buyers are banks in 2022. So, for banks that are selling servicing and no longer want MSR assets because of their high-risk weighting, he adds, “they really don’t need their correspondent channel anymore because that’s just a vehicle to bring in more MSRs.”

Sprague warns that since many IMBs rely on banks to buy their loans through the correspondent channel, there could be a disruption in liquidity on that channel. “Less buyers of those loans means less demand. Less demand and more supply mean prices come down.”

3. Find new warehouse facilities. “The final leg of this three-part stool,” Sprague says, are warehouse facilities. IMBs rely on warehouse banks to lend them money to fund originations, and as more banks like Comerica leave or scale back the warehouse lending business, “non-depositories that don’t have access to the federal home loan bank will need somebody to help finance their originations.”

In this environment, Sprague sees more IMBs having to pivot and find new warehouse facilities. “It’s sort of this trickle-down effect of bank failures across multiple segments of liquidity. And as their costs go up because profitability is coming down or fewer people are willing to lend against them, those people can charge higher rates.”

4. Get direct access to the Agencies. As an IMB’s liquidity gets narrowed, Sprague notes, they have fewer options. “Less options are never a good thing when it comes to liquidity,” he says. “I want as many sources of liquidity as I can get, and I want to try to get any many outlets for my loans as possible. Scarcity on either side of that does not work very well.”

He advocates for independent mortgage companies to seek direct access to the agencies. “The fact that your buyers have purchased your suite of originations to date doesn’t mean they’re going to buy from you tomorrow.” An ideal scenario, Sprague says, would be to “maximize your liquidity options that includes direct access to the Agencies, having a deep pool of correspondent buyers and having the ability to retain servicing.”

Sprague concedes that a direct Ginnie Mae relationship may not be an option initially. “But if they don’t have a Fannie Mae and Freddie Mac ticket, I think it’s critical that IMBs think about what they need to meet those capital and servicing requirements so they can sell loans directly to Fannie Mae and Freddie Mac.”

5. Understand how originations impact risk. While Sprague stresses the importance of looking at liquidity on the servicing side, he reminds the CEOs and CFOs he talks to that it is just as important to look at liquidity needs the origination side.

Origination quality can affect liquidity and untimely repurchase risk. To assess liquidity and repurchase risk, Sprague advises clients to answer a handful of questions:

• Are you originating loans that you could sell to multiple investors?
• If half your investors went away, what does that do to your product mix?
• Do you still have liquid loans to sell?
• Have you cut your staff to such a level that you’re creating undue repurchase risk?

The last thing an IMB can afford to do is to increase their liquidity risk via the originations Sprague says, if you have illiquid loans that you cannot find a buyer for, or “are creating loans with undue repurchase risk. It will impact profitability”

To learn more about managing liquidity amid the prevailing winds of the market or to tap into more of Seth Sprague’s expertise in mortgage banking, email us at info@richeymay.com