The largest banks are charging relatively high interest rates to borrowers that qualify for a government refinance program, according to analysts, who say that the trend bodes well for mortgage profits in the second quarter.
The largest mortgage servicers, including Bank of America (BAC), JPMorgan Chase (JPM) and Wells Fargo (WFC), have been inundated since January with a wave of new refinance applications for the revised Home Affordable Refinance Program. The program, known as Harp 2.0, was designed to help mostly underwater borrowers whose loans are guaranteed by Fannie Mae or Freddie Mac take advantage of low interest rates.
Banks are most likely to offer refis to their existing borrowers, which requires very little additional work or costs, analysts say. But in comparison to the market rates offered to many new borrowers, the servicers are not lowering their rates as much as they could.
"Most large banks have been quoting higher rates for refinance loans than for purchase loans," says Derek Chen, a director of agency mortgage-backed securities strategy at Barclays. "Harp borrowers are kept captive to their existing servicers and as a result have to pay a higher rate" than new borrowers would.
That bodes well for banks' profits, since they are spending less on the refis than they would on newly-originated loans, while getting more revenue at the same time.
"It's clearly a gift to the largest banks," says Laurie Goodman, a senior managing director at Amherst Securities, who calls the profits the big banks are making on Harp 2.0 refinances "huge."
"The lender can obviously charge a higher rate if he is the only one able to originate the loan," Goodman wrote in a research note last week. "In a competitive environment, we would expect some of the benefit to be passed on to the borrower. In the absence of competition, the lender has broad pricing power."
"Fannie, Freddie and the FHFA have given the capacity-constrained originators the ability to extract excess profits from these loans, and the servicers are taking advantage of this opportunity," Goodman wrote.
The three largest servicers are getting paid premiums of 3.5 points to 7 points for selling the loans in bulk to Fannie Mae and Freddie Mac. Because the large servicers also own captive title and flood insurance businesses, "some of the closing costs are actually captured as revenue in other businesses," making it even more profitable for the large banks, according to Goodman. Servicers also may charge points or fees that further increase their profits.
To open the program to a larger pool of underwater borrowers, the Federal Housing Finance Agency in November revised Harp to allow loan-to-value ratios greater than 125%. The loans are guaranteed by Fannie Mae and Freddie Mac, but refinancing lowers their credit risk, risk of default, and potential losses to taxpayers, mortgage experts say.
The FHFA reduced the liability on certain loans to sweeten the deal for servicers — a crucial change that released servicers from the prospect of buying back some loans that may have not met guidelines. Harp 2.0 also eliminated the requirement for banks to conduct new property appraisals before offering refis.
The revised requirements favor "same-servicer" refinancing, says Chen, because a different servicer does not get released from borrower "representations and warranties" on the new loan.
"A bank would not want to take on another bank's underwater loan without fully re-underwriting it, given the implications on the servicing side and reputation risks," Chen says.
Many banks and lenders are wary of taking the risk of refinancing underwater borrowers who have higher likelihoods of defaulting, so they are only refinancing borrowers whose loans they originated and currently service.
Wells Fargo has placed its own restrictions on Harp refinancing. Though Wells Fargo will refinance borrowers with loan-to-value ratios greater than 125%, it will only accept Harp 2.0 refinancings of up to a maximum LTV ratio of 105% for loans originated by its wholesale and correspondent channel that are not currently serviced by Wells, says spokeswoman Vickee Adams.
Terry Francisco, a spokesman for Bank of America, says the Charlotte banking giant is giving applications from current B of A customers priority. Because applications take 60 to 90 days to fund, "most of the fundings will show up in the second quarter and it's been very strong," he says. "A lot of borrowers that had high loan-to-value ratios that disqualified them did not participate in refinancing in the past, and we're continuing to see strong demand."
JPMorgan Chase declined to comment.