Some Spokane-based banks are shifting or considering a shift this year toward keeping more home loans they originate on their books, versus the common practice of selling a vast majority in the secondary mortgage market, bank executives say.

While those in the industry describe different reasons behind the shift, industry-wide factors having at least some influence include the current low interest-rate environment, strong bank liquidity, and more rigorous mortgage underwriting standards nationally. Some bank leaders also cite more challenges in selling mortgages in the secondary market.

Typically, banks and other financial institutions will originate home loans in the primary mortgage market, and then sell off a large portion of those mortgages in the secondary mortgage market. The homeowner sees no difference in loan terms; the only change is the name on the loan and perhaps where monthly payments are sent. Some banks still retain the servicing of the loans they sell.

A majority of U.S. mortgage loans are sold on the secondary market to two entities, the government-run Federal National Mortgage Association, known as Fannie Mae, and the Federal Home Loan Mortgage Corporation, known as Freddie Mac, which own or guarantee about half of all U.S. home loans and rely on third-party firms to service mortgages. Some companies also buy mortgages in the secondary mortgage market.

Within the past two years, though, the options to sell mortgages in that market have tightened, and underwriting standards have become more stringent overall as the mortgage industry has adjusted to regulatory changes triggered by the housing market collapse.

"It's getting more and more onerous to sell mortgages on the secondary market," says Randy Fewel, president and CEO of Inland Northwest Bank.

He attributes that partly to stiffer underwriting requirements industrywide in qualifying applicants—and somewhat to financial or regulatory challenges among some entities that buy mortgages in the secondary market.

"They've gone so far that we're having to re-do a lot of things we did at application, and we have to do them again at near closing," he says. "Some of it you can say it's prudent, but because of the crisis, everyone is gun-shy and they've made the requirements so much tougher."

One of the largest banks here planning a shift in its loan portfolio is Sterling Bank. Sterling has a newer long-term goal to keep in its portfolio between 10 percent and 20 percent of the residential mortgages it originates, says Ezra Eckhardt, its president and chief operating officer.

Sterling originates between $2 billion and $2.5 billion worth of residential mortgages per year on average, and it normally sells about 95 percent of those loans on the secondary market, Eckhardt says, although it retains the servicing on a vast majority of them. Sterling plans mainly to focus on keeping adjustable-rate mortgages in its portfolio "in order to reduce the bank's sensitivity to interest rate risk," Eckhardt adds.

Eckhardt cites two main reasons for Sterling's portfolio shift: a goal to boost total loans in that lending category and also to put more balance in its $5.6 billion overall loan portfolio, splitting it about a third each in commercial real estate loans, business loans, and consumer loans that include residential mortgages, home equity, and auto loans.

"We're very interested in keeping more residential loans on our balance sheet, and we think we have the opportunity to add in somewhere on the order of $600 million of residential mortgages," Eckhardt says. "We think we'll have the opportunity as the market turns to do that."

However, Eckhardt adds that the mortgage market in general is "quite complicated," and involves banks carefully watching risk in holding mortgages on the books in a low interest rate environment.

Sterling currently sells mortgages on the secondary market to Fannie Mae, Freddie Mac, and Wells Fargo Bank. It used to sell to Bank of America, which doesn't participate in the secondary mortgage market anymore, Eckhardt says. He adds that Wells Fargo and Chase Bank, which is another big player in the secondary mortgage market, have limited capacity to buy mortgages.

"That's a factor," Eckhardt says about the secondary market shifts. "That's why it's complicated. There's so many we can keep on the books. So many people can take out loans. Interest rates are low, so there's a demand, but the loans have to go somewhere. They have to find a home."

He adds, "You're seeing the beginning of what will likely be an increase in interest rates because of market demands and a limited number of outlets to sell loans on the secondary market."

Scott Kisting, chairman and CEO of Spokane-based AmericanWest Bank, says that institution also is moving toward keeping more residential mortgages on its books, citing as reasons strong liquidity, which for AmericanWest means excess funds available to lend, and the attractiveness of gaining more mortgage business. He also says that reduced demand for commercial loans and personal lending such as home equity loans means that a higher percentage of an institution's capital is available to be put into residential mortgages.

Kisting says AmericanWest plans to originate $250 million in new mortgages in 2012, and the bank is planning to keep about $90 million to $100 million worth of those loans on its books, rather than selling them on the secondary market.

