Mortgage Boom Spurs Worries Over Quality of Bank Earnings: Interactive Graphic

Record mortgage earnings are once again propping up quarterly results, and subjecting banks to crossfire over how long the good times can last.

The gap between consumer rates and secondary market rates — a proxy for profit margins — has spiked to levels higher than at any time during the past 12 years. (Use the slider at the top of the graphic to zoom in on spread, rate and volume data for a particular time period. Text continues below.)

Wells Fargo (WFC), the largest mortgage producer by far, said last week that heavy volume “feels like it is going to last at least a few quarters.” JPMorgan Chase (JPM), the No. 2 originator, said strong performance would continue “next quarter, maybe for a couple of quarters after that,” but that the bank is not counting on it.

Investors aren’t counting on it either. Wells Fargo shares fell 2.6% Friday and JPMorgan shares fell 1.1% even though both companies posted third-quarter results that day that beat analyst forecasts.

The spotlight fell on factors like a 25-basis-point contraction in Wells’ net interest margin from the previous quarter to 3.66% as executives were peppered with questions about how nimbly they could scale back costs when the mortgage business slows.

“We have been through this before,” Timothy Sloan, Wells Fargo’s chief financial officer, said on a conference call, speaking of the violent swings in activity that have marked the past decade. Managers watch flows on “a daily basis, and they have been very good at dialing up and dialing down to adjust to volumes.”

Jamie Dimon, JPMorgan’s CEO, said a drop in originations would be offset by lower credit losses and a retreat in servicing costs that would accompany higher interest rates and a better economy. “If the economy gets better, we are fine. You lose some production income but everything else will be better.”

Another round of quantitative easing launched by the Federal Reserve in September helped drive down mortgage rates in the third quarter, and pushed the Mortgage Bankers Association’s index of refinance activity to its highest level since 2009.

The drop in secondary market rates far outstripped the drop in consumer rates, widening the gap between the two and foreshadowing the handsome profits that lenders have reported. (The relationship between asset prices and yields is inverted, so higher consumer rates relative to secondary market rates indicate higher margins for lenders, which mostly sell mortgages to investors.)

Critics have argued that such spreads are the result of pricing power wielded by a mortgage oligopoly created by consolidation during the housing collapse, while lenders have emphasized the tendency for applications to overwhelm production capacity when rates move suddenly.

Sloan said there tends to be downward pressure on margins after they expand, though he was not sure whether the spread would flatten in the fourth quarter. “We are really pleased we are originating one of every three mortgages that is done in the country,” he said.

Still, he said that Wells Fargo’s other businesses would have to pick up to offset earnings that will be lost once the mortgage business cools down.

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