Flat Curve Deters Banks from Making Mortgage Investments

Commercial banks and thrifts abruptly stopped adding single-family loans and mortgage-backed securities to their portfolios in the fourth quarter in response to rising short-term interest rates and a flattening yield curve.

The Federal Deposit Insurance Corp. also reported last week that borrowings against home-equity lines of credit actually declined at commercial banks in the fourth quarter for the first time in five-and-a-half years.

FDIC-insured institutions increased their holdings of one-to-four family loans by $6.7 billion in the fourth quarter, after adding $150.1 billion in one-to-fours to their balance sheets over the previous three quarters. This slowed the annual rate of growth in one-to-four family assets to 11.4% in 2005 from 14% in 2004.

However, the annual rate of growth of their MBS assets slowed to 2.3% in 2005 from 13.1% in 2004. Banks and thrifts added less than $1 billion in mortgage securities to their portfolios in the fourth quarter and ended the year with $1.14 trillion in MBS.

Banking consultant Bert Ely noted that a flattening yield curve has forced banks to sell MBS, particularly if those purchases were financed with Federal Home Loan Bank advances or other borrowings. "As rates go up, people liquidate those positions," he said.

The consultant based in Alexandria, Va., also noted that borrowers are rolling home-equity lines into fixed-rate loans and taking out cash.

Freddie Mac recently reported four of five borrowers who refinanced in the fourth quarter did cash-out refis.

FDIC senior bank analyst Ross Waldrop noted an increase in closed-end second loans as HELOC borrowings slowed dramatically in the second half of last year.

In fact, borrowings against HELOCs declined by $3.9 billion in the fourth quarter to $534.3 billion. After growing at an annual rate of 40% in 2005, HELOC borrowing slowed to an 8.9% annual growth rate in 2005.

At the same time, closed-end second mortgages jumped by $20.2 billion in the fourth quarter as borrowers locked-in fixed rates, Mr. Waldrop said.

Banks and thrifts saw their holdings of closed-ended seconds jump by 45.8% last year to $167.4 billion.

The FDIC's Quarterly Banking Profile lumps commercial banks and thrifts together. However, commercial bank holdings of one-to-four family loans, MBS and HELOCs declined slightly from the third quarter to the fourth quarter. Thrift institutions had marginal increases in all three asset categories.

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