After years of turmoil in mortgages and real estate, banks are taking on more risk. Wells Fargo (NYSE:WFC) is pushing harder to originate jumbo mortgages to hold on its books. So are emerging online lenders like BofI Holding (NYSE:AX), which owns Bank of Internet, a highly competitive jumbo lender.
And even though economic growth is coming in at a snail's pace, the average American is doing a much better job managing his or her budget. That's encouraging banks to hold more loans on their own balance sheet.
The 1 chart that explains "risk-on" attitudes
Charts really do say 1,000 words. I'll let this chart do the talking for me:
Here you see the number of delinquent mortgages that are either 90+ days late or currently in foreclosure. Since February 2010, the percentage of delinquent American mortgages in Fannie Mae and Freddie Mac portfolios has dropped in nearly every single month.
This trend creates new opportunities. Not only can banks capitalize on lower defaults by holding mortgage securities on their balance sheets, but they can also participate in some of the credit risk with new products from the two mortgage guarantors.
Fannie Mae is on a roadshow to sell new mortgage-backed securities to investors. Unlike other products, this portfolio won't have the 100% full guarantee of Fannie Mae. Instead, investors will take on the risk of default, protected only against 0.3%-1.65% of total losses, depending on the tranche investors purchase. Once losses cross 3%, investors would lose the entirety of their investment.
Good for banks, great for government
New risk-sharing mortgage-backed securities are great all around. First, banks have an option to participate in credit risk while earning a larger return on Fannie and Freddie paper on their balance sheet. Secondly, the government can move closer to its goal of putting the majority of mortgage risk on the back of private industry.
Now is the perfect time to launch credit-sensitive mortgage investments. With defaults moderating from a financial crisis high, and home prices up more than 12.4% year over year, the credit cycle looks like it's only just beginning. By the time the next recession hits -- and we hope it's nothing like the last recession -- homeowners should have sufficient equity to bare much of the brunt if home prices cool once again.
Since banks are oh-so willing to hold their own mortgages, it shouldn't be a big step for them to learn to love some risk sharing in mortgage-backed securities. From a larger philosophical perspective, it's great to see they'll have some skin in the game of underwriting standards, too.
This is just a step, but it's a step in the right direction. Risk on!