In secured warehouse lending, managing risk exposure to an individual issuer is critical, especially as facility sizes scale. Lenders establish customized concentration thresholds per issuer per facility based on stringent risk criteria assessment.
The concentration limits for each facility are specific to their lending product, risk categories, credit performance, excess spread, and other similar factors.
In this post, we will look at concentration limits set in warehouse credit arrangements across different risk dimensions. We also provide examples of how lenders set concentration limits depending on collateral profiles.
A risk-calibrated methodology for determining issuer limits enables greater precision in controlling warehouse portfolio exposures as facility sizes increase.
Issuer Concentration Limit Guidelines Per Facility
Warehouse lenders assess several criteria to establish appropriate issuer exposure thresholds on a per facility basis, including:
Collateral Performance
- Strong performing collateral: minimum 50% of the facility. e.g. if you are an unsecured consumer lender, risk category A (as the definition of high quality collateral).
- Average performing collateral: min 25% of the facility. By a similar definition loans with average risk adjusted returns can’t be less than 25% of the facility.
- Poorly performing collateral: max 15% of the facility. These are generally the highest risk segment of the portfolio. Lenders want to cap high risk customers. In bad times, bigger concentration of high risk loans may result in significantly degraded performance.
Collateral Credit Quality
This is similar to Collateral Performance but limits could be set based on FICO scores (for consumer loans), or monthly cash flows (for SMBs). Lenders will review your loan tape and the metrics you use to classify collateral quality. Because of the varied nature of products originated by platforms, lenders have different definitions of credit quality.
- Prime quality assets: Up to 4% per facility
- Non-prime assets: Up to 2% per facility
Collateral Asset Class Risk
If you are originating multiple types of products and have one facility with that’s buying all these products. Lenders will put limits on the types of products as a percentage of the facility. Examples include:
- Low risk assets like conforming mortgages
- Higher risk assets like subprime loans
Issuer’s Financial Strength
Depending on the financial strength of your company, lenders may have tighter concentration limits. They may also change concentration limits based on advance rates. Lenders generally consider the strength of the company in 2 ways:
- Strong balance sheet
- Levered balance sheet
In addition, overall issuer exposure limits factor in warehouse lender’s risk appetite, facility size, and issuer’s maturity in originating assets.
For example, a conforming mortgage issuer with strong financials and asset performance may qualify for a 5% limit in a $500 million facility. However, a deeply subprime auto lender may be restricted to just a 1% limit in a $100 million facility.
Important to note that lenders generally put concentration limits at the time of origination. For the revolving period, the outstanding balance may be covered by limitations of the borrowing base.
Conclusion
Fine tuning issuer concentration thresholds on a per facility basis provides precise calibration of credit exposures based on detailed risk assessment criteria. A customized methodology also allows for flexibility in financing diverse assets as facilities grow.
Warehouse line participants can collaborate to define appropriate issuer exposure guidelines per facility aligned to unique collateral profiles and risk capabilities.