Riding the Mortgage Revenue Wave

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The banking industry's increasing reliance on mortgage revenue has put investors on edge over a refinancing wave that will inevitably fade. But with strong volume and healthy profit margins appearing to have continued into early 2013, banks are adding production capacity and remain intent on gaining market share. They have seen cycles before, they say, and can scale down operations when the time comes.

In the fourth quarter, mortgage earnings accounted for 14 percent of total revenue at Wells Fargo. As the top chart at the right shows, that was the highest percentage in at least three years. (Go to AmericanBanker.com/data-tools for interactive charts, including data on industrywide volume and profit margins.)

Even at Bank of America, the mortgage business's contribution generally has been growing of late, though the company has shuttered production channels and slashed loan originations after its traumatic acquisition of Countrywide Financial (see second chart).

B of A's mortgage bank is smaller, but the company's total revenue also plummeted during the time shown here. In the chart, mortgage banking revenue as a percentage of total revenue is not shown when mortgage banking revenue was negative, such as in the fourth quarter last year at B of A, when the business line recognized $3 billion of expenses to repurchase bad mortgages.

Now, B of A is trying to regain market share, adding loan officers and reassigning staff that had been tied up handling the company's mountain of troubled mortgages.

"We will continue to move them because ultimately the retail production side is a good business right now," CEO Brian Moynihan told investors in January.

The gap between the interest rates that consumers pay on new mortgages and the rates on bonds into which the mortgages are packaged-a proxy for the profit lenders earn when they make new loans since the relationship between asset prices and yields is inverted- has been stubbornly wide since the middle of 2011.

The precise mix of factors behind the differential is unclear. Lenders note that the cost of servicing loans has increased because of tougher oversight, but another important element almost certainly is the pricing power banks exercise, as low overall rates lead to floods of applications that can overwhelm production capacity.

"Gain on sale" margins increased at Wells Fargo in the fourth quarter, though the company said it expects competition to push the margins right back down. Based on the "hundreds of billions of dollars" of mortgages in Wells Fargo's servicing portfolio that still carry rates that are higher than the rates on new loans, Chief Financial Officer Timothy Sloan told investors in January that "it doesn't feel like ... this is going to be the last quarter that we are going to see good volume."

U.S. Bancorp CEO Richard Davis seemed to espouse a similar view when he quipped, "Nobody has ever figured out how many times people can refinance a house. They seem to be able to do that endlessly."

Still, he reassured investors that the company will be able to reel in overhead when it has to. "We have been very careful not to build the church for Easter Sunday. We are able to accommodate all of our volume today, but we have got a pretty good variable capability of reducing quickly, adding quickly."

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