The Ongoing Appeal of the Secondary Mortgage Market

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Some bank balance sheets have become inhospitable to 10- and 15-year home loans

Given the risks posed by assets with long terms and fixed rates, it's no surprise that the 30-year mortgage has remained out of favor with banks. But home loans with even shorter maturities are unwelcome now in some institutions' loan portfolios.

BB&T has been selling 10- and 15-year mortgages in the secondary market since the second quarter. Other banks followed its lead the next quarter, determining that mortgage loans, with their declining yields, are not worth the longer-term risk of rising interest rates.

"We're not even adding any more 15-year mortgages," says Gerard Host, the president and CEO of Trustmark in Jackson, Miss. The $10 billion-asset company is retaining 10-year fixed-rate and adjustable-rate mortgages, but the 15-year mortgage is "a longer-term loan and, at a relatively low rate, it creates interest rate risk," Host says.

According to Freddie Mac, the average yield on a 15-year mortgage had fallen 55 basis points this year to 2.69 percent as of early November. That makes it difficult for banks to achieve the 3 percent spread between deposit and loan rates that they typically need to make money.

"We're trying to manage our spread income without taking too much interest rate risk," says Phil Wenger, incoming chairman, president and CEO at Fulton Financial in Lancaster, Pa. In August, the $16.3 billion-asset company began limiting the amount of 15-year mortgages it would originate and keep in its portfolio in any given month.

Still, many banks are underwriting more mortgages than they have in recent years, because people are refinancing to take advantage of low rates. Wenger says Fulton only began holding 10- and 15-year mortgages last year. "In a normal rate environment, a 10-year mortgage is very rare," he notes. "With rates as low as they are, a lot of people are refinancing ... and they're going from 15 years to 10."

Some banks may be tempted to originate and hold more mortgages because they need to reduce their concentration of commercial real estate and are struggling to book the commercial and industrial loans that would help them do so.

But analyst Mark Fitzgibbon of Sandler O'Neill & Partners says it's "incredibly dangerous" to book longer-term, fixed-rate mortgages because it can make banks more rate-sensitive and "it scares the daylights out of the regulators."

Dominic Ng, chairman and CEO of East West Bancorp in Pasadena, Calif., agrees that holding onto home loans could be a big mistake.

"That is going to be a very slow-ticking time bomb," he told analysts on a conference call in October.

Luckily for banks, the secondary market has been strong enough to digest what's being discarded from bank balance sheets.

Trustmark, which grew third-quarter mortgage production by 11 percent from the previous three months (and more than 50 percent from the year prior) to more than $500 million, sold nearly all of its newly underwritten mortgages that quarter in the secondary market.

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