Bank executives ought to be picking out nice holiday gifts for Fannie Mae and Freddie Mac. Financial firms have made a mint this year offloading home loans on the giant government-backed mortgage insurers. In the third quarter, bank profits from that business hit an all-time high.
The huge profit jump comes at a time when the government still needs to decide the fate of Fannie and Freddie, and when many think the companies, which were bailed out by the government in the financial crisis, should be doing more to avert foreclosures. But Ed DeMarco, the head of the government agency that oversees Fannie and Freddie, has resisted calls to lower the amount that underwater borrowers owe on their homes.
Bank profits in general are at a new post-financial crisis high. In the third quarter, U.S. banks earned a collective $37.6 billion, according to the Federal Deposit Insurance Corp., which released new data on Tuesday. That's up 7% from a year ago. The FDIC's list of so-called problem banks shrunk to 694, which was the first time that number has been below 700 in three years.
Much of the improvement, though, appears to be coming from loans sales, and much of those profits appear to be coming from the mortgage business. Wells Fargo (WFC), for instance, made $248 million selling residential home loans predominantly to Fannie and Freddie in the third quarter. That compares to a loss of $75 million for all other loan sales.
In all, banks made $5.6 billion off loan sales, up 227% from a year ago. That's the most banks have made off that business in any three month period since the FDIC began tracking that number more than a decade ago. By comparison, interest income, which is what the banks make from the loans and investments they hang onto, rose just $700 million, or less than 1%.
The notion that banks are making record profits off mortgages at a time when borrowers are paying record low rates for new loans may seem odd. The reason has to do with the fact that banks rarely hang onto their mortgages. Instead, they sell off the majority of those loans shortly after closing them, these days to Fannie and Freddie.
Typically, banks make a small profit, around 0.3% of the loan value on those mortgage sales. But recently, the spread between what banks charge for home loans and what they can sell them for with the assistance of Fannie and Freddie has risen to about 1.8 percentage points. Paul Miller, a bank analyst at FBR Capital Markets, says the profit margins for the banks are even larger when they do government-sponsored mortgage modifications.
"A lot of people got out of the business," says Miller. "The mortgage market is simply out of balance."
Regulators have recently been looking into why mortgage rates, spurred on by record low interest rates, haven't fallen more. (Mortgage rates have fallen to a recent 3.4%. But that's still much higher than Fannie and Freddie funding rates, and the 10-year Treasury bond at a recent 1.6%.) On Monday, the Federal Reserve Bank of New York held an all day conference on the topic. According to attendees, the reasons discussed included a lack of competition in the mortgage market, and the fact that banks are still dealing with a high number of foreclosures. Many expect the spread between government bonds and mortgage rates to narrow in the next year. That's made some question just how long the current bank profit rebound can continue.
"Banks are keeping mortgage rates up, so when they sell those loans to Fannie and Freddie they can make much more profit," says Bert Ely, a bank consultant. "The problem is it's not clear how sustainable those profits are."