Banks of All Sizes Reap Mortgage Rewards

A surge in mortgage lending drove strong profits for banks of all sizes in the first quarter, with some banks attributing the improvement to new regulations.

Large banks, including JPMorgan Chase (JPM) and Wells Fargo (WFC), credited a pickup in mortgage banking returns for helping boost their quarterly revenues. Most companies’ mortgage results looked especially good when compared to those of a year earlier, when mortgage lending hitting a rough patch due partly to bad weather.

Government programs also helped increase borrower demand for refinancings. Some bankers say new regulations also helped boost their mortgage businesses by causing some lenders to drop out of the market and thus reducing competition.

 “If you’re committed to mortgage banking, you’re going to get the business,” says Bernard H. Clineburg, chairman and chief executive of Cardinal Financial (CFNL) in McLean, Va., which lends in Maryland, Virginia and Washington, D.C.

“We see resales … doing very, very well, and with new regulations a lot of fly-by-night operators and mortgage brokers have been knocked out. So there’s less competition,” Clineburg adds.

The $2.6 billion-asset Cardinal reported a 47% jump in first quarter mortgage profits to $7.7 million compared with a year earlier.

It was one of several community and regional banks that had prepared for an eventual rebound in mortgage profits by hiring loan officers and opening lending branches.

Persistently low interest rates and a government refinancing program for underwater borrowers have helped boost origination volumes. However, bankers are not seeing much demand for new mortgages, with many saying their profits are coming primarily from refinances.

“Gain on sale” margins, or the difference between what a consumer pays and what banks earn from selling loans in the secondary market, have jumped since late last year and are expected to stay elevated, according to Frederick Cannon, the director of research for Keefe Bruyette & Woods. Bank of America (BAC), JPMorgan Chase and Wells Fargo all reported increases of 50 to 100 basis points in gain on sale margins compared with the fourth quarter, according to KBW.

“Generally mortgage banking and good gain on sale spreads are adding a penny or two to community and regional bank earnings, even if their mortgage operations are small,” Cannon says.

The largest mortgage servicers have been inundated since January with a wave of new refinance applications for the revised Home Affordable Refinance Program, known as Harp 2.0. The program was designed to help mostly underwater borrowers whose loans are guaranteed by Fannie Mae or Freddie Mac take advantage of low interest rates.

JPMorgan Chase's revenue tied to mortgage production and servicing swung to a profit of $461 million, compared to a $1.1 billion loss a year earlier. Wells Fargo does not break out revenue for its mortgage business, though noninterest income grew to $2.87 billion, up from $2 billion a year earlier, due to a big uptick in originations.

While Bank of America’s consumer real estate services unit posted a net loss of $1.1 billion, down from a loss of $2.4 billion a year earlier, the Charlotte bank said that its revenue was helped primarily by higher mortgage banking and core production income.

Some of the bigger banks’ decisions are helping their smaller rivals. Both B of A and Citigroup Inc. (NYSE: C) have exited the wholesale channel, in which loans are originated primarily by mortgage brokers, leaving that market more open to competitors.

“It’s provided a good opportunity for us to step into a void and gain some market share,” says Mark A. Hoppe, the president and chief executive of Taylor Capital Group (TYC), parent of $4.7 billion-asset Cole Taylor Bank.

Cole Taylor’s mortgage banking revenues skyrocketed to $17.5 million in the first quarter, from $1.5 million a year earlier. That growth resulted primarily from an improvement in margins on mortgage originations and sales in the secondary market, Hoppe says.

“When volume goes up, margins go up as well, which is slightly counterintuitive,” says Hoppe, adding that the vast majority of applications were for mortgage refinancings while the purchase market “is still pretty soft.”

Joe Garrett, a principal at the mortgage banking advisory firm Garrett, McAuley & Co., says community banks “are making a killing” on mortgage banking profits. But he cautions that such returns may not last forever.

“If you’re making good money, what are you doing to protect yourself for the day the music ends?” Garrett says. “Mortgage bank earnings are very volatile and can turn around quickly. What happens when volume drops?”

For example, one of Garrett’s client banks created a plan for action based the volume of mortgage originations; if volume dropped over several weeks, the bank would close a certain number of branches and lay off a percentage of loan officers. (Garrett would not identify the bank.) “Banks are doing so well in mortgage banking, it can be a little seductive,” he says.

Rick Weiss, an analyst at Janney Montgomery Scott LLC, also expressed caution about mortgage volumes, even though several banks have said that their pipelines of mortgage applications are strong heading into the second quarter.

“Out of all the business a bank does, mortgage banking may deserve the lowest trading multiple because of the volatility, and there’s not a lot that can be done about that,” Weiss says. “It’s better to have the earnings than not, but because of the volatility, at some point the earnings will be shut off, rates will move up, refinancing will stop and the real worry is if there’s no loan growth.”

Jay Brinkmann, chief economist and senior vice president of research at the Mortgage Bankers Association, says the high demand for refinance applications has allowed lenders to charge slightly higher interest rates.

Those that are at capacity are not giving any price concessions,” he says.

Scott Happ, the president and CEO of Mortgagebot LLC in Mequon, Wis., says purchase applications in the direct-to-consumer channel rose 40% in the first quarter from a year earlier, while refinance applications jumped 150% in the same period.

“Given the fact that many homeowners don’t have the normal equity, the market is not going to have the normal momentum it would have, but directionally we’re seeing some material improvement,” Happ says, calling online purchase applications “the canary in the coal mine.”

“Because the interest rate market has been pretty stable, it’s been a nice environment to hedge your pipeline and achieve these gains on sale margins,” he says.