When it comes to mortgages, Washington Mutual Inc. is betting on a decidedly old-fashioned strategy: make them and hold them.

The nation's largest thrift actively seeks to make loans for its $150 billion mortgage portfolio. By contrast, most top lenders act mainly as mortgage bankers, selling the bulk of their loans to Fannie Mae, Freddie Mac, or other secondary-market outlets.

Wamu, as the thrift is known, sells about half the loans it makes and holds the rest on its books. That lets it reach more borrowers and offer them more choices, executives say.

"We have an advantage and an opportunity as the nation's leading portfolio lender," said Craig S. Davis, executive vice president in charge of Wamu's 6,000-employee mortgage operation.

Indeed, its portfolio-beefed up by three thrift acquisitions in three years-puts the Seattle-based thrift in practically the same league as Fannie and Freddie, whose portfolios total $441 billion and $263 billion, respectively.

But portfolio lending has its drawbacks. Veteran thrift watchers remember 1980, when skyrocketing deposit rates devastated thrifts that held fixed-rate mortgages.

In managing its assets and liabilities, Wamu needs to fill its portfolio with adjustable-rate loans to match its floating-rate deposits. That can be hard to do when rates are falling and consumers prefer fixed-rate loans to lock in the low rates.

Mortgage bankers, however, face their own limitations. For starters, they have to make sure their loans conform to the standards of secondary market agencies. Sometimes that means turning down borrowers, and not necessarily for credit reasons.

"Many of the folks who originate conforming loans are using what we call 'black boxes,'" said Marangal I. Domingo, senior vice president and treasurer of Wamu. "If you don't fit into the black box," he said, for reasons such as loan size or documentation, "sorry, you don't get the loan."

Because Wamu doesn't sell all its production, it can make loans that exceed Fannie's and Freddie's size limits, or require less documentation.

Its strategy of lending for its own portfolio also enables Wamu to design its own quirky products, such as the "option ARM"-an adjustable-rate mortgage with a flexible payment schedule aimed at entrepreneurs, people paid on commission, and others who want the ability to defer payments.

Option ARM borrowers can stretch out their payments for as long as 40 years. In return, Wamu gets a floating-rate asset to match its deposits.

The bigger menu of products, Mr. Davis said, endears the thrift not only to consumers but to Realtors and mortgage brokers-two key loan sources. Real estate brokers send customers to Wamu knowing they will get a loan, he said.

As for mortgage bankers, he said Wamu tries to be "their portfolio lender of choice," and makes a commitment not to treat them as "spigots" that can be turned on and off, as some other lenders do.

"We have a real, true relationship with them," he said. "We're not going to cut them off, we're always going to be their portfolio lender."

To be sure, Wamu is not the only national home lender that also invests in mortgages. BankAmerica, the leading servicer and No. 4 originator, has a mortgage portfolio roughly the same size as Wamu's, although BankAmerica's has more mortgage-backed securities and fewer loans than Wamu's.

Chase Manhattan Corp. and Wells Fargo & Co., also top-five originators and servicers, boast substantial mortgage holdings. As of Sept. 30, Chase held $76 billion of mortgages, while Wells and its merger partner, Norwest Corp., held a combined $52 billion.

Indeed, most of the top originators and servicers are owned by banks. Countrywide Credit Industries is the only large independent mortgage banker.

Mr. Davis acknowledged that BankAmerica is competitive in some areas of portfolio lending, but maintained that most banks are not. "In terms of having capital to hold loans in portfolio, I don't think anybody is as focused on it as we are," he said. Wamu has about $1.5 billion of capital to make new loans.

Simply having a loan portfolio is "very different from being a portfolio lender," he added. "Anybody can decide they want to keep some of the loans that they would normally sell to Fannie or Freddie. We're talking about loans that (cannot be sold) in the secondary market."

Feeding Wamu's portfolio was not easy last year, when more than 80% of originations industrywide were fixed-rate. Mr. Davis said Wamu hit its ARM generation targets for 1998.

But half of its ARM production was in so-called hybrid ARMs, which, unlike the option ARM, pay a fixed rate for several years before converting to an adjustable rate.

The hybrid loans pay an inferior spread over a thrift's cost of funds compared to "true" ARMs, said Jonathan E. Gray, analyst at Sanford C. Bernstein & Co. And if interest rates shoot up during the temporary fixed- rate period, "you may earn no spread at all."

"It's like telling yourself you're on a diet, and eating something that has little fat but lots of sugar," Mr. Gray said. "A significant amount of (Wamu's) ARM production is not doing for them what ARM production is supposed to do."

Tough as it was to generate adjustable-rate mortgages last year, some thrifts managed to generate higher percentages of traditional ARMs than Wamu did. For example, some 83% of Golden West Bancorp's production had interest rates that reset after the first month, Mr. Gray noted.

But Golden West, based in Oakland, Calif., originated only $8.1 billion in 1998, while Wamu produced $43 billion. Wamu tried to maintain high volume in order to keep origination costs down, Mr. Davis said.

"If we decided we wanted (only) $10 billion of ARM production, we could have done 100% option-ARM production," he said, adding that Wamu's loan officers, known as "loan consultants," try to tailor loans to customers' needs.

Wamu will not make the riskiest sort of hybrid ARMs, which have fixed- rate periods of seven and even 10 years, said Mr. Domingo, who manages Wamu's holdings of home loans and mortgage-backed securities.

Besides, he said, falling rates, which prompt homeowners to pay off loans early, have been a "greater challenge" than rising rates.

For that reason, Wamu's sophisticated hedging strategy combines interest-rate-swap agreements, in which it passes on fixed-rate interest payments to a counterparty in return for a floating-rate payment stream, with interest-rate caps.

Other companies have just used swaps, and "have paid the price," Mr. Domingo said. When loans were prepaid, these companies found it expensive to buy out of their swap contracts. The borrowers had refinanced because rates were lower, and for that reason the counterparties wanted hefty fees to cancel.

A cap agreement holds that if rates rise above a certain level, the counterparty must pay the holder the difference. When rates fall, such an instrument would depreciate in value-but that would be a much less expensive fate than having to buy out of a swap agreement, Mr. Domingo said. At yearend, Wamu had entered $7.41 billion of swaps and cap agreements.

Wamu's other key strength in mortgages, its executives said, is its variety of origination sources.

The company has 250 retail mortgage branches in 29 states and the District of Columbia, staffed with 1,200 loan officers who work with local real estate brokers and produce 45% of Wamu's volume. Mr. Davis said he expects to expand the retail sales force to 1,500 this year.

Mr. Davis also said he intends to expand Wamu's network of wholesale offices to 28 from the current 23, and its team of wholesale account managers to 150 from 120. They get loans from brokers in the same markets as the retail division.

Wamu had not done much broker business before its 1996 purchase of American Savings, Irvine, Calif., but wholesale lending now accounts for 40% of volume.

The remaining 15% of Wamu's volume comes from its 1,000 bank branches, known as financial centers, in eight states. These branches bring in mostly fixed-rate loans, Mr. Davis said, because their most active origination periods are during refinance booms, when customers simply walk in.

Last month, Wamu said it would soon start taking applications on the Internet. Mr. Davis predicted that on-line originations could account for 20% to 25% of Wamu's production within two to five years. A telemarketing facility is also in the works.

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