Innovative Funding Strategies Michele Perrin MBA National Convention, October 26, 2004 Mortgage Banker Finance

2 Funding Strategies  Warehouse lines of credit  Traditional repurchase (repo) lines  Gestation lines  Early purchase facilities – similar to gestation with some new twists

3 Comparison of Funding Strategies: Description Warehouse Lines Repurchase Facilities Gestation ReposEarly Purchase Provided primarily byBanksWall Street Banks, Investors Line SizesLimitedLarge Accounting Treatment On balance sheet On or Off balance sheet Off balance sheet Non-use feesYesUsually notNoUsually not Takeout Commitment Required?UsuallyYes Usually Will it fund wet?YesSomeNoYes Will it fund to closing?YesSomeNoYes Require Personal Guaranty?YesSomeNoSome Advance RatesUsually 98%Up to 102% Up to 100%

4 Warehouse Lines  Offered by Banks  Accounted for as a borrowing  Increases leverage  Limited line sizes  Not bankruptcy remote  Carries a non-use fee  Requires personal guaranty of owners

5 Traditional Repurchase Lines  Offered by Wall Street brokerages  May use financing or purchase language  Often won’t fund wet  Usually requires a takeout commitment  Offered to broker’s active sellers  Not committed  May fund over 100% of par

6 Gestation Repo  Always requires a takeout commitment, often in the form of an agency forward  Does not fund wet or to the funding table  Usually off-balance sheet  Generally does not require guaranties or commitment fees (not committed)  May fund over par

7 Early Purchase Facilities (EPFs)  Off-balance sheet  Some providers require that the loan be sold to them  May or may not be committed  May have no personal guaranty  Generally carries no non-use fee or commitment fee

8 Other Features of EPFs  Will fund wet and to the closing table  Available in larger amounts than warehouse lines  Some do not require that the loans be sold to the provider as investor  May be committed for up to one year  May not require takeout commitment at time of funding  May allow funding of Alt-A and subprime loans  May fund up to 100% of par value

9 Off-Balance Sheet Treatment  Recorded as sale when funded by provider  Reduces leverage  Improves liquidity ratio by decreasing current liabilities  May reduce the required net worth by keeping the leverage lower

10 Why Off-Balance Sheet Treatment?  Lenders usually require the leverage ratio (liabilities divided by net worth) to be greater than 15:1  Lenders want to see a liquidity ratio (current assets divided by current liabilities) of no less than 1.03:1 to 1.05:1  Cash as a percent of assets: Lenders would also like to see cash of about 1.5-2% of total assets  Off-balance sheet facilities help reach these goals as shown in the following example.

11 Off-Balance Sheet Treatment Effect

12 Why Does a Repo or EPF Get Sale Treatment?  The legal document is a Purchase and Sale Agreement  The transaction must not require repurchase by the Seller—the purchaser completes the pre-arranged sale to a third party investor  Must be bankruptcy-remote—that is, it must meet the legal requirements for a sale  Must meet requirements of SFAS 140 for auditor buyoff

13 SFAS 140—Three Requirements to Get Sale Treatment  Transferred assets must have been isolated from the transferor—even in bankruptcy  The transferee must have the right to pledge or exchange the assets it receives  No repurchase agreement

14 Caveats for Users of Off-Balance Sheet Vehicles  Must be monitored closely for stale loans just like a warehouse line  Maintain adequate net worth and liquidity to manage risks of all loans in the pipeline  Some warehouse lenders will add these balances back to calculate covenants

15 Conclusion  Find out more about these facilities and see if one of them is right for you  Ask your current lenders how they would treat such a facility  Check with your auditors about how they would treat the facility you have in mind (they may need to review the agreement)  Ask lots of questions—these facilities vary greatly in what they will allow  Then get ready to grow!

Thank You!