Fed Helps Lenders’ Profit More Than Homebuyers:Mortgages

The Federal Reserve’s latest mortgage bond purchases so far are helping profit margins at lenders including Wells Fargo & Co. (WFC) and JPMorgan Chase & Co. (JPM) more than homebuyers and property owners looking to refinance.

Since the Fed’s Sept. 13 announcement that it would buy $40 billion more securities per month, the rates offered for new 30- year loans have fallen by just 0.13 percentage point, compared with a drop of about 0.7 percentage point for yields on the bonds into which the loans get packaged, according to data compiled by Bloomberg and Bankrate.com. The gap between the two, which typically signals increasing lender revenue when it widens, has reached a record of more than 1.7 percentage point.

Fed Chairman Ben S. Bernanke’s stated goal of helping boost the housing market is being undercut by lenders’ inability to keep up with consumer demand, even as investors drive up bond prices. Banks have been slow to lower rates after being overwhelmed this year by applications to refinance mortgages.

“Think about it this way: If you had a restaurant with 100 people out the door waiting in line, would lowering prices be the first thing on your mind?” said Scott Simon, the mortgage head at Newport Beach, California-based Pacific Investment Management Co., manager of the world’s largest bond fund.

Margins on sales of mortgages have widened by about 50 percent since the Fed’s announcement from the average level this year, which already was elevated, said Kevin Barker, an analyst at Washington-based Compass Point Research & Trading LLC.

“It’s very good to be a mortgage originator right now,” he said in a telephone interview.

Fed Targets

The Fed is targeting the $5.2 trillion market for mortgage bonds guaranteed by government-backed Fannie Mae, Freddie Mac and Ginnie Mae, which helps determine the rates that lenders can offer. Lenders bundle about 90 percent of new loans into the securities to sell to investors, giving them funds to make more.

The added time it’s taking to close on loans is signaling the industry’s limited capacity for handling more.

Mortgage refinancings completed in August took an average of 51 days, up from 42 days in March and 37 days a year earlier, according to Ellie Mae, a Pleasanton, California-based mortgage- technology firm. Loans for home purchases, which lenders often prioritize, took 47 days, up from 43 days in August, 2011.

Mortgage rates have continued to set new lows following the Fed’s announcement, reaching 3.44 percent on Sept. 25, according to Bankrate.com. Almost every lender lowered its rate by at least 0.125 percent, Steven Abrahams, a mortgage-bond analyst in New York at Deutsche Bank AG, said in a note today.

Home Prices

The trend, which the Fed has also helped engineer with stimulus efforts including pledges to keep short-term interest rates near zero, has contributed to a recovery in housing this year after a 35 percent slump in prices since mid-2006.

U.S. home values climbed more than forecast in July, with the S&P/Case Shiller index for 20 metropolitan areas released yesterday showing a rise of 1.2 percent from a year earlier, the biggest 12-month jump since August 2010.

Still, Michael Bauer, a San Francisco Fed economist, signaled in a May paper that the central bank was aware its purchases of mortgage-backed securities might provide limited help for homeowners or buyers. The “weaker link between MBS yields” and actual loan rates “may persist for some time,” Bauer said.

At a press conference after the Fed’s announcement, Bernanke said that he’s been attempting to reduce loan costs because the residential property market is “one of the missing pistons in the engine” of the economic recovery.

Borrower Programs

Along with low rates, President Barack Obama’s administration has helped fuel gains in refinancing this year by making it easier for borrowers with Fannie Mae and Freddie Mac loans without home equity to qualify and by reducing costs for homeowners with older Federal Housing Administration loans.

A weekly Mortgage Bankers Association index of refinancing applications hit a three-year high of 5452.8 during the week ended July 28. While the gauge fell to 4224.48 in late August, it was still 23 percent more than this year’s low in March, and then climbed to 4765.3 last week.

Lenders only have the ability to handle the pipelines of pending loans produced by an index level “somewhere around” 5500, according to Pimco’s Simon, whose firm’s Total Return Fund has joined lenders in benefiting from the Fed’s action with outsized bets on home-loan securities.

Wells Fargo, JPMorgan and US Bancorp (USB), the three largest U.S. home lenders, may be among the biggest beneficiaries of higher margins even as borrowing volumes remain constrained. Vickee Adams, a spokeswoman for San Francisco-based Wells Fargo, declined to comment, as did Tom Kelly of New York-based JPMorgan and Teri Charest of Minneapolis-based US Bancorp.

Market Share

Wells Fargo alone controlled 33.1 percent of the origination market through the first six months of the year, according to newsletter Inside Mortgage Finance. Unlike rivals such as Bank of America Corp. (BAC) and MetLife Inc. that over the past year shrank or closed home-loan units, the bank said it added the equivalent of about 2,000 workers last quarter.

The company recorded gains of about 2.25 percent on mortgages it sold during the period, up from 1.9 percent in 2011’s fourth quarter, according to comments by Chief Financial Officer Timothy J. Sloan on conference calls. Countrywide Financial Corp., the then-market leader later bought by Bank of America, reported a margin on prime loans of 0.80 percent in 2007, before the industry’s capacity and competition fell.

Over the past two years, a 1-percentage-point decline in mortgage-bond yields has generally translated into a 0.6- percentage-point decrease for rates, Barclays Plc analysts including Nicholas Strand wrote in a Sept. 21 report.

Bond Price

The drop has been smaller when loan rates fall to new lows that are significantly less than their averages. That means borrowing costs will now probably be “very sticky,” they said.

The Fannie Mae securities that lenders have been packaging most new loans into, with coupons of 3 percent, are trading at 106 cents on the dollar, up from 103.3 cents before the Fed announcement, according to Bloomberg data.

That means a lender gets 6 percent more than the principal amount of a loan upon a sale. They also receive income stream usually equal to 0.25 percent a year that can be retained for servicing the mortgage.

The gains that are helping banks are also benefiting bondholders. An investor betting