How Banks Handle Mortgages: Keeping Vs. Packaging

Banks play a critical role in the mortgage market, deciding whether to keep mortgages for their own portfolios or to package and sell them as mortgage-backed securities (MBS). This decision can significantly influence the overall dynamics of the housing market and the availability of credit. Let's delve into the percentages involved and the strategies employed by banks in this crucial process.

Understanding the Mechanics of Mortgage Lending

When banks issue mortgages, they assess the risk and potential return on each loan. In traditional trade financing, banks typically hold collateral such as hypothecated stocks to secure the loan. However, in the realm of industrial financing, where the loan amount is substantial, collateral often includes factory assets like land and machinery. Conversely, in mortgage financing or real-estate transactions, the value of the underlying asset can be far more significant. For a mortgage with a value of $100, banks usually only lend around $60 after securing appropriate collateral.

The Percentage of Mortgages Banks Keep

The answer is affirmative. In 2012, approximately 80% of the $1.7 trillion in new mortgages originated went to government-sponsored enterprises (GSEs) such as Fannie Mae and Freddie Mac, as well as to FHA and VA (Federal Housing Administration and Department of Veterans Affairs). Less than 1% were packaged and sold into non-conforming private MBS. Therefore, the remainder, which is around 19% to 20%, went into the banks' portfolios.

However, it is important to note that the bank-only number would be less than this 80% due to the inclusion of non-bank originators. Nonetheless, commercial banks still retained a substantial portion of the mortgage market. This retention can be attributed to the banks' desire to manage and control their own loan portfolios, which allows them to maintain better risk management and stronger customer relationships.

Reasons for Banks to Keep Mortgages

Banks have several compelling reasons to keep mortgages in their portfolios rather than selling them off as MBS. First, holding mortgages in their portfolios provides banks with an ongoing stream of interest income, as they continue to earn income from the loans they have issued. Second, by retaining mortgages, banks can tailor their loan products to better serve their customers. This personalized approach can lead to stronger customer loyalty and satisfaction. Lastly, holding mortgages allows banks to maintain a direct line of communication with their borrowers, which can be crucial during times of market volatility or unforeseen financial challenges.

Types of Mortgages Banks Keep

Banks can choose to keep various types of mortgages in their portfolios. These include:

Conforming Mortgages: These are mortgages that meet the underwriting criteria for Fannie Mae and Freddie Mac, which are more likely to be secured and sold to investors. Non-Conforming Mortgages: These don't meet the strict criteria set by GSEs and are thus kept by banks for their own portfolios. Hybrid Mortgages: These are a mix of fixed-rate and adjustable-rate mortgages that are structured to fit customers' needs and circumstances.

By keeping these types of mortgages, banks can diversify their loan portfolios and mitigate certain risks associated with relying on unsecured loans.

Consequences of Banks Keeping Mortgages

When banks keep mortgages in their portfolios, it has several effects on the housing market. Firstly, it can lead to a more stable credit environment since banks will be more willing to extend credit to borrowers who meet their lending standards. Secondly, it can increase the accessibility of credit for certain types of borrowers who may not qualify for securitized products. Lastly, it promotes the growth of local economies as banks invest more in the community, leading to job creation and economic activity.

Challenges of Keeping Mortgages

While there are many benefits to keeping mortgages in portfolios, it is not without its challenges. Managing a large portfolio of loans requires substantial resources and risk management expertise. Banks must carefully assess and monitor each loan to ensure that it remains a sound investment. Additionally, holding large quantities of mortgages can tie up capital, limiting the banks' ability to invest in other areas of the market.

Conclusion

In conclusion, the decision between keeping mortgages in their portfolios or packaging them into MBS is a complex one that depends on a variety of factors. Banks play a crucial role in the mortgage market, and understanding their decision-making process can provide valuable insights into the broader housing and credit landscape. As the mortgage market continues to evolve, it will be interesting to see how banks navigate these choices and the impact it has on the overall economy.