Originate to Distribute Mortgages Default More

Mortgages sold on the secondary market quickly after being originated were underwritten more poorly than loans kept on bank’s books, according to a report from the University of Michigan Ross School of Business.

The so-called originate-to-distribute (OTD) model, where mortgages are sold in bulk to investors shortly after being originated, allowed banks and lenders to loosen guidelines and throw underwriting rules out the window in return for big incentives.

“Purnanandam’s analysis shows that the more a bank participated in the OTD market before the 2007 collapse, the larger its mortgage asset charge-offs and defaults after the disruption,” the report said.

“When the market for mortgage loans collapsed, these banks were forced to carry the troubled mortgages on their balance sheets. The research also shows higher foreclosure rates for OTD mortgages than those mortgages kept by the originators.”

Purnanandam blames an “incentive problem” where banks and lenders weren’t as discerning about borrowers if they knew the mortgage would eventually be sold to a third-party.

“The screening came down, and the banks were willing to lend to folks they otherwise would not have,” said Purnanandam. “We find a systematic pattern in that the banks that were originating and selling their mortgages are suffering disproportionately more.”

Data also revealed that banks with lower capitalization were more likely to originate low-quality loans, while banks primarily funded by customer deposit accounts did not originate “excessively inferior” OTD loans.

To read the entire article click here

Other articles of interest...
Wall Street isn’t buying Obama’s reform plan
Banks and other firms are quick to attack Obama's consumer-friendly overhaul of financial rules. The stage is set for a legislative battle, with Wall Street turning to allies in Congress.
We’ve Gone From Saving Wall Street in Order to Save Main Street to Just Saving Wall Street
But parsing through his 85-page plan, it's not clear how these reforms will ensure that our financial system works for the economy as a whole.
Rates Fall Back on Lower Inflation
Average mortgage rates across the board fell in the week ending June 18 after spiking briefly the week before, according to a survey released today by mortgage giant Freddie Mac (FRE: 0.7353 +2.12%).