Banks Set to Post Blowout Mortgage Earnings for 2Q

By Harry Terris

JUL 6, 2012 5:26pm ET

Expect banks to report another quarter of blowout mortgage revenues in coming weeks.

Mortgage rates touched new lows and refinancing volume continued to climb during the last three months. The spread between interest rates paid by consumers and the lower yields demanded by bond investors remained wide. That reflected either the pricing power of the surviving lender oligopoly or discipline among originators and production bottlenecks in the face of surging homeowner demand.

Mortgage rates spiked briefly as the first quarter came to a close, raising the prospect that a rebound in refinancings originating in the fourth quarter would peter out. Instead, a string of weak employment reports and an escalation of the euro-zone crisis helped push the 30-year fixed-rate mortgage to below 3.9% in recent weeks, according to a Mortgage Bankers Association survey. Meanwhile, the trade group’s index of refinancing activity increased to levels last observed in late 2010 (see the first chart).

MBA forecasts suggest that the elevated volume could have some staying power. In June, the organization predicted that refinancings would fall 20% from the first quarter to $218 billion this quarter, an amount that is still roughly twice what the MBA forecast in March for the second quarter.

Meanwhile, mortgage rates available to consumers were more than 100 basis points higher than rates on bonds that fund the home loans for most of the second quarter, with the spread widening to more than 125 basis points in June (see the second chart). The relationship between asset prices and yields is inverted, so higher consumer rates relative to secondary market rates indicate higher profits for lenders, which mostly sell mortgages to investors.

In a report last month, KBW lifted earnings projections for banks ranging from the $805 million-asset Access National (ANCX) in Reston, Va., to the $341 billion-asset U.S. Bancorp (USB) because of the strong mortgage earnings outlook.

Critics have argued that crisis-era consolidation has concentrated the bulk of originations among a handful of lenders, allowing them to pad earnings and prevent the benefits of low rates from flowing fully to borrowers.

In particular, criticism has focused on elements of the Home Affordable Refinance Program. An Obama initiative designed to allow borrowers with little or no equity in their homes to access market rates, it has been criticized for giving lenders added pricing power over mortgages in their own portfolios. Under Harp, lenders that refinance borrowers serviced by competitors expose themselves to greater risk of having to buy back loans because of underwriting flaws than in refinancing mortgages they already service. (Harp volume has spiked since the program was expanded early this year.)

Lenders argue that they are pricing rationally in view of waves of losses from repurchases of bad loans and that the mortgage industry is a highly competitive place where fat profits are transitory.

At least one major competitor, Bank of America (BAC), is seeking to reclaim market share ceded as it narrowed its focus to retail originations. “We have grown loan officers now dramatically,” Chief Executive Brian Moynihan told investors in late May, saying that revenues were as strong as they had been in previous quarters despite the smaller footprint because of wide spreads.