Rates Set Banks Up to Report Strong Mortgage Earnings

Rock-bottom home loan rates persisted through the first quarter, goosing origination volume and setting banks up to post another round of strong mortgage banking results.

The volume also appears to have helped keep the profits from producing each loan plump in a capacity-constrained industry.

Mortgage rates available to consumers have been more than 100 basis points higher than rates required by investors in the secondary market since the middle of August, and the gap spiked past 130 basis points in January. (The relationship between asset prices and yields is inverted, so higher consumer rates relative to secondary-market rates indicate higher profits for lenders, which mostly sell mortgages on to investors.)

The wide spread between consumer and secondary-market rates when loan pipelines have been full reflects the dramatic consolidation among lenders since the housing bust, and a push to set prices that accommodate higher servicing costs and absorb losses from repurchases of bad loans. The most aggressive originators from the bubble years have either collapsed or retreated from the market.

Margins may have also been fattened by quirks in a federal initiative designed to allow underwater borrowers to refinance at lower rates.

To increase volume under the Home Affordable Refinance Program, Fannie Mae and Freddie Mac instituted new policies late last year that relieve originators of some of the risk that they would have to buy back loans because of underwriting flaws.

But putback risks remain relatively high for originators that refinance mortgages serviced by competitors, giving lenders additional pricing power over mortgages in their own portfolios, analysts have argued.

In any event, Harp 2.0, as the expanded program is known, has at least contributed to lending volume.

This month, analysts at KBW raised their earnings forecasts for BancorpSouth (BXS), Fifth Third (FITB), Huntington Bancshares (HBAN), PNC Financial Services (PNC), U.S. Bancorp (USB) and Wells Fargo (WFC) in anticipation of higher mortgage banking revenues than they had previously expected.

Mortgage rates have been edging up recently as the outlook for the economy has improved, however. The Mortgage Bankers Association has forecast that refinancing volume will fall by about 20% from the first quarter to about $200 billion this quarter, and then by almost half to $110 billion in the third quarter.

Speaking to investors in March, Wells Fargo’s chief financial officer, Timothy Sloan, declined to predict precisely when spreads would narrow, but said it was a matter of time.

“At some point, the level of refinance activity that we’re seeing right now is going to slow down,” he said.

“My crystal ball is not working in terms of exactly when that’s going to happen, but at some point margins will probably come down.”