The long-anticipated collapse in mortgage applications, finally a reality, stands to take a bite out of bank earnings in the second quarter and beyond.
There is an upside in higher interest rates for home lenders. Mortgages are likely to stay in servicing portfolios for longer, for instance. But the sudden crash in volume in May and June complicates an orderly transition from a period of fat origination revenues. (The following graphic shows data on loan volume and profit margins. Interactive controls are described in the caption. Text continues below.)
The average rate on a 30-year mortgage increased by more than one percentage point since early May to 4.7% in early July, according to the Mortgage Bankers Association. The trade groups index of refinance applications fell by about half over the same time, to its lowest level since the middle of 2011.
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 is still wide by historical standards. But at between roughly 100 and 130 basis points in the first half this year, it is well below the range of roughly 130 to 180 basis points in the second half of last year.
In a note in June, analysts at Sterne Agee projected that mortgage banking revenues at multinational and regional banks would fall 25% to 35% from the first quarter.
Analysts at KBW reckoned that originations could get a last-gasp stimulus from borrowers seeking to close loans before rates rise higher still, and that some companies have offsets from things like the decline in expenses to buy back faulty mortgages they had previously sold. Even at Wells Fargo (WFC), which KBW views as relatively well-positioned, the analysts predicted a 6% decline in mortgage banking income from the first quarter, however.
As recently as the middle of June, bank executives had not significantly changed their outlooks for the mortgage business, and instead continued to tout buildups of origination capacity in presentations to investors. Rates had been rising, but that was before Federal Reserve Chairman Ben Bernanke said on June 19 that the central bank might begin to taper its asset purchases later this year, catalyzing the bond rout.
After a strong start to the second quarter, U.S. Bancorp (USB) Chief Financial Officer Andrew Cecere said on June 11 that he still expected mortgage revenues to increase from the first quarter. He also said that hedges would neutralize any gain in the companys mortgage servicing rights.
At the same conference, SunTrust (STI) CFO Aleem Gillani said that increased origination infrastructure would help the company capture untapped refi business under the federal governments Home Affordable Refinance Program.
Lenders cant count on loans to buy homes to fill the void left by refis. Yes, as the housing market strengthens, purchase applications have increased. But they remain well below levels that prevailed for most of the first decade of the century. Even after the tumble in May and June, refi applications still accounted for 64% of the total.