Why pay when you can get paid?

That’s the boiled-down logic behind a new buyer of mortgages on the secondary market that’s positioned itself to compete with Fannie Mae and Freddie Mac.

The Mortgage Partnership Finance program, offered by the Federal Home Loan Bank, began a pilot run in Boston this April. Geared toward community banks, the program was developed in Chicago but recently has found its way to an additional eight of the Federal Home Loan Bank’s 12 locations nationwide.

“When a bank normally sells the loan to Fannie Mae or Freddie Mac, they sell everything. They pay a guarantee fee when they sell the loan taken right off the top. In MPF, they still sell the loan but they hold some of the expected credit loss and they get paid for doing that. Instead of paying a fee, they are receiving a fee back,” said M. Susan Elliott, executive vice president of member services at the Federal Home Loan Bank of Boston.

The program is offered to all FHLB members. In New England, the number of financial institutions in the membership totals 458. The program purchases 15- and 30-year fixed-rate mortgages on one- to four-family, owner-occupied, residential properties. While the banks that originated the loans retain the credit risk, the FHLB takes on the catastrophic credit risk, interest-rate and prepayment risk.

“The one thing that differentiates MPF from the traditional secondary market is that it rewards lenders based on credit quality instead of volume,” Elliott said.

Paul Pouliot, vice president and mortgage manager at the Federal Home Loan Bank of Boston, said that national players have an advantage because of the high volume of loans they originate, which allows them to negotiate special pricing when selling loans. “A community bank doesn’t have the leverage capability to negotiate because they don’t have the wherewithal or the capital to do those types of volumes. So they are charged a higher amount [selling on the secondary market] which, in turn, subsidizes the larger player.”

“Virtually all our deals with our vendor partners are negotiated one way or the other,” said David Jeffers, vice president for corporate relations at Fannie Mae. Sometimes, because of the volume, banks are able to get better deals at Fannie and sometimes at Freddie, he said.

Fall River-based First Federal Savings Bank of America is the first Massachusetts bank to take part in the MPF program since its local launch four months ago. “The unique aspect of this product is … you get better pricing and … you can get the mortgage loans off your balance sheet and let someone else manage the interest risk,” said Ed Hjerpe III, executive vice president, treasurer and chief financial officer of First Federal. Hjerpe has been familiar with the program since it was first introduced in Chicago because, until three years ago, he was chief financial officer of FHLB in Boston. “The program always made sense to me while I was an employee,” he said.

According to Elliott, the program has really taken off in the Midwest, the region where it was first piloted. Community National Bank in Oregon, Wis., signed onto the program two years ago. “We’re a community bank,” said Dan Behrend, vice president of the $100 million-asset bank. “Our competitors are the large banks. We had been with Freddie for many years and we were finding we were no longer able to compete with the larger banks Â… they [Freddie Mac] offered lower rates to the larger banks . . . than to us.”

The MPF program allowed the bank to offer lower rates to its customers while earning money on the fee FHLB paid to them, as well, said Behrend.

So far, the bank has completed $15 million in sales to the FHLB but still goes to Freddie for some of its business, said Behrend. “The MPF program has fewer products to offer than Freddie because it’s brand new. So, when we’re doing adjustable rate or balloon mortgages, we still [use] Freddie. Since the rates are not attractive, we haven’t been doing as many,” he said.

The program hasn’t always been smooth sailing, however, said Behrend. At first it required the lenders to keep two sets of books: the scheduled balance and the actual balance. Software used by most banks is not equipped to handle that, he said. But FHLB listened to the bank’s concerns and now keeping tabs of the actual balance only is necessary, he said.

Another benefit for community banks revolves around payment arrangements. According to Behrend, when a note is paid off, that money must be turned over to Freddie within five days. But with the FHLB program, all money is always due on the 18th of the month following the payment. “So we get to retain that and make money off that Â… and that increases our yield tremendously,” he said.

Authorization Questioned
However, the program has met with some opposition. Recently, Sen. Phil Gramm, R-Texas, drafted an amendment to a Veterans Administration HUD appropriation bill which would cap the program at $15 billion. According to Christi Harlan, communications director for the Senate Banking Committee, of which Gramm is chairman, the cap would allow the banking committee more time to determine if the MPF program may be an area where the FHLB “was not authorized to go.” The committee wants to ensure against “the possibility that taxpayers would be left on the hook because, essentially, this is a government guarantee program,” she said.

According to Elliott, such a cap would have “pretty negative consequences. MPF volume[s] are $13 billion, so it would shut the program down pretty quick,” she said.

“Our regulator doesn’t have a problem [with the program],” said Mark S. Zelermyer, assistant vice president and director of corporate communications for FHLB in Boston, which falls under the supervision of the Federal Housing Finance Board.

Fannie and Freddie, claims Jeffers, are more heavily regulated than MPF. In 1992, congress completely revamped the regulatory structure for Fannie and Freddie, resulting in “much tougher regulatory oversight,” he said. “We have always strongly supported that kind of smart regulation. We believe, as institutions created by Congress, that we need to know that Congress has the confidence that we’re doing what we’re supposed to be doing, how we’re supposed to be doing it,” he said. But Jeffers points out that the FHLB is also a government-sponsored enterprise that should be subject to the same oversight as the others in the secondary market now that they’ve chosen to enter it.

The FHLB was created by Congress in 1932 essentially to provide housing as a direct result of the Great Depression, said Zelermyer.

In 1997, the pilot program for MPF was launched in Chicago and met with success. In June of 2000, the Federal Housing Finance Board made it a permanent program, according to Zelermyer. Since then, nine of the 12 FHLB regions in the country have launched their own MPF programs. In Massachusetts, the First Federal Savings Bank of America is the only bank that has sold loans to the program, although three others have been approved to take part, said Zelermyer.

“One of the reasons that it is successful is that they [the banks] get paid to do what they do best,” said Elliott. “Secondly, the other big advantage is the price we will pay them to buy the loan. It’s a better price,” she said.

FHLB is able to generate that better price because of its makeup, she said.

“[The] home loan bank system is a cooperative. As such, our shareholders and our customers are [part of] the same group. While we have profit measures and profit goals, they aren’t the same as those owned by shareholders [of publicly traded institutions]. Because of that, we can offer a better price and take less for ourselves,” said Elliott.

While FHLB is moving slightly onto the formerly exclusive turf of Freddie and Fannie, the bank hasn’t received any public response from them, said Elliott.

“We say great,” said Jeffers of Fannie Mae. “Because we’ve shown over the last 30 years that when Freddie and Fannie compete, it creates benefits for our customers and, in the end, consumers. So we say, come on in, the business is great, the mission is satisfying – but you have to step up to the plate and be measured the way we are Â… you need to play by the same rules.”

According to Elliott, the programs may benefit community banks most but should be attractive to virtually every lender unless they do not sell their loans in the secondary market at all.

Behrend said the program may become an important option for many community banks. “Freddie Mac is great for the large banks, but not for the community banks,” he said.