"We're almost at that number now," he adds. "Before, we were holding about 25 percent prior to this shift this year. Part of it is liquidity."

AmericanWest's total mortgage loans for 2011 were in excess of $102 million, but the bank has ramped up its mortgage lending focus for this year, Kisting says. It also acquired three banks last year and plans to open a Seattle branch.

He adds, "Because of how well capitalized our bank is, we really ramped up our mortgage lending, probably tenfold. There are a certain percentage of loans we'll be keeping on the books. They have much better yield than a lot of government securities today."

Fewel says INB also in the past few months has considered changing its approach regarding the quantity of real estate mortgages it keeps in its portfolio, which has typically been at about 5 percent. Overall, the bank originates about $60 million to $80 million home mortgages in a year, he says, and it may consider retaining up to 10 percent or 15 percent.

"Typically, statistics show the average life of a 30-year fixed rate mortgage is about seven years because people divorce, upsize, or downsize," he says, adding that a bank could consider keeping a few more of those types loans, "knowing that we're probably only going to have them on average for about seven years."

Fewel says INB has sold mortgages to two entities, PHH Mortgage, owned by PHH Corp. of Mount Laurel, N.J., and SunTrust Mortgage Inc., a Richmond, VA-based wholly-owned subsidiary of SunTrust Bank. Fewel says both have "become very difficult to deal with for about a year or two now."

He adds, "By that, I mean they keep coming back asking for more information. They have gotten slower. They have gotten pickier, and they have just gotten more difficult to deal with. What used to take two to three weeks, it's much more likely to be six weeks today. So we're busy looking for new investors to sell to."

But Fewel adds that as a smaller community bank, it doesn't sell directly to Fannie Mae and Freddie Mac, which work with much bigger pools of mortgages. INB sells to someone else, like SunTrust, and that company then pools the mortgages and sells them.

Fewel says community banks, particularly, want to sell mortgages on the secondary market because of interest-rate risk.

"If I give you a 30-year mortgage, we don't have 30-year sources of funding," he says. "If interest rates go up to 12 percent and I'm sitting on a 4 percent mortgage, I'm now upside down and losing money on that deal. I'm having to pay my depositors at 12 percent to keep money in my bank ... The big money-centered banks, they have sophisticated ways to hedge that interest rate risk."

Although mortgage underwriting is more stringent now and has more applicant documentation requirements, Kisting says the whole process of due diligence on writing up loans still boils down to quality lending, "so we're having no problem selling on the secondary market."

"All banks are asset hungry right now," he adds. "What you want to be is a bank that takes care of business but also takes care of personal needs of people."

However, Kisting says that banks managing their interest rate risk will always be a factor.

"As interest rates rise, it won't be as necessary for banks to hold these mortgages," he says. "As rates go up, we need to make sure we're selling at the right time."

Washington Trust Bank, of Spokane, has always kept a portion of home mortgages on its books as part of loan diversification, says Jack Heath, the bank's chairman and chief operating officer. It has an overall loan portfolio of about $2.8 billion, and of that, about $300 million worth is in residential mortgages, he says.

Washington Trust sells about 80 to 90 percent of the home loans it originates, usually to Fannie Mae or Freddie Mac, Heath says. He adds that Washington Trust isn't contemplating any significant shift in that.

"We feel that although banks have a lot of liquidity and deposits are plentiful, as the cycle changes, deposits will be highly sought," in that most banks' loan-to-deposit ratios are at all-time lows, he says. "We want to stay in a strong liquidity position and be available to loan to our customers."

He says Washington Trust has chosen to keep in its portfolio a certain number of what it views as solid mortgage customers, but who may have some "idiosyncrasy" in getting a loan, such as young professionals who have moved to town but haven't yet established credit.

"We do have a number of loans that are unique loans," he says, adding that with the more selective secondary market today, "You'll find issues with appraisals, or with income—although adequate—someone's income has gone down in this economy, so we've addressed our customers' needs that have some idiosyncrasies, but they're fine (so) we'll portfolio them."

However, Washington Trust doesn't keep 30-year fixed rate mortgages in its portfolio, he says. "The rates are just too low to keep on our books. Most of the ones we are keeping on our books are the five-year and 10-year fixed rate, primarily five-year (loans)."