Banks' increasing reliance on mortgage revenues has put investors on edge over a refinancing wave that will inevitably fade.
Strong volume and healthy profit margins appear to have continued into early 2013, however, and banks say they are adding production capacity and intent on gaining market share. They have seen cycles before, they say, and they can scale down operations when the time comes. (The first tab in the following graphic shows data on mortgage revenues and originations at the five biggest banks, and the second tab shows data on industrywide volume and profit margins. Interactive controls are described in the captions. Text continues below.)
Mortgage earnings climbed to 14% of total revenues at Wells Fargo (WFC) in the fourth quarter, the highest level in at least three years. At Bank of America (BAC), the mortgage business's contribution has generally been growing recently even though the company has shuttered production channels and slashed loan originations after its traumatic acquisition of Countrywide Financial.
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 recognized $3 billion of expenses to repurchase bad mortgages.)
Now, B of A is trying to regain market share, adding loan officers and reassigning people who 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," Brian Moynihan, the company's chief executive, told investors this month.
The gap between the interest rates consumers pay on new mortgages and the rates on bonds into which they 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 is almost certainly the pricing power banks exercise as low overall rates lead to floods of applications that overwhelm production capacity.
Gain-on-sale margins increased at Wells Fargo in the fourth quarter, though the company said it expects competition to push them down.
Based on the "hundreds of billions of dollars" of mortgages in Wells Fargo's servicing portfolio that still carry higher rates than rates on new loans, Chief Financial Officer Timothy Sloan told investors this month 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 (USB) Chief Executive Richard Davis said: "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 would be able to reel in overhead when the time comes. "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."