The Next Mortgage Threat: Homeowners Who Stay Put

Bankers suffering through the mortgage refi hangover are coming to a sudden, perhaps more painful, realization — it could last a lot longer than they thought.

One of the big reasons is that banks may have been too successful during the refinancing boom for their own good.

Not only did the boom set banks up for an immediate fall once rates started rising nearly a year ago and refi activity cooled, but it gave a large swath of potential customers a strong disincentive to seek a new mortgage for a long time.

Millions of homeowners in recent years took advantage of the market and refinanced their mortgages at rock-bottom rates — including 19 million alone through the Home Affordable Refinance Program. Thus, if those same homeowners choose to move, they'd almost certainly take on a mortgage with a higher rate, and therefore a costlier monthly payment, says Joel Kan, director of economic forecasting at the Mortgage Bankers Association.

"There is definitely more incentive to stay put than to move" for those homeowners, Kan says. "Once you lock in a low rate, you're much less likely to move."

That means the slump in home sales that has already damaged financial results could persist.

More than a dozen banks reported double-digit declines in mortgage banking revenue in the first quarter. KeyCorp (KEY) and SunTrust Banks (STI) each took hits of more than 70%.

The drop-off in mortgage banking may be affecting some banks' strategic plans. Taylor Capital (TAYC) in Chicago said this month that it would no longer try to sell its mortgage division. Brian Martin, an analyst at FIG Partners, wrote in a research note on Monday that the decision was "not a surprise, given the industrywide falloff in mortgage-related revenues."

To be certain, other factors are in play. For one, the inventory of available homes for sale is low because the nationwide foreclosure rate has slowed dramatically. The lower inventory also results in higher prices, driving potential buyers out of the market.

"If you don't have inventory, you don't have sales," says Ken Fears, manager of regional economics at the National Association of Realtors.

Then there are consumers' broader worries about the economy and their personal financial situation. Mortgage originations fell about 30% in the first quarter from a year earlier at $14 billion-asset FirstBank in Lakewood, Colo. That's largely because of consumer uncertainty, says Patrick Brady, the president of the bank's northern Colorado market.

"There is, in general, more hesitancy about moving and purchasing" a new home, Brady says.

Indeed, mortgage originations nationwide fell to $332 billion in the first quarter, down nearly 27% from the previous quarter and 42% from a year earlier, according to a report issued this week by the Federal Reserve Bank of New York. That's the lowest level since the third quarter of 2011.

The situation is worse in high-cost areas, like the San Francisco Bay area, says Stan Humphries, the chief economist at Zillow. Taking on a new mortgage that carries a 4.2% rate, versus a rate of 3.5%, "might not represent a very large increase in monthly payments and is easily absorbed… in Middle America," Humphries says.

But in San Francisco, New York, Los Angeles, Washington and other areas with expensive real estate, "it could be a difference of a few hundred dollars per month or more … which can make a big difference," Humphries says.

The average rate on a 30-year fixed mortgage in April was 4.34%, up from

3.45% a year earlier, according to Freddie Mac.

Soft home sales are not all bad for banks. Revenue from servicing mortgages benefits banks as homeowners don't prepay loans and banks receive the steady income from monthly payments. SunTrust in the first quarter reported a 73% decline in mortgage-production-related income, to $43 million, from a year earlier. But SunTrust's servicing income grew 42% over the same time period, to $54 million.

Still, most banks derive mortgage revenue from originations, not servicing.

Banks tried to adjust when the refi boom showed signs of cooling off. Wells Fargo (WFC), Citigroup (NYSE: C) and others cut thousands of mortgage-related jobs. That task still isn't finished, some bankers have said.

"We continue to rationalize our mortgage business lines, in line with lower production levels," Tayfun Tuzun, the chief financial officer at Fifth Third Bancorp (FITB), said during an April 17 conference call.

But the mortgage-origination business dropped so dramatically that some analysts have questioned whether SunTrust is terminating mortgage employees quickly enough to keep pace.

Matt Burnell, an analyst at Wells Fargo Securities, recently asked SunTrust if there are "further opportunities for rightsizing" the bank's expense base in its mortgage business. Burnell compared the year-over-year decline in SunTrust's mortgage revenue (73%) against the fact that the division's expenses only fell 30%.

"Over the course of the remainder of this year we will be trying to take fixed costs little by little out of that system," CFO Aleem Gillani responded.

Others made similar comments, including Daryl Bible, chief financial officer at BB&T (BBT). The Winston-Salem, N.C., company reported a 59% decline in mortgage revenue in the first quarter, to $74 million, from a year earlier.

"To address the lower mortgage revenues," Bible said in an April 17 conference call, "we are taking aggressive action to align our production and origination businesses to coincide with lower volumes."