Banks Turn Wary of Congress-Controlled Mortgage Backers


Source: 401(K) 2012.

A long-standing love affair between Fannie Mae , Freddie Mac , and the American banking system may be coming to an end.

Recently, lenders have turned away from conforming loans -- loans that qualify for sale to Fannie and Freddie -- to cash in on jumbo borrowers. Here's why.

A "tax" on mortgages
In 2012, Congress changed the rules on the government-sponsored entities' conservatorship status. Since then, all profits from Fannie and Freddie are the government's, not shareholders'.

Congress is quite happy with its new cash cows. Fannie and Freddie have paid consistent billion-dollar dividends back to the U.S. Treasury, most recently returning $14.6 billion in the second quarter.

The mortgage-backing duo are making more and more money from guarantee fees -- fees banks pay to the entities to package mortgages for investors and insure against borrower defaults.

Since 2008, guarantee fees have more than doubled from less than 25 basis points to 50 basis points. The fees generated some $12.5 billion in profits for the GSEs in 2012, profits that are quickly paid out to the U.S. Treasury.

Source: Federal Housing Finance Agency.

Higher fees aren't all about revenue. The U.S. government hopes it can encourage private companies to take on the risk of default, eventually paving the way to wind down Fannie and Freddie by driving up guarantee fees charged to mortgage bankers.

Banks run to better markets
Earlier this month, Jumbo mortgage rates fell below conforming rates for the first time ever. Jumbo loan rates historically float 25 to 50 basis points higher than conforming loans because banks typically hold jumbo loans on their own balance sheet.

As guarantee fees rise and banks rethink credit risk, jumbo loans are starting to become big business for mortgage bankers. JPMorgan Chase announced it would loosen lending standards in several markets where it is active in jumbo loan origination. Bloomberg reportsWells Fargo is following a similar path in hot markets like San Francisco, where prices took only a brief breather through the financial crisis to continue on an upward trajectory.

The jumbo market may offer some of the best risk-reward origination opportunity for lenders. Online bank BofI Holding has been actively seeking jumbo originations, writing loans to borrowers with average FICO scores of 744 and loan-to-value ratios of 63% in its most recent fiscal fourth quarter.

The Foolish bottom line
Courting high net-worth borrowers makes sense. Wealthier borrowers generally have better credit metrics, and most importantly, higher lifetime customer value. A jumbo loan is just another step to cross-selling checking accounts, credit cards, or car loans.

Banks will likely continue their pursuit of wealthier borrowers as uncertainty surrounding the future of Fannie and Freddie's guarantee fees and the Fed's interest rate policy builds. Banks should prefer jumbo loans, which are largely agnostic to any legislative changes coming through Fannie and Freddie.

Jumbo loan rates at or near conforming rates are likely here to stay for the long haul.

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