Academic journal article ABA Banking Journal

Mining Solutions in Your Mortgages

Academic journal article ABA Banking Journal

Mining Solutions in Your Mortgages

Article excerpt

Is there hidden value in your residential lending portfolio that could be helping your bank over a rough time?

Could be. One Northeast institution, which I will call First National Bank, discovered that whole loan securitization turned seasoned residential mortgages into an effective tool.

Setting the stage. In 1987, First National had $550 million in assets and a 6.5% total capital ratio. Like many other institutions in the region, the bank was enjoying strong loan demand. The shift from basic manufacturing industries to a service economy in the 80s led to a real estate boom that many bankers believed would continue. Margins were wide and assets were well-secured.

During roughly the same period, beginning in 1985, First National had competed aggressively for market share in the residential loan market. By the first quarter of 1990, the bank had originated $125 million of residential loans, with 75% of the originations being adjustable-rate mortgages.

The fixed-rate loans were generally securitized and sold to the Federal National Mortgage Association and the Federal Home Loan Mortgage Corp. The bank held onto the adjustable-rate loans.

Overall, both management and board were pleased with the residential loan strategy, seeing it as a way to penetrate a new market while adding good margin, low-risk assets to the balance sheet.

Boom goes bust. When the impact of the 1986 Tax Reform Act was felt--several years after its enactment--bankers and developers realized that supply exceeded demand.

First National was no exception. The bank had significantly increased its holdings in commercial real estate.

The severity of the problem grew apparent as delinquencies rose and equity capital eroded. The bank decided to concentrate on restructuring efforts in the commercial loan area, realizing that it would take months, if not years, to turn the portfolio around.

By the beginning of 1990, the bank's total capital ratio had fallen to 5%-just as federal regulators were becoming more concerned about real estate loans. Management reviewed its options for offsetting the rapid decline in its capital base. It turned to its residential loan portfolio to see what help it might offer. An audit of the portfolio determined:

(1) About 82% could be securitized; $22.5 million of the loans were ineligible because they were jumbo mortgages.

(2) Documentation was basically in good order. The audit determined that in many of the cases where it was lacking, the bank's mortgage department could obtain the necessary documentation to complete the loan files and permit securitization to go forward. …

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