America’s mortgage markets: Spread besting

BEFORE they became a magnet for losses and lawsuits, mortgages were moneyspinners for America’s banks. They are again. The Federal Reserve’s campaign to push down interest rates has fuelled a wave of home-buying and loan refinancing. And to the frustration of the Fed, those lower rates are not being fully passed on to customers by the banks.

Profitability on federally-guaranteed mortgages is tied to the difference between what a bank charges a homeowner, and the yield paid to an investor once the loan is bundled into a mortgage-backed security (MBS). Since mid-2011 MBS yields have fallen further than mortgage rates, so the spread widened to a record (see chart) before falling back a bit recently.

Continent of dreams

  • Kings of the wild frontier
  • When the music gets you
  • Spread besting
  • Voting but not counting
  • Of privacy and opacity
  • Don’t go Zhou
  • Bonanza or bane
  • Robocolleague
  • Fannie Mae and Freddie Mac, two government-backed housing agencies, have played a part by hiking the fees they charge to guarantee a loan against default. That cost gets passed on to borrowers. But even after accounting for these fees, banks still earn roughly $3.50 on every $100 loan they sell compared with about $1.50 in 2007, according to a study sponsored by the Federal Reserve Bank of New York*.

    Banks now need a wider spread to cover the cost of buying back dud loans from Fannie and Freddie because of faulty underwriting. But that adds only 19 cents to the cost of a $100 loan, the authors figure. Most of the increase reflects higher profits for originators. Some have pricing power over customers who have trouble refinancing elsewhere. But capacity constraints matter more. Before the crash a lender would respond to higher demand by adding staff or buying more loans from outside brokers, says Paul Miller of FBR and Co, an investment bank. Now it simply holds the line on interest rates, which tempers volume but boosts profits.

    Certain banks have stopped buying loans originated by third parties. Bank of America halted such purchases in 2010 and 2011; its portfolio has shrunk to 9.5m mortgages at end-2012 from 13.4m two years earlier. In-house mortgage origination offers better margins and tighter quality control. The need to keep expenses under control also affects capacity: JPMorgan Chase has announced 13,000-15,000 job cuts in its mortgage unit, for example.

     Explore and compare global housing data over time with our interactive house-price tool

    Some argue that regulatory upheaval has also muted activity. “There’s a learning process, part of which is you don’t expand capacity if you don’t understand all the rules,” says Mr Miller. Not everyone agrees with that. Laurie Goodman of Amherst Securities, one of the study’s authors, doubts that uncertainty over future rules would affect loans today since they would not apply retroactively.

    Indeed, rules are slowly getting clearer. In January the new Consumer Financial Protection Bureau (CFPB) released its definition of a “qualified mortgage” (although a row about the constitutionality of CFPB appointments hangs over it). Banks that follow its rules to ensure a borrower can repay his loan will probably be shielded from lawsuits. What’s more, as home prices recover, default becomes less likely. So lenders will become less worried about being forced to repurchase a bad loan, says Paul Willen of the Boston Fed.

    Though falling, spreads are unlikely to return to pre-crisis levels. Mortgage lending in America is safer but also less competitive. Everything has its price.

    * “The Rising Gap Between Primary And Secondary Mortgage Rates”, by Andreas Fuster, Laurie Goodman, David Lucca, Laurel Madar, Linsey Molloy and Paul Willen. November 2012

     

    Tags:

    Leave a Reply

    Your email address will not be published. Required fields are marked *

    *