To Sell or To Retain: Interest Rate Risk and Banks' Mortgage Securitization Decisions

Abstract

This paper shows the importance of interest rate risk and prepayment risk in fixed-rate mortgages in influencing banks’ securitization of mortgages. Banks with longer-maturity liabilities are more capable of taking the interest rate risk and therefore securitize fewer mortgages. In contrast, banks with shorter-maturity liabilities securitize more mortgages and originate fewer jumbo mortgages, which can not be securitized through Fannie Mae and Freddie Mac. Moreover, household mortgage refinancing induces prepayment risk. The prepayment risk matters more for banks with longer-maturity liabilities, due to their high retention of mortgages on balance sheets. Ex ante, anticipating the prepayment risk, banks with longer-maturity liabilities securitize more mortgages. Ex post, banks with longer-maturity liabilities are less likely to help households refinance their existing mortgages.