What is Warehousing in Finance?

Warehousing is an intermediate stage in a collateralized debt obligation (CDO) that includes the purchase of loans or bonds that can serve as collateral in a CDO transaction. It is the accumulation and custodianship of loans or bonds that will become ultimately securitized through a CDO transaction. Typically, warehousing periods last for three months. During this time, the underwriting bank is subject to the risks involved in having the assets in their possession. At the end of the period, the transaction is closed after it has been finally securitized and sold as a part of the CDO.

Warehousing Explained

A collateralized debt obligation (CDO) is a structured finance product that is supported by a pool of loans and assets that are repackaged and sold to investors. These repackaged loans and assets are sold to institutional investors. A CDO is a type of derivative because its value is derived from another underlying asset. In the case of loan defaults, these assets serve as collateral.

Typically, CDOs are created when investment banks pool assets with high cash flow tendencies such as bonds, mortgages, and other types of debt. These cash flow-generating assets are then repackaged into tranches based on their credit risks. These tranches are senior debt, mezzanine debt, and junior debt. Senior tranches are less risky as they have top priority on the collateral if at all there is a default. Credit rating agencies also rate senior tranches higher but may offer lower yields. Junior tranches, however, are rated lower but they offer higher yields. These tranches of securities eventually become the final investment products, as their names reflect the specific underlying assets.

It is the responsibility of an investment bank to run the warehousing of the assets ahead of the time the CDO will be launched into the market. All assets will be stored in a warehouse account until the target amount is completed, after which the assets will be transferred to the corporation or trust created for the CDO.

As the name implies, CDOs serve as collateral of promised repayments of underlying assets, which gives them their value. Other types of CDOs are collateralized bond obligations (CBOs) and collateralized loan obligations (CLOs).