Some large banks sold fewer mortgages to the government housing agencies last quarter, using them to manage interest rate risk and to slow the contraction of loans.
M&T Bank Corp., SunTrust Banks Inc. and Fifth Third Bancorp said they saw new value in keeping quality home loans on the books given the anemic lending environment and falling rates on securities, especially Treasuries and bonds issued by Fannie Mae and Freddie Mac.
Retained mortgages helped them maintain the balance of rates and maturity dates in their deposit and lending books, perhaps the most important harmony in banking.
"Everyone is dealing with declining loan portfolios. … This helps them stave that off," said Scott Siefers, a managing director with Sandler O'Neill & Partners LP who covers Fifth Third. "It helps to preserve some revenue. They must have just decided from a risk-reward standpoint it makes sene to hold on to these."
Mortgage standards have tightened dramatically since the economy collapsed, so there is little risk of new mortgages going bad. These three banks are also healthy enough to do without the revenue bump that comes from selling a home loan to Fannie and Freddie. They can afford to hold on to performing mortgages that will deliver hard-to-find interest income in a weak lending environment, experts said.
"My suspicion is that they feel from a yield perspective they can do better and still have the optionality to sell or securitize it down the road," said Kevin Fitzsimmons, another managing director with Sandler O'Neill.
M&T and Fifth Third have lost their appetite for government-backed bonds, which have been increasingly popular with other large banks eager to invest deposits. Rates on such bonds — already less favorable than on loans — have been falling. These companies are worried about owning too many in case rates increase.
With businesses and consumers still reluctant to borrow, mortgages are the only game in town for any bank interested in putting substantial loan-related earning assets on the books.
"With the run-off in our securities book, our level of asset-sensitivity has been getting a little higher than we like," Rene Jones, M&T's chief financial officer, said in a conference call with analysts Wednesday. "We believe that it makes more sense in the current environment to retain our own production of mortgage loans rather than to sell them and simultaneously purchase securities from others."
Late in the third quarter, M&T began retaining mortgages that conform to lending standards of Fannie and Freddie. The Buffalo, N.Y., lender has typically sold those types of mortgages to the housing agencies because it felt they offered lower returns than other types of loans it retains, such as business-related credits.
But businesses still aren't borrowing, which means M&T's commercial-related portfolios are shrinking.
M&T has also been letting investment securities run off its books for the last six months to protect itself in case interest rates rise. They were $7.67 billion at Sept. 30, down about 5% from the prior quarter. Total loans and leases, meanwhile, fell $269 million, or less than 1%, to $50.79 billion.
By holding mortgages, M&T is trading short-term gains for potentially more revenue over the long term, Jones said. It is losing the bump in revenue that come from selling a loan, but that should be offset by higher net interest come in quarters to come, he said.
Retaining mortgages is also the "cheapest" way for the $68.2 billion-asset lender to manage interest rate exposure given the wide disparity right now between rates on mortgages and rates on securities, Jones said.
"We long sort of viewed residential mortgages as substitutes for securities," Jones said. "It really doesn't make sense for us to be selling assets at the same time we're buying them, because we're basically just giving up the transaction spread."
For $174.7 billion-asset SunTrust, holding on to more mortgages is about managing risk while dealing with tepid loan demand. For the last several quarters it has been retaining more safe, high-quality assets while running off more volatile construction and home equity loans. The safest loans the Atlanta-based company can find at the moment: mortgages and student loans that are backed by the government.
"We're not looking to grow the overall on-balance-sheet mortgage portfolio significantly," Mark Chancy, SunTrust's CFO, said in a call with analysts Thursday. "We're trying to continue to de-risk our overall loan portfolio and add back quality assets, particularly in this case with a government guarantee."
SunTrust's total loans rose about 2% from the prior quarter, to about $115.1 billion, in part because it retained more guaranteed mortgages. It also bought a large portfolio of auto loans.
As of the most recent quarter, it had government guarantees on about $8 billion of loans, or 7% of its loan book. It retained about $1.2 billion more mortgages guaranteed by Fannie in the quarter. Core mortgages rose 5% from the prior quarter, to $25.6 billion.
SunTrust keeps investing in securities, though it is playing it safe there, too.
Most of its securities growth last quarter came from investments in U.S. Treasury notes. Its housing agency-backed securities rose 5%, to $17 billion. Total securities available for sale rose about 10%, to $30.3 billion.
Retaining some more mortgages helped Fifth Third slow the pace of loan contraction and manage interest rate exposure.
The $112 billion-asset company sold fewer refinanced mortgages to Fannie and Freddie in the quarter. Holding on to them added about $400 million to its loan book, offsetting run-offs of construction loans and commercial mortgages. Fifth Third's loans and leases fell by just $232 million from the prior quarter, after shrinking $1.2 billion in the April-to-June period. They ended the quarter down less than 1%, at $76 billion.
Daniel Poston, Fifth Third's CFO, said refinanced mortgages have better loan-to-value ratios, lower maturities and higher interest rates than conforming mortgages the Cincinnati company sells to the housing agencies.
Fifth Third is relying on more refinanced mortgages to manage its interest rate exposure. More people are prepaying loans, which can create an interest rate risk by shortening the average length of maturities in a lending portfolio. Banks always have to make sure they are paying less to borrow money than they are to lend it out, so maintaining a balance of when earning assets and liabilities expire and roll over at new rates is paramount.
Poston said the refinanced mortgages are helping maintain a "balanced interest rate-risk position."
Fifth Third sees "retaining these assets as a good way to re-extend the overall duration of our earning asset portfolio in the face of higher prepayment speeds," Poston said.
Fifth Third is also shuffling its asset mix by reducing securities while adding more quality loans with good yields.
Commercial and industrial and auto loans rose in the quarter. Those are two of the highest-yielding loan categories in its portfolio.
Fifth Third's total securities and short-term investments, meanwhile, declined 4.7% from the prior quarter, to $19.9 billion.
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