Community banks have long faced a conundrum when originating government-insured home mortgages because they typically had only one secondary marketing outlet: the large bank aggregators that are also their competitors.
But an imminent pilot program in Chicago could soon change that dynamic for smaller banks, allowing them to bypass the megabanks and potentially get better pricing for some home loans.
The Federal Home Loan Bank of Chicago is expected to get approval soon to buy home loans and issue mortgage-backed securities guaranteed by the Government National Mortgage Association, or Ginnie Mae. The pilot program is expected to launch by September and is likely to expand to other FHLBs in the next year. The plan requires regulatory signoff from the Federal Housing Finance Agency, which oversees Fannie Mae, Freddie Mac and the FHLBs.
Some bankers are eager for a new outlet for their loans.
Donavon Ternes, the president, chief operating officer and chief financial officer at Provident Savings Bank in Riverside, Calif., says he would be interested in selling loans to the FHLBs if the price was right.
"From a mortgage banking perspective, it's who has the better price," says Ternes. "We are very interested in maximizing our returns and to the extent there is another entrant providing liquidity, we would expect better pricing for our products."
Many small banks are averse to holding long-term mortgages on their balance sheets. They can sell conforming mortgages to Fannie or Freddie, but cannot sell directly to Ginnie, which securitizes loans guaranteed by the Federal Housing Administration, Department of Veterans Affairs and Rural Housing Service. So the community banks typically sell these government loans to Goliaths like JPMorgan Chase (JPM) or Wells Fargo (WFC).
The Chicago program might allow some community banks and credit union members to stay in the mortgage business. Though mortgage lending is a fundamental bank product, small banks that originate just a handful of home loans have considered quitting the business because of increased regulation. Lenders have had to add more back office staff to deal with the Consumer Financial Protection Bureau's ability-to-repay requirements and Qualified Mortgage rule.
Some small banks that originate rural housing loans do not do as much FHA or VA lending and don't bother with managing and hedging a loan pipeline. The new Ginnie-FHLB program would give these institutions the opportunity to continue originating a small number of loans that they typically would have a tough time selling at a decent price.
"If it's competitive, it could move a substantial amount of business," says Ron Haynie, a senior vice president of mortgage finance policy at the Independent Community Bankers of America. "Since smaller banks are selling to the big aggregators, it's going to come down to pricing."
The program also may incentivize smaller banks to jump-start their offerings of Federal Housing Administration, Veterans Affairs and rural housing loans.
"This could really open up the availability of FHA/VA and rural housing lending into smaller parts of America," says Ted Tozer, the president of Ginnie Mae. "Small bankers will have the same pricing access as the big banks."
The FHLBs would not be taking on interest rate risk, which instead is shifting to the secondary markets. Community banks can opt to retain servicing rights or can choose another Ginnie-approved entity to service the loans. The FHLB does not own or retain the servicing rights.
The FHLB of Chicago became a Ginnie issuer on paper in the early 2000s but has never issued any Ginnie securities, says Chicago FHLB spokeswoman Melissa Warden. The Chicago FHLB has been working with Ginnie for nearly a year to reactivate its issuer status and begin buying loans from its members.
The program will be administered through Chicago's existing Mortgage Partnership Finance program, which allows members to sell fixed-rate loans backed by Fannie Mae and Freddie Mac into the secondary market. Ten of the 12 FHLBs participate in the MPF program and many are expected to adopt the Ginnie program as well.
"This is the first time the FHLBs will have a relationship with Ginnie," says Tozer. "The plumbing is there. We are leveraging our platform with the federal banks' platform."
The Chicago FHLB introduced the Mortgage Partnership Finance program in 1997 with the hopes that it would compete with Fannie Mae and Freddie Mac for lenders' secondary market business. Other FHLBs followed suit with similar initiatives. The Chicago and Seattle Home Loan banks pursued ways to securitize the loans they bought from member banks, but found only limited success.
Unable to securitize, the Home Loan banks had no choice but to retain mortgages on their books, ultimately largely killing the programs when loans started going bad during the financial crisis. The Chicago Home Loan bank stopped making purchases under its program in 2008. But the FHLBs started dramatically increasing mortgage purchases in 2012.
Last month, the Chicago FHLB agreed to a partnership with Redwood Trust, a real estate investment trust in Mill Valley, Calif., that buys jumbo loans. That deal allows the roughly 1,500 community banks, thrifts and credit unions that participate in the MPF program to sell loans of up to $729,750.
The Redwood and Ginnie programs are aimed at bringing more liquidity to the mortgage market and providing additional outlets for small banks without exposing them to interest rate risk.
Some financial institutions that hold a lot of mortgages on balance sheet may also be interested in the program because they may have to divest of servicing rights or face higher capital requirements under Basel III.