JPMorgan Chase, looking to stem falling revenue in its mortgage business as fewer Americans refinance, is increasingly buying loans from smaller lenders, a practice that competitors including Bank of America view as risky.
In the first half of 2015, the bank bought 62 percent of the $58 billion in home loans it added to its books, compared with 56 percent in 2014 and 37 percent in 2011.
While other big banks buy mortgages from other lenders, known as correspondents, JPMorgan has racked up the biggest increase among its peers in the proportion of loans it buys from others, according to data from trade publication Inside Mortgage Finance. JPMorgan is fighting for business in what has been a shrinking market.
According to the Mortgage Bankers Association, applications for U.S. home loans have fallen by about 25 percent since mid-January, when a temporary drop in rates spurred a small wave of refinancing. Since May 2013, when mortgage rates first started jumping amid fears the Federal Reserve would hike rates, application volume has fallen by more than 50 percent.
Fewer applications overall make it harder for JPMorgan to make as many loans directly to consumers in its bank branches. Still, JPMorgan's willingness to buy loans from correspondent banks is a sign that banks are comfortable taking more risk in the mortgage market, nearly a decade after the housing bubble popped.
"As they gain more confidence about the environment, they go right back to the correspondent channel for more volume," said banking analyst Charles Peabody of Portales Partners.
To be sure, Bank of America avoids the loans, because it doesn't want to be exposed to bad decisions made by smaller banks that do the actual lending.
"There's more risk in being that far away from the customer," said D. Steve Boland, the Bank of America executive in charge of mortgage and auto lending. For example, a smaller lender could fail to verify a borrower's income properly, and just sell the loan on to a bigger bank.
High degree of confidence
To minimize that risk, JPMorgan, like other banks, specifies exactly what correspondent lenders have to do to vet loans, and forces the smaller lenders to buy back loans that turn out to have fallen short of those requirements.
Greg Beliles, correspondent lending head at JPMorgan, wrote through a spokeswoman that the bank works with "experienced, well managed and high quality" lenders. Bank of America's concerns may stem from its experience with Countrywide Financial, which Bank of America bought in 2008, the largest correspondent lender in the U.S. at the time.
Countrywide failed at least in part due to bad loans that it bought from correspondent banks and could not sell back to them. The Countrywide deal has been a huge millstone for Bank of America—the bank has paid some $70 billion in settlements and legal penalties linked to the financial crisis, much of which came from its acquisition of the lender.
Other lenders had trouble with correspondent loans during the crisis. Residential Capital, once the mortgage arm of Ally Financial, filed for bankruptcy in 2012, in part because of its exposure to correspondent lenders that were not able to make good on claims. Ally is the successor firm to GMAC, the car financing arm of General Motors.
JPMorgan said it reviews every loan it buys in detail. That attention gives it a "very high degree of confidence in the loan quality we are purchasing," JPMorgan's Beliles wrote in his email.
He said JPMorgan keeps the bulk of mortgages it buys from other lenders on its balance sheet, rather than bundling them into bonds and selling them to investors. Banks like JPMorgan may be dialing up their risk taking a bit, but there is little evidence of a new bubble forming.
While a few small lenders are creeping back into products like subprime mortgages, bigger banks are by and large avoiding them. Delinquency rates on single family mortgages, which peaked at 11.26 percent in the first quarter of 2010, have declined fairly steadily ever since and stood at 5.77 percent at the end of the second quarter, according to data from the Federal Reserve Bank of St. Louis. In the last crisis, delinquency rates started rising in 2004, and by the third quarter of 2007, a year before Lehman Brothers failed, reached 2.76 percent, their highest level in 14 years. Correspondent loans can bolster a bank's bottom line.
Eric Stoddard, the Wells Fargo executive who has overseen the bank's business of buying mortgages from other lenders for almost 15 years, said it is cheaper to buy these loans than to make home loans in its branches.
The loans carry another advantage: the buying bank gains the right to collect monthly mortgage payments from the borrower, and receives a small monthly payment for its efforts. That right, known as a "mortgage servicing right," can be a valuable asset, especially when rates are rising. One lender said banks who buy loans from him are taking less risk than they would be making their own loans because of their ability to force him to buy the loans back.
PERL, which has 200 employees and expects to make about $1.6 billion in home loans this year, sells about 60 percent of its loans to JPMorgan, according to founder and president Ken Perlmutter. "I think BofA's a little foolish" not to buy loans, Perlmutter said. Bank of America, however, believes the risk isn't worth taking. The bank, which serves one out of two U.S. households, doesn't need to buy loans from other lenders if it has so many customers of its own.
"I've already got a relationship with the customer," said Boland. "Our strategy is about capturing more of that relationship."