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Published on 07/31/1995 All articles from this issue

The 'portfolio lender': Ensuring the

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By Frank DeMasi

Special to the Town Crier

availability of mortgage credit

Today's pop quiz:

Q. What is a "portfolio lender"?

A. A financial institution that continues, year-in and year-out, to lend money to Americans who seek to purchase a home.

This question gained currency recently when a major Northern California bank threw in the towel and essentially dismantled its residential lending business.

It's understandable, perhaps. Making home loans is, in many ways, a more difficult business than it used to be. In part, this reflects economic changes. The relative interest rate stability that characterized the early post-war decades disappeared in the 1970s, and continues to prove elusive in the 1990s. You only have to reflect on the up-the-down-staircase trip interest rates have taken over the last several years, under the guidance of Alan Greenspan and the Federal Reserve.

But difficult is not impossible, as a number of California lenders (including, locally, Great Western Bank) have shown. Companies like Great Western fall into the category of portfolio lenders. They keep a large portion of their assets (or, in the jargon of banking, their investment portfolio) in residential real estate. No fly-by-night lenders, they are committed to making home loans available to consumers throughout all phases of the interest rate cycle.

The linchpin of their ability to do this is the adjustable rate mortgage, or "ARM." When long-term interest sales rise or get stuck at high levels, the ARMs offered by portfolio lenders keep homebuying affordable. ARMs, after all, are tied to short-term interest rates, which usually trail long-term rates substantially as markets heat up and credit tightens.

For the borrower, the result is an affordable loan and substantial savings. For the lender, the result is a portfolio investment structured to approximate changes in the bank's own cost of money over time. Before Great Western introduced the ARM in 1981, lenders had to take the huge risks inherent in "borrowing short to lend long" - an unworkable strategy in an era of constantly changing interest rates.

A second key to successfully meeting loan demand through all phases of the interest rate cycle is flexibility. When interest rates are falling, Great Western, for instance, is fully prepared to meet consumer demand for competitively priced fixed-rate mortgages. In this kind of climate, portfolio lenders essentially function like their competitors in the mortgage banking industry, making fixed-rate loans and servicing the borrower, but selling the loan itself to investors in the trillion-dollar United States secondary mortgage market.

Portfolio lenders are flexible in another important sense. Even when interest rates are declining, as they are now, several categories of buyers - first-time homebuyers and move-up buyers trying to get the most house for their money - still prefer ARMs. Why? Because ARMs can make qualifying for a home less of a challenge. Because portfolio lenders retain ARMs as investments, rather than sell them into the secondary market, they are in a better position to be more flexible in their application of key credit standards, such as debt-to-income ratios, to ARM borrowers.

The strategies may shift as economic circumstances change, but the benefit to consumers is constant - mortgage credit remains affordable. Portfolio lenders create significant social value, because they provide a stable, dependable source of funding for the American dream - the frequent gyrations of the American economy notwithstanding.

DeMasi is Great Western Bank's district sales manager for residential lending in the Los Altos area.