JPMorgan's Retreat Shows Just How Tough the Mortgage Market Is

JPMorgan Chase's (JPM) pullback from the mortgage market is sending shock waves through the industry, underscoring the grim prospects for lenders in the face of lackluster home sales.

Home lending has been "the most painful business ever," JPMorgan Chief Executive Jamie Dimon said at an investor presentation Tuesday, when the New York megabank announced it would cut another 6,000 mortgage jobs this year, on top of 11,000 last year.

To the surprise of many lenders, JPMorgan Chase forecast that its mortgage business will not turn a profit this year even though Dimon reiterated "we are here for the long game."

The outlook from Chase, the second-largest home lender behind Wells Fargo (WFC), is a forceful reminder that the housing market has not yet fully recovered from the downturn, with home sales and overall mortgage lending still below prerecession levels - and not expected to turn a corner anytime soon.

"We are desperately trying to right-size our staff to what we think the size of the market will be," says Mark Mason, vice chairman and CEO of HomeStreet (HMST), based in Seattle, who remains a bull on mortgages. "It shows how tough the originations business is today, and I was struck by the fact that Chase expects to lose money [in mortgages] in the entire calendar-year 2014."

Donavon Ternes, chief operating officer and chief financial officer at Provident Savings Bank in Riverside, Calif., says the verdict is still out on whether homebuying activity will gain further momentum this year. Some lenders may jump at the chance to hire loan officers from JPMorgan Chase and potentially steal market share, he says.

But the outlook still seems bleak.

"Everybody is cautious," says Ternes. "The pullback is significant. You only have to look at the refinance numbers [industrywide] to understand that every mortgage banker's volume was down significantly in the fourth quarter and that business is not going to pick up anytime soon."

The $1.1 billion-asset Provident Savings has already cut 72 jobs in its mortgage division, a 23% reduction from June to December of last year. But the cyclical nature of the mortgage business also makes it tough to predict, Ternes says, especially since home sales typically hit a seasonal lull in the first quarter.

Lenders in California say there is plenty of pent-up demand but too little inventory. The Golden State has rebounded much faster than other markets and lenders there have a much higher expectation for home purchase volume this year than those in the Rust Belt or the Midwest.

"If Chase were to pull back too severely and the business did not fall off as much, some lenders will be in a position to take market share from Chase," says Ternes. "It's a balancing act. You don't want to get caught with fewer staff than you need and that happens often when the mortgage business cuts back too severely and miscalculates volume."

Clearly, JPMorgan Chase is retrenching. The bank described several initiatives to improve profits, including investments in technology, and a focus on its core retail branch channel, which accounts for more than half of its mortgage volume today.

"Going forward it sees a smaller, simpler and less volatile mortgage business," wrote Jason Goldberg, an analyst at Barclays, in a note to clients.

JPMorgan Chase also told investors that it will continue to use its balance sheet to fund an increasing number of jumbo loans, many to high-net-worth clients. It also plans to retain a larger proportion of conforming loans that in a normal cycle probably would be sold to Fannie Mae or Freddie Mac.

"As we previously announced, we are responding to the stabilizing housing market and the declining number of customers refinancing their mortgages due to the rising interest rate environment," JPMorgan Chase said in a statement.

The industry contraction was predicted by many lenders last year as the harsh reality settled in that home purchases could not make up for the drop in refinance activity largely because job growth remains too anemic. Purchase applications reached a 19-year low last week, according to the Mortgage Bankers Association.

Bankers say there are a number of structural reasons why home sales have no chance to replace the refinance volumes of the past few years. In addition to a lack of inventory in many markets, home lenders have refinanced most existing homeowners into low interest rate loans below 4%.

"Interest rates now are still one-third higher than the rate most borrowers have on their current mortgages, which is a difficult hurdle for most households to overcome," says Mason.

Large land developments have become scarce and take much longer to gain approval from local governments, which has added to the supply imbalance, he says. An encouraging sign, though, is the resurgence in condominium development, which normally happens later in the recovery cycle.

"We are currently financing condo construction," Mason says. "But there are structural issues going on that don't indicate any near-term relief unless prices go up a little more and new housing can be built."

Industry veteran Dave Hurt, vice president of global capital markets at the data firm CoreLogic, says many lenders have never seen a market this slow.

"I think the industry is going to reset to the new normal," Hurt says. "JPMorgan certainly had some excess head count, but we've also lost a couple of segments of the market, such as first-time homebuyers and middle-tier move-up buyers, that drive originations."