No More Monolines

A recent discussion with a mortgage banker whose been toying with the idea of forming or buying a bank reminded me of the recent announcement by another mortgage broker that it was temporarily withdrawing its application for a new bank charter.

One of Washington's largest mortgage brokers has temporarily withdrawn its application to form a new bank, in part because of a tighter regulatory climate surrounding home loans.

Homestone Mortgage Inc. President and CEO Keith Tibbles said the five-year-old lender pulled back the application after the Federal Deposit Insurance Corp. recommended changes to the bank's initial business plan.

"They felt like we should broaden some of our lending areas," Tibbles said, adding that Kirkland-based Homestone plans to resubmit its application soon.

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Homestone filed its application for a bank charter several months ago, with hopes that transitioning from a mortgage firm to a bank would expand Homestone's footprint and help it tap into the Puget Sound region's booming banking market.

It's a move with which state regulators are relatively familiar, due to state banking rules that make it relatively easy for mortgage companies to convert to banks.

By operating as a bank, a mortgage company can significantly reduce the amount it pays for the funds used to back mortgage loans. Golf Savings Bank, Pacific Crest Savings Bank and Seattle Savings Bank were all originally mortgage institutions, according to Brad Williamson, director of the banking division at the state Department of Financial Institutions.

For all the talk of "broadening lending areas," Brad Williamson hit the nail on the head as to why mortgage bankers want to operate as a bank: leveraging FDIC-insured deposits and Fed or FHLB borrowings, as opposed to money raised from other sources. The borrowing cost savings are significant.

I have no personal knowledge of this application, what trouble it ran into, or why it was withdrawn. The regulators aren't discussing it, and Mr. Tibbles alleges that it was a question of "timing."

According to Tibbles, timing may have played a big role in the FDIC's reservations about Homestone's application. With the nation's housing market slumping and the subprime mortgage sector in the midst of a severe correction, Tibbles said the FDIC was concerned that Homestone is too heavily invested in residential mortgages.

According to Tibbles, Homestone is "very concentrated in residential," and the FDIC recommended that its new bank place more of an emphasis on commercial loans to balance its portfolio.

"As part of our business plan, they would like to see us get into commercial lending sooner" than the company had originally planned, Tibbles said.

Using the FDIC's definition of subprime lending, Tibbles said subprime loans account for roughly 5 percent of Homestone's year-to-date loan volume of $438 million.

Despite the small share, Tibbles said those totals were enough to raise FDIC eyebrows at a time when banks nationwide are struggling to recover from the subprime sector's collapse.

"In the absence of the subprime issue," Tibbles said, "we would probably be up and running."

Homestone's application setback may also signal increased regulatory scrutiny on the state level. The Puget Sound region has seen roughly 10 startup banks since 2005 and, as the market gets more crowded, regulators are taking an even closer look at new applications.

"In the last couple of years there's been so many (startups) that we need to make sure the business plan is followed pretty closely," Williamson said.

I have no doubt that the recent subprime residential market meltdown, and the downturn in the overall residential real estate market, hurt the application's prospects. However, for a number of years, the regulators have discouraged applications for new charters, or for approval of acquisitions of existing institutions, where the business plan calls for rapid growth through basically one type of loan or other banking product. The regulators have discouraged "monoline" business plans for the last five or six years, at least. They feel more comfortable with traditional business plans where the product mix is diversified. Obviously, any plan that emphasizes residential real estate lending is going to receive closer scrutiny today, but it would receive a closer look even if the residential mortgage market was as hot today as it was several years ago.

Some people might think that the lender might have been better off looking at a federal thrift charter, since the mission of that charter is to provide home loans, and the OTS is an agency with a lot of expertise in regulating mortgage lenders. If a mortgage company wants to operate on a multi-state basis, federal preemption of state licensing and examination requirements will also add significant savings. That's would be a valid alternative. Yet, the FDIC will also have input into a new federal thrift charter, so its concerns will have to be addressed. More important, my personal experience is that the OTS is just as concerned as is the FDIC with "monoline" business plans that emphasize "undue" concentration on single family residential lending. One has only to look at the difficulties that publicly traded REIT American Home Mortgage Investment had from 2001 through 2003 in acquiring a federal thrift. The OTS shot them down twice, reportedly for just such concerns. American Home Mortgage finally acquired a federal thrift last October, but the news release announcing the acquisition almost overwhelms the reader with the word "diversify."

I'd expect that Homestone will take a page from American Home Mortgage's revised play book and come back to the table with a business plan that, just like Nancy Pelosi, celebrates diversity. Homestone certainly isn't giving up.

Looking ahead, Homestone hopes its next application will be approved quickly and that the bank will be up and running by year's end.