Mortgage Slump's Full Toll on Small Banks Revealed — But Fixes Remain Elusive

Bankers have been warning for several months about a significant slowdown in mortgage revenue — now we know the severity of the decline.

Mortgage banking income at banks with less than $20 billion of assets fell, on average, 21% from the second quarter and 27% from a year earlier, according Keefe, Bruyette & Woods data. The firm looked at income tied to originations, net servicing and gains from the sale of mortgages.

Figuring out what to do next is the murkier part for bankers.

Activity is expected to slow even more in coming quarters as a spike in long-term interest rates continues to hamper refinance activity, and as more banks grapple with the Consumer Financial Protection Bureau's qualified-mortgage rule.

"A lot of the refi activity has been wrung out," says Jim Adkins, a founder and managing member of Artisan Advisors, a community bank consulting firm. "It's not as active of a market, and I don't see that changing."

The slowdown in mortgage revenue was a punch in the gut for banks that are trying to boost fee income. It was a big reason that noninterest income in the third quarter fell 9% from the second quarter and 11% from a year earlier, according to American Banker research of 350 banks' results.

Waning mortgage activity has sent some bank executives scurrying to quickly cut costs or to find new revenue sources. For instance, noninterest income at Valley National Bancorp (VLY) in Wayne, N.J., fell almost 45% in the third quarter compared with a year earlier, to $22.4 million. Gains on sales of residential mortgage loans fell roughly 89% from a year earlier, to $2.7 million.

Valley National has already cut staff in its mortgage department by about a third with more reductions possible if activity stays slow, executives at the $16 billion-asset company said during an Oct. 24 conference call to discuss quarterly results.

"We were opportunistic when it came to the mortgage banking activities and, while that market existed, we think we did quite well," Gerald Lipkin, Valley National's chairman and chief executive, said during the call. "I'm still somewhat perplexed as to why it was almost like a light switch going off in the refinance activity when rates moved up 100 basis points. It just shut the market down even though, historically, 30-year and the 15-year [mortgages] are at very, very low levels."

To make up for lost revenue, Valley National is looking at ways to expand. Those could include entering new markets, hiring lenders or adding products, Lipkin said. "We have some new loan products that we've introduced in the last year that are starting to take hold and I think will help generate future earnings for the bank," he said.

The QM rule, which takes effect Jan. 10, is likely to reduce mortgage lending even more by making it more difficult for some borrowers to get financing and prompting some banks to stop making mortgages. The CFPB's rule could also add costs to originations, Adkins says.

"We are doing everything we can to make a loan short of giving it away," William Dunkelberg, the chairman of Liberty Bell Bank (LBBB) in Marlton, N.J., said during an interview at American Banker's Small Business Banking Conference in New Orleans.

"Regulation will eventually make it very hard for us to do many 30-year mortgages," says Dunkelberg, who is also the chief economist for the National Federation of Independent Business.

A rebound in mortgage lending seems unlikely in the foreseeable future, so bankers need to reevaluate their products and pricing, industry experts say.

Many bankers, who have been worried about losing business to competitors, have left money on the table by failing to appropriately price their services, says David Powell, the president of bank consulting firm Vitex. Bankers especially have been unwilling to raise service charges. "The No. 1 goal has been to retain customers," he says.

Powell recalls working with a Rhode Island bank that decided to stop servicing mortgages, including loans for other lenders, because the pricing was too competitive and it wasn't earning enough from the business. Still, that bank is likely to keep originating and selling its loans, he says.

The third quarter was "mediocre for most banks," even if you strip out quarterly mortgage revenue comparisons, says Jeff Davis, managing director of the financial institutions group at Mercer Capital. "Many businesses have not been as robust."

Earnings are likely to remain flat over the next few quarters, Davis says. Community banks, in particular, will continue to struggle with net interest margin compression and mortgage income will keep shrinking, he adds.

"This is the toughest time to be a banker," Powell says. "You've got regulation, the unusually long economic cycle, historically low interest rates. It's the perfect storm."

Paul Davis contributed to this article.