Question

Explain why some financial institutions prefer to sell the mortgages they originate. Research and provide an example either current or historical.

Answer 1

Answer: Mortgages are long-term loans made to home owners in order to finance the purchase of a home. Most mortgages are 20 - 30 years long loans. Mortgage originators do not perfer to hold these long-term morgages because it ties up their capital and leaves them with less funds to make additional loans i.e. it reduces the originator's liquidity. This is one of the reasons why financial institutions perfer to sell the mortgages they originate.

In addition to liquidity, the mortgages are also sensitive to changes in interest rates. As the interest rates rise, the value of the mortgages held by the financial institution decreases. Hence, they prefer to sell the mortgages they originate when they anticipate a rise in interest rates. This results in two advantages to the originator. First, they dont have to take a loss on the value of mortgages held - in fact they may be able to show a small profit. Second, the proceeds of such a sales enhances the liquidity of the financial institutions, which help them lend more.

Before the subprime crisis in 2008, it was very common for an originator to sell the mortgaes in the form of a Mortgage Backed Security to the market. In 2006, Countrywide Financial originated $40.6 billion in mortgages and issued MBSs worth $38.5 billion. In the same year, New Century Financial had originations worth $51.6 billion and it sold $33.9 billion the in secondary market.

Generally, the MBSs were sold in tranches or groups and each trache had a rating assigned by a rating agency like Moody's. Most of the home originators sold the MBSs to Fannie Mae and Freddie Mac.