Large bank demand fuels jumbo loan rate upheaval

G-fee hikes, Fed tapering also drive competitive pricing

The market could blame higher guarantee fees and uncertainty around the Federal Reserve tapering its bond-buying program for the unprecedented inversion in pricing between conventional and jumbo loans. However, this is only a small contributor to the mortgage rates for the latter dipping below the former recently. And it could become a long-term trend.

The change in dynamic comes during a time when nonconforming jumbo loans with 20% downpayment had an average contract rate of 4.71% while a comparable conforming loan had an average rate of 4.73%, according to the Mortgage Bankers Association.

Large bank demand for jumbo loans is the primary driver in this unprecedented paradigm and may keep this relationship inverted well after uncertainty around tapering is resolved, explained Deutsche Bank (DB) analysts in their latest report.

"Large banks are likely highly motivated to add non market-to-market assets, given that under Basel III changes in value of their available for sale securities portfolio will flow through their regulatory capital starting in 2014," Deutsche Bank analyst Christopher Helwig said.

He added, "Additionally, proposed increased leverage requirements at the largest banks could skew the value proposition in favor of jumbo loans versus residential mortgage-backed securities."

Mega bank demand for jumbo loans is dramatically increasing and it should be noted that the private-label residential securitzation market highly favors this mortgage product.

The jumbo loan phenomenon comes at a time when Fannie Mae and Freddie Mac are in talks of reducing their conforming loan limits, hoping this change will reduce the government's dominant footprint in the mortgage market. The indication is that the government-sponsored enterprise are reducing their footprint on high-value mortgages. Financing the future demand, therefore, will come from another source.

The private-label securitization space has seen banking institutions make a comeback in the sector post-crisis, including Credit Suisse (CS) and JPMorgan Chase (JPM).

However, specialty finance companies are also eyeing the space, including Shellpoint Partners to allow for increasing issuance of nonagency RMBS.

If jumbo loans are sustained, it could have an impact on large bank demand for mortgage-backed securities going forward.

Additionally, the shift has implications for the availability of mortgage credit, and the size and role private capital in the mortgage market, according to Deutsche Bank.

"This relationship is unprecedented even during the peak of the mortgage credit bubble," Helwig explained.

Jumbos are being priced so aggressively because higher g-fees are driving the cost of conventional mortgage finance higher, coupled with the Fed taper has generally been driving MBS wider.

Consequently, these uncertainties have fueled recent rate volatility and when rates spiked, many banks began to price conventional loans wider than jumbo loans.

"It is historically very difficult for large banks to ‘move the needle’ when it comes to reallocating assets on the balance sheet. However, one lever they can flip fairly easily is pricing on a mortgage rate sheet in an effort to increase or decrease origination volumes," according to the report.

It continued, "Highly competitive pricing on jumbos could indicate that large banks see this rate inversion as an opportunity to put high quality assets on the books and are employing highly competitive pricing to grab as much outstanding origination as possible while rates are inverted."

Another potential incentive for the competitive repricing of jumbo loans is the Federal Deposit Insurance Corp. proposed enhanced leverage requirement that will impact institutions in excess of $700 billion in total assets or $10 trillion in trust assets.

Under the proposed standard, qualifying banks will have to hold 5% capital at the holding company.

Depending on the composition of the bank’s balance sheet, higher leverage requirements may mean that banks will be able to employ less leverage against MBS with risk weights lower than the leverage requirement of the total assets, Helwig noted.

Overall, the inversion of pricing between jumbos and conventionals will result in both short-term and long-term impacts, with g-fee hikes and large bank demand further sustaining such an inversion.

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