Wells Fargo & Co., the fifth-largest U.S. bank, on Monday said it stopped offering a popular subprime mortgage product in response to market and regulatory pressure.
The company in an e-mail said it ended on Friday retail offerings of so-called 2/28 loans, which at 65 percent of all subprime mortgages last year are the staple of the industry. Payments on 2/28 adjustable-rate mortgages (ARM) are based on rates that are fixed for two years and then are adjusted twice a year for the remaining 28, if the loan is not refinanced.
Decisions were partly driven by the $583 billion market for subprime mortgage bonds, where sales rely on opinions of rating companies such as Moody’s Investors Service, Wells Fargo said. Rating companies in the past two weeks have unleashed a flood of downgrades on subprime bonds in response to rising delinquencies and increased their assumptions of losses that new loans will produce.
“These changes are being made to align our practices with industry guidance, as well as appropriately respond to recent downgrades by key ratings agencies regarding subprime bonds,” the San Francisco-based bank said in a statement. Wells Fargo Home Mortgage is in Des Moines, Iowa.
Other big lenders including Countrywide Financial Corp., Washington Mutual Inc., Merrill Lynch & Co.’s First Franklin and H&R Block Inc.’s Option One Mortgage have also said they would stop making 2/28s.
Wells’ is one of the starkest illustrations of tightening credit conditions following increased mortgage delinquencies. Bonds backed by Wells Fargo loans are considered among the best in the subprime industry, although no lender has gone untouched as delinquencies rise and the persistent U.S. housing slump turns investors away from riskier debt.
The median cost to buy credit default swap (CDS) insurance on Wells Fargo subprime bonds has risen to $865,000 from about $275,000 at the end of May. That cost covers each $10 million in face value of the bonds, which are rated Baa3, and ranks CDS on the bank’s bonds the third cheapest among 35 issuers followed by Deutsche Bank AG.
Similar insurance for Countrywide subprime bonds has risen to $1 million from about $410,000.
The demise of 2/28s at lenders also follows “guidance” from the Federal Reserve and four other regulators that urges banks to qualify borrowers based on the highest rate the loan could incur after it resets, instead of the lower, initial rate. By using only the lower rate, it was easier for home buyers to qualify.
Wells Fargo’s retail or third-party lenders have also discontinued one-year ARMs and some 40/30 ARMs.
Wells Fargo this month said its second-quarter profit rose 9 percent to a record, as higher customer fees offset a decline in mortgage banking income and a jump in loan losses.
