Big Banks Keeping Choicest Mortgages Rather than Sell to GSEs

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JPMorgan Chase (JPM) and Wells Fargo (WFC) are retaining more high-quality, conforming mortgages that they would normally sell to Fannie Mae or Freddie Mac, raising concerns that the banks are adversely selecting the weakest loans for the government-sponsored enterprises.

The banks are in talks with Fannie to determine if guarantee fees need to be raised to cover the higher risk to the GSE of holding more loans with less-than-stellar credit characteristics. The banks contend they are still delivering loans of high quality to Fannie. The GSEs routinely evaluate the mix of loans being delivered to them and hold banks accountable if that mix deviates significantly from the past.

"If a lender wants to retain some loans on their books, that is totally acceptable and understandable," says Andy Wilson, a Fannie spokesman, who says the issue is not a contentious one. "What we have to do is have a conversation about the risk profile of what the banks would deliver and make sure they are pricing appropriately."

The change is analogous to a health insurer that suddenly found all of the people insured under the age of 35 had dropped coverage of their health plans.

"If there is a shift in the profile of risk, we need to price it right," Wilson says. (Freddie declined to comment for this article.)

Chase has decided to keep anywhere from 10% to 25% of higher-quality conforming loans that it normally would sell to the GSEs, a person familiar with the matter said. Wells has not disclosed in the past year the amount of conforming loans it will retain.

Fannie and Freddie's guarantee fees are typically embedded in mortgage rates to protect investors from losses on home loans. Those fees have become a sore spot because they raise the cost to the borrower of getting a mortgage. Borrowers pay roughly 57 basis points in guarantee fees and more in so-called loan level price adjustments assessed by the GSEs based on a loan's characteristics.

Those fees alone can add up to 75 basis points to the mortgage rate, a significant cost for the privilege of selling a loan to Fannie or Freddie.

"Each bank has a view of the risk of the loan, the costs and what price they can get, net of all that, versus holding a loan on balance sheet," says Cliff Rossi, a professor of finance at the University of Maryland.

Rossi, who once headed single-family mortgage credit at Freddie, says the fees are high enough to make holding the loans more attractive. The additional fees as more than enough compensation for retaining the risk.

"If these are good credits, banks are going to hold them all day long," he said.

The big banks' shift to retaining more loans gained impetus late last year when the Federal Housing Finance Agency, the GSEs' regulator, announced a fee hike to bring more private capital back into the market.

The new FHFA Director Mel Watt delayed that expected fee increase in January to examine its potential impact on the market.

Since the 2007-2008 financial crisis most of the mortgages banks kept on their balance sheets have been jumbo loans to high-net-worth borrowers. But banks are flush with cash and with loan volumes plummeting over the last year they desperately need to add quality assets to their holdings.

The shift also indicates that the banks are extremely comfortable with the loans they are retaining, which have high FICO scores and low loan-to-value ratios, because they are most likely to have low defaults.

"We've said pretty consistently that we like mortgages as an asset and continue to put high-quality loans on balance sheet," says Tom Goyda, a Wells spokesman. Wells disclosed in the third and four quarters of 2012 and in the first quarter of 2013 that it would retain more loans ranging from $417,000 to $625,500 — amounts eligible for GSE purchase in pricier housing markets.

Fannie's market share declined 10% in the first quarter but it is unclear how much of that decline could be attributed to the big banks selling it fewer loans, Wilson says. Freddie does not disclose market share. The average credit score on loans purchased by Fannie and Freddie is 752, according to an analysis by the Urban Institute.

The downside is that the GSEs now may end up with chancier borrowers, those with low FICO scores and high loan-to-value ratios. That has led to concerns that the GSEs could be adversely selected to receive lower-quality loans. That is an issue that has long plagued the Federal Housing Administration, which has a mandate to support first-time homebuyers.

"The company providing insurance is always fearful they will be adversely selected," says Rossi. "This is a very common circumstance for the GSEs to be in, and which they want to guard against in a big way. If they now say they have underpriced the risk, they will need to exact some additional guarantee fee over time."

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