Bad Mortgages Weigh on Banks

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The Wall Street Journal
By: Nick Timiraos
June 30, 2011

U.S. banks hold a much higher rate of defaulted mortgages on their books than do mortgage giants Fannie Mae and Freddie Mac, according to a report issued Wednesday by the Office of the Comptroller of the Currency, which regulates national banks.

The report said 19.7% of mortgages in banks' portfolios were delinquent at the end of March. By contrast, nearly 6.8% of mortgages backed by Fannie and Freddie were nonperforming, as were 11.4% of all mortgages.

Nevertheless, Fannie and Freddie are more hobbled than the biggest banks: Their mortgage holdings are large, the firms hold little capital and they don't have other business lines to offset mortgage losses. Fannie and Freddie guarantee more than $5 trillion of mortgages, double the amount held by all the nation's banks and thrifts combined.

While many subprime and other risky mortgages were packaged into securities and sold to investors, banks chose to keep certain loans or were stuck with them after securitization markets froze in 2007. Loans on bank balance sheets "in and of themselves are reflective of lesser-quality loans" than those backed by Fannie, Freddie or federal agencies, said Bruce Krueger, a senior OCC mortgage examiner.

Mr. Krueger said the high nonperforming-loan rate on bank-held mortgages also reflects differences in how foreclosures are being processed. Fannie, Freddie and federal agencies require mortgage servicers to adhere to strict timelines that govern the modification and foreclosure processes, but banks don't face similar requirements for the loans on held their books.

That means more borrowers whose loans are held by banks could linger in delinquency before foreclosure begins, and they might also spend more time in foreclosure before the bank takes back the home.Nearly 8% of mortgages held on bank balance sheets were in the foreclosure process at the end of March, compared with 2.6% of those backed by Fannie and Freddie and 2.8% of those backed by government agencies.

Overall mortgage delinquencies have declined for five straight quarters, but the share of loans in the foreclosure process remained at its highest level since the foreclosure crisis began and was unchanged in the first quarter from the fourth quarter, according to the OCC report. Banks have been forced to revamp their foreclosure processes after improper legal filings and other document-handling issues surfaced last fall.

Banks and thrifts hold about $2.6 trillion in mortgage debt, including about $765 billion in second mortgages and home-equity lines of credit.

Some analysts said the figures should raise concerns about banks' loan-loss reserves, especially if home prices take another tumble. The loan delinquency rates "suggest that the banks are severely underprovisioned relative to potential losses," said Daniel Alpert, managing director of Westwood Capital. "Even without the [second mortgage] issue, it's qualitatively not good."

Separately, a report released Wednesday offered another sign housing markets aren't getting worse. The number of people that signed contracts to buy previously owned homes jumped by 8.2% in May from April, rebounding after an 11.3% decline in April, according to the National Association of Realtors.

The gain was the largest since November and 14% higher than last May's level, which dropped sharply after home-buyer tax credits expired. But in absolute terms, pending home sales remain at a "very depressed level," said Joshua Shapiro, chief U.S. economist at MFR Inc.

Write to Nick Timiraos at nick.timiraos@wsj.com

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