Wells Fargo (WFC) may see an 18% drop in mortgage revenue this year as profit from selling loans shrinks, according to Richard Staite, an analyst at Atlantic Equities LLP.
Revenue from mortgage production, without subtracting what must be set aside to cover repurchases, will fall to $10 billion this year from $12.2 billion in 2012, London-based Staite said in a report today. If interest rates stay at current levels, 2013 revenue at the San Francisco-based company could be "considerably lower," he wrote.
Banks posted record mortgage-banking income last year as reduced competition and low mortgage rates allowed lenders to charge high prices for selling home loans into mortgage pools. Those margins will narrow as bond yields rise, driving a decline in production revenue, Staite said. Yields on 30-year mortgage debt climbed 0.23 percentage point in the last week.
"This will impact mortgage origination revenues, potentially significantly," said Staite, who downgraded his rating on the stock Jan. 16 from "overweight" to "neutral" and lowered the 12-month price target to $38 from $40. Wells Fargo "is most exposed to a contraction with over 14% of revenue from mortgage production and potentially as much as 20% of profits."
The so-called primary-secondary spread, a measure of the difference between primary mortgage rates and mortgage-bond yields and a proxy for the revenue earned on loan sales, widened to a record 1.8 percentage points in September, data compiled by Bloomberg show. The difference fell to about 1.05 percentage points on Jan. 24.
Lenders also may face fewer originations, with the Mortgage Bankers Association forecasting a 19% decline from last year's almost $1.8 trillion. Wells Fargo originated $524 billion, according to a company statement.
The bank could soften the impact by curbing the cost of buying back faulty loans sold to investors and from litigation, Staite said. An economic recovery that leads to higher interest rates also will boost banks' net interest margin, the difference between what they make on loans and pay for funds, Staite said. He recommends Bank of America Corp. and Citigroup Inc. as the best performers in an economic rebound.
"All banks including WFC will see benefits from a housing recovery and rising long-term interest rates," he said, referring to the company's stock ticker. Wells Fargo will lag behind "due to the potential negative impact on mortgage production revenues."
Wells Fargo's shares rose 0.5% to $35.29 at 3:10 p.m. in New York. The stock gained 2.7% this year through yesterday, trailing the 5.1% advance in the 24-company KBW Bank Index.