Secondary mortgage market stays below 1988 levels, mirroring sluggish home sales.

Secondary mortgage market stays below 1988 levels, mirroring sluggish home sales

The sale of mortgage loans by Los Angeles-based savings and loan associations has picked up recently, following a major slump last year. However, such sales have yet to attain 1988 levels.

The ebb and flow of sales activity does not reflect fluctuations in demand, which has more or less remained buoyant throughout this period, according to Ken Portz, senior vice president at CalFed, Inc.

Rather, declining sales are part and parcel of a slower real estate market, said Sam Lyons, senior vice president at Great Western Financial.

With fewer home buyers taking out mortgages, there are fewer loans to sell into the secondary market, he explained. Add to this that most institutions want to hold onto some of their loans in their portfolios, and the supply becomes harder to come by. "We only sell off our excess production, and with less origination activity, we have less excess production," Lyons said.

Great Western, as well as other institutions, sets production targets based on growth objectives, rates of prepayment and a host of other factors, according to Lyons. Anything above production targets would fall into the excess production category, subject to sale.

At H.F. Ahmanson, the parent of Home Savings of America, Great Western Financial and First Federal Savings Bank of California, all active participants in the secondary market, sales increased during the second quarter of this year, with sales more than doubling at First Federal. Only at CalFed did loan sales continue to decrease, declining to $106.1 million from $610.5 million during the first quarter.

At none of these institutions were second-quarter sales near 1988 levels. All of them experienced significant declines in sales in 1989, with more than a 50 percent decline at Ahmanson.

Less loan production is only one of the reasons for the drop in loan sales. Another significant factor is the inverted yield curve which arose last year, making long-term mortgages a harder sell, Lyons said. A return to a more normal yield curve explains why sales have recently increased.

An inverted yield curve means that longer term instruments carry a lower interest rate than shorter term. Many potential buyers of mortgages might become apprehensive in this situation, since they expect higher returns for the increased risk, other things equal, associated with longer term instruments.

Some of the changes in sale activity comes from company specific policies. Great Western, for instance, decided to purge its inventory of all fixed-rate loans. A backlog of such loans inflated sales in 1988. Now that the thrift holds none in its portfolio, sales are down. The thrift does continue to book and sell fixed rate loans, but their flow is small in proportion to total loans. During the first half of this year, only $500 million of the $6 billion loans originated were fixed rate loans, all of which were immediately sold.

The remainder of mortgages are adjustable rate loans (ARMs), which "have become very dear to lenders because of the shrinking real estate market, so we have become very reluctant to sell them off," Lyons said. While Great Western sold roughly $900 million for the first half of 1990, such sales represented less than 20 percent of its ARM originations.

The Financial Institutions Reform, Recovery and Enforcement Act of 1989 has also cast a pall over the secondary market for mortgages. Thrifts can no longer sell loans with recourse, meaning the seller would protect the buyer from losses on the loans, and at the same time remove the loans from their books, explained Babette Heimbuch, president of First Federal. Selling the loans with recourse made it easier to sell the loans by limiting the downside for the buyer. Taking the loans off the books made it easier for the seller to meet capital requirements by shrinking the asset base. All the seller had to do was make a small provision for loan losses. First Federal has taken time to bring to market loans without recourse because the pricing had to be reviewed and the unfamiliar product marketed, Heimbuch said. Nonetheless, First Federal has begun selling loans this way, and Heimbuch expects sales to pick up.