The mortgage industry’s leaders are once again betting they can grab a bigger slice of a shrinking pie.
The Mortgage Bankers Association has projected refinancing volume will tumble 75% over the course of this year. Analysts doubt cuts in lender overhead can keep pace. Most banks acknowledge the slowdown in mortgages, which supplied blowout profits last year. But some insist buildups in capacity have positioned them to take market share and sustain revenues, and that in any event a strong mortgage operation is essential for a full-service bank and worth the investment. (The following graphic shows data on loan volume and profit margins. Interactive controls are described in the caption. Text continues below.)
The rate on a 30-year mortgage has increased about 30 basis points since early December, according to the MBA. The trade group’s index of refi activity, while volatile, has generally been lower in the first quarter than the fourth quarter.
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 — remains elevated by historical standards, but has also dropped from levels observed in the third and fourth quarters.
Last month, analysts at KBW estimated a 20% drop in gain-on-sale margins and an 8.5% reduction in originations from the fourth quarter at SunTrust (STI) would cut about 7% off their forecast for the company’s earnings per share in the first quarter. “There could be building pressure on the company to make good on its operating efficiency programs sooner than later,” they wrote.
But in a presentation in March, SunTrust Chief Executive William Rogers said that while profit margins had been narrowing since the third quarter, the company was optimistic about volume in part because of an expansion in the platform through which it sells mortgages directly to borrowers by phone and online.
Similarly, PNC Financial (PNC) President William Demchak told investors last month that his company anticipates higher production this year. “Capacity constraints prevented us from capturing more of the origination market for much of 2012,” he said. So “we significantly increased our capacity to process and underwrite originations by expanding our two main operation sites and bringing a new Florida site online.”
More lending infrastructure explains much of the profit margin squeeze, since competition pushes consumer rates down. And, according to the KBW analysts, cost cuts are unlikely to keep up: there is less room to maneuver on the cost to produce loans.
As the housing market improves, lenders are looking to an anticipated pickup in home purchase loans to cushion the deceleration in refinancing. They are also counting on offsets from servicing operations, where loans are less likely to vanish from portfolios when rates rise.
Wells Fargo (WFC) attributed its rise to the nation’s dominant mortgage lender in part to its enormous servicing portfolio, which has raised eyebrows because it will require large amounts of capital under Basel III. When rates are low and borrowers want to refi, the servicer generally gets “the first call,” Chief Financial Officer Timothy Sloan told investors last month.
U.S. Bancorp (USB) CEO Richard Davis told investors, “the decision we made four years ago to triple the size of our mortgage business” was among the company’s proudest moves. “So far so good.”