Banks could end up holding more home loans on their balance sheets next year instead of selling them to Fannie Mae and Freddie Mac, the result of fee increases that are designed to increase the role of private capital in the mortgage market.
But whether the higher fees announced last week by the Federal Housing Finance Agency will actually do anything to jump-start the market for private-label mortgage securitizations remains an open question.
Since the housing crisis, demand for private-label mortgage-backed securities — essentially those not backed by Fannie, Freddie or the Federal Housing Administration — has largely been limited to jumbo loans made to high-quality borrowers. The volume of private label securitizations has plummeted from a peak of $2.2 trillion in 2007 to a mere $12.5 billion in deals completed so far this year, because investors remain skittish about buying securities that do not carry a government guarantee.
Some analysts and mortgage experts say that a hike in guarantee fees will do little to encourage more private investment in the mortgage market.
The theory is that if fees are raised enough, investors would be compensated for their cost of capital and potential losses, while providing them with an acceptable return on equity.
But observers say that higher fees — which would amount to between 1/8th to 1/2 of a percentage point in a borrower's mortgage rate — are simply not high enough to entice private investors.
"The recent fee increases will have little impact on the economic feasibility of private-label securitizations," says Scott Buchta, head of fixed-income strategy at Brean Capital in New York.
The fee increases could make it more attractive for banks to keep on their books loans they might otherwise have sold to Fannie or Freddie. By announcing the fee hike, the FHFA, which oversees Fannie and Freddie, has essentially set the price for credit risk and it's a fee banks are likely to charge whether they plan to sell the loans or not. Banks desperately need to add high-quality assets and they may view the additional fees as sufficient compensation for retaining the risk.
Moreover holding home loans may result in more favorable capital treatment for a bank than holding them in securitized pools, especially in a rising rate environment.
"Everyone is looking at the transition from agency to private-label as private capital [coming back into the market] but bank portfolio lending is a logical first step between the two," Buchta says.
Matthew Jozoff, head of securitized products research at JPMorgan Chase (JPM), agreed. He has analyzed the pricing for various types of loans and found that banks will likely hold on to the loans made to borrowers with high Fico scores and low loan-to-value ratios. Many banks such as Wells Fargo (WFC) have already being retaining high-quality jumbo loans.
"Fees for high loan-to-value ratio loans are still too low relative to where private capital would enter the market," Jozoff says.
Several of the top banks could not be reached for comment or their spokespeople said they were still analyzing the fee changes.
Other market experts said lowering limits on loans sold to Fannie and Freddie would have a bigger impact on bringing in private capital back into the mortgage market.
On Monday, the FHFA asked for public comment on a plan to reduce the maximum size of loans that Fannie and Freddie can purchase from mortgage lenders. The plan would reduce loan limits to $400,000 nationwide, from the current $417,000, and to $600,000 in high-cost areas from the current $625,000.
Analysts say private investors would be able to fill that void if there is no competition from Fannie and Freddie for higher loans.
Fannie and Freddie's guarantee fees are typically embedded in mortgage rates to protect investors from losses on home loans. The FHFA ordered the fee increases last week.
Mortgage lenders were further surprised on Monday when Fannie and Freddie posted on their web sites that they were instituting "price adjustments" for loans with the riskiest characteristics, such as high loan-to-value ratios.
While the annual guarantee fee increase will raise the cost of a typical 30-year mortgage by roughly 14 basis points, the FHFA's loan level adjustments could increase overall mortgage financing costs by 20 to 40 basis points.
Mortgage lenders and the Mortgage Bankers Association are criticizing the fee increases — which are expected to go into effect between March 1 and April 1 — because they will raise the cost of home loans for a sizeable chunk of borrowers — those with down payments of between 5% to 20%, and credit scores ranging from 680 to 759.
Indeed, incoming FHFA director Rep. Mel Watt, D-N.C., is likely to face intense pressure to scale back the fee hike if it threatens to dampen the housing recovery. Watt was confirmed last week as the new FHFA director, succeeding Edward DeMarco, who has been acting head since 2009.
Borrowers who are considered the worst credits, with low FICO scores and high loan-to-value ratios, are likely to be encouraged to take out loans backed by the Federal Housing Administration instead.
"This will push more borrowers to FHA," says John Hudson, vice president of regulatory affairs and production manager at Premier Nationwide Lending, a Texas wholesale lender. "An 8th of a point to a half-point change in the rate can make all the difference in a borrower getting a mortgage," he says