What it means
A bank or lender that makes loans often does not plan to keep them. It collects loans on its balance sheet, which is called warehousing them, until it has a large enough pool to sell to investors or package into a security.
During that holding period the lender carries risk. Interest rates and credit conditions can change before the sale, and the loans could fall in value, so lenders hedge (protect against) the risk or keep the holding period short.
The warehouse needs funding. Lenders typically use short-term credit lines from banks, secured on the loans themselves, and the cost of that funding set against the interest earned is the carry.
Lenders keep a close eye on whether the credit line is large enough to cover the expected volume of new loans. In the physical sense, the term covers storing goods in a warehouse and the associated costs of rent, handling, insurance and the cash tied up in stock.
Companies measure these costs against the benefit of having goods ready to ship. Faster delivery can win sales, but excess stock ties up cash and may become obsolete.
There is also a problematic meaning in securities markets, where warehousing can describe accumulating shares through friendly parties to hide a stake or avoid disclosure. This can breach reporting rules in many markets, and it is not the normal meaning of the term in finance.
Readers should check which meaning is intended before relying on a figure or a policy. The balance sheet, risk and funding questions are different in each case.
In practice
Real-world examples.
Example
A mortgage lender originates home loans for two months and holds them on a credit line. When it has $200,000,000 of loans, it sells them to a bond issuer, repays the line and begins a new batch. The finance team tracks the average days each loan spends in the warehouse and tries to keep it as short as it can.
Example
A retailer rents space in a distribution warehouse to hold goods before the holiday season. The finance team adds up rent, staff, insurance and the interest on the cash tied up to decide how early to bring in stock.
Example
A compliance officer at an investment firm learns that a client arranged for friends to buy shares on its behalf so it could build a stake without a public filing. She reports it, because that kind of warehousing can breach disclosure rules.
Formula
Calculation
Net carry = loan balance x (yield on loans - cost of funding) x (months held / 12)
Suppose a lender warehouses $50,000,000 of loans yielding 6.5% a year, funded by a credit line costing 5.0% a year, and holds them for 3 months. The interest rate gap is 6.5% - 5.0% = 1.5%. Net carry = 50,000,000 x 0.015 x 3 / 12 = $187,500. If the loans lose 0.5% of their value before sale, the lender loses 50,000,000 x 0.005 = $250,000, which would more than wipe out the carry.Case study
Seen in the real world.
Redwood Lending is an illustrative, fictional business lender that makes small business loans. It planned to hold each batch for three months before selling it to investors, funded by a bank credit line.
In one quarter, market interest rates rose sharply while the batch was still on its books. Investors demanded a higher yield, and the price of the loans fell by 1.2%, which on a $30,000,000 batch was 30,000,000 x 0.012 = $360,000.
At the same 1.5% gap between loan yield and funding cost, the net carry over the three months was only 30,000,000 x 0.015 x 3 / 12 = $112,500, so the lender made a net loss of about $247,500 on the batch. It later shortened its holding period, hedged part of the interest rate exposure and negotiated forward sales to investors. The illustrative lesson is that warehousing earns a small steady return but carries the risk of a larger sudden loss. Redwood now caps the size of each batch and the number of days it can be held before a sale must be agreed.
Watch out
Common mistakes.
- Treating the carry as pure profit, when it can be wiped out by a small fall in the value of the assets.
- Using a long holding period without hedging, which leaves the lender exposed to interest rate and credit moves.
- Confusing warehousing in finance with simple physical storage, when the risks and accounting treatment differ.
Questions
People also ask.
Why do lenders warehouse loans at all?
They need enough loans to form a pool that investors will buy, and building that pool takes time.
How are warehoused loans funded?
Usually with short-term credit lines from banks, secured on the loans, which are repaid when the loans are sold.
Is warehousing shares always illegal?
No, but secretly accumulating shares to avoid disclosure thresholds can breach reporting and market rules, so it needs legal advice.
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