Whether today's unusually low interest rates will continue to feed a refinancing boom remains an open question, but it's clear the lenders still in the game are making a lot more on each loan.
Lenders say first-quarter profit margins are the widest they have seen in years, despite concerns that the refi wave could result in higher prepayment costs for servicers.
"If you're in a position to make loans, you're making historically wide profit margins, so this is a very good time to be in the lending business," said Tom Millon, the president and chief executive of Capital Markets Cooperative, a Ponte Vedra Beach, Fla., provider of secondary marketing services to banks.
The big caveat, of course, is that some of these loans "could go bad," Millon said, and many lenders are "looking backward" at loans made in the third and fourth quarters with the same concern.
Still, there has been a significant pricing shift since late last year that is boosting profits, especially for large aggregators such as Bank of America Corp., Citigroup Inc., JPMorgan Chase & Co. and Wells Fargo & Co.
During the boom days large aggregators paid an extra fee — typically an eighth of a point — for loans sold in bulk by correspondent lenders under "mandatory pricing" arrangements. In return for higher prices, the correspondent lender had to deliver a certain loan volume to the aggregator and accept the risk of selling loans that may not get funded.
Volatility has changed that equation. Now, with stricter underwriting guidelines and the problems that some borrowers have obtaining mortgage insurance, many loan applications never get funded. That has made lenders far more willing to accept lower rates when selling the loans. Under these "best efforts pricing" arrangements, the lenders do not receive a premium, but they avoid taking on the risk of selling loans that do not go through.
Historically, the spread between best efforts and mandatory pricing has been roughly 25 to 35 basis points, but in recent months that spread has widened to between 95 and 100 basis points, Millon said.
Matthew Pineda, the president of Castle & Cooke Mortgage LLC in Salt Lake City, agreed that volatility has created the wider spread. "The market is so unpredictable today that everyone is running conservative, so pricing gets padded, and mandatory pricing is not worth the risk."
As a result, lenders increasingly are choosing best efforts pricing, because there is less risk associated with delivering the loan, he said. "Nobody is going to be rolling out a lean margin in today's market, because if they can make half a point on a loan, why give it up? Until the business slows down, you're not going to see anyone give away money."
The lower rates are boosting bankers' income. Wells said last week that it would report first-quarter net income well above analysts' expectations, in part because of higher profit margins for mortgage originations. B of A, Citi and JPMorgan Chase have said they were profitable in the first two months of the quarter. Others lenders are saying March was their strongest month in terms of volume in a year.
One factor contributing to higher profits is the fact that most lenders have cut back dramatically on staff and expenses in the past year and are limited by a contraction of warehouse lines and reduced competition.
Barry Habib, the CEO of Mortgage Success Source LLC's Mortgage Market Guide and a former national sales trainer at CTX Mortgage, said many lenders are writing a lot of business but are not closing the loans. "We've seen about half of the wholesale lenders go out of business, and so now there's a bottleneck of loans going through a much narrower group of lenders, and they are less likely to pass on price improvements to the customer, which is helping profitability."
According to Pineda, many lenders are picking up a full point of profit on each loan, and if they are hedging their interest rate risk correctly, margins are even fatter.
Another critical factor: Lenders are charging higher interest rates and have moved away from brokers and correspondent lenders.
Several years ago, during the heyday of originations, bankers had far lower profit margins, because competition was so fierce, but the volumes were high. Now there are far fewer players in the game, and lenders say they have more volume than they need.
As a result, despite an environment in which rates are historically low, some lenders have not cut their rates as much as they could; some are even charging consumers fees up front to qualify for low-rate refinancing deals.
"The big aggregators are holding prices higher in order to slow down production and that's increasing their margins," said Michael Koch, a senior vice president and the director of residential lending at $1.9 billion-asset AmericanWest Bank in Spokane, Wash.
And lenders are retaining more of the profits by handling originations in-house. Some big banking companies, including B of A, are funneling origination volume through their retail branches, rather than using mortgage brokers and correspondents.
"There's no doubt the profit margins are big because the pricing has been on fire at retail," said Brian Koss, managing partner at Mortgage Network Inc., a privately held lender in Danvers, Mass.
Wholesale lenders said the change in the pricing is coming from bankers who have long said loss rates on broker-originated loans were two or three times higher than for loans originated by retail employees.
Peter Levasseur, the former president and CEO of Fortes Financial Inc., said the major banking companies have made strategic decisions to drive origination volume through their branches.
"If you've got these huge branch networks, the brick and mortar, then retail tends to be more profitable," he said.