The mortgage business is dwindling, thanks to a strengthening economy that has caused 30-year mortgage rates to jump from 3.34% one year ago to the current 4.46%. The lucrative refinance market has all but dried up, and big banks have been gradually loosening lending standards in an effort to garner more of the purchase-loan market. As the Federal Housing Administration has increased feesfor its low down payment mortgages, other lenders have been trying to grab borrowers have been shopping around since the FHA tab went up.
Biggest banks are jumping in
Over the past year, lending standards have relaxed somewhat as home prices have risen. Since midyear, Wells Fargo (NYSE: WFC ) has dropped down payment requirements on nonconforming, or jumbo, loans from 20% to 15%, while JPMorgan Chase (NYSE: JPM ) has lowered its down payment to 5% for purchases of homes in states that saw the worst of the foreclosure crisis. In October, Bank of America (NYSE: BAC ) relaxed its own standards, from 20% to 15% for a down payment, on jumbo loans of less than $1 million.
More recently, Bank of America, Wells Fargo, and TD Bank have been offering loans with down payment requirements of only 5%. Additionally, Bank of America, JPMorgan, and Wells Fargo have also announced that they will continue to offer their customers nonconforming loan products -- despite the advent of tougher "qualified mortgage" rules in January.
Are these new developments a smart move for big American banks -- particularly Bank of America, which is still suffering from the mortgage excesses of the pre-financial crisis era?
How much risk is too much?
So far, the evidence doesn't point to another bout of reckless subprime lending, though there has been a definite loosening of post-crisis loan restrictions.
Mortgage software provider Ellie Mae noted in its latest report that average FICO scores of borrowers have decreased significantly, from 750 in October 2012 to this October's current score of 732. Importantly, however, the percentage of closed loans with a FICO score of less than 700 increased to 28% in October 2013, compared to just 16% one year prior.
While relaxing standards a bit from the post-crisis clampdown on credit is not terrible, the move toward laxity could be detrimental to banks, particularly those with buckets full of crummy loans still muddying their balance sheets.
For example, although there is no barrier to institutions making loans that don't fulfill the new qualified mortgage rules, banks will likely face greater responsibility when originating such mortgages. In addition, investors will be wary of purchasing those loans, considering the added liability.
Time will tell how these new restrictions will affect lending, as well as how far into risky mortgage-making territory big banks are willing to creep in order to snag more market share. For Bank of America, extra caution is needed, since it is still reeling from the mortgage meltdown.
Not only does Bank of America expect to face additional mortgage fraud cases in 2014, but the bank has a smoldering pile of home equity lines of credit on its books that is the largest among its peers. These loans, interest-only until they mature to 10 years of age, will be resetting over the next few years, adding principal payments onto borrowers' current lower payments. Already, 2003-vintage Helocs, as they are called, are facing high default rates.
In addition, the big bank has a slew of FHA mortgages to contend with, loans that are supposedly government-insured -- except if banks are found to have engaged in some type of fraud or misconduct, in which case they could face treble damages. Of the largest banks, Bank of America holds the lion's share of these loans: nearly 200,000, compared to 136,000 for Wells Fargo and 70,000 for JPMorgan Chase. For Bank of America, building up its mortgage business again is an excellent plan -- as long as it includes a hefty dose of risk-aversion.
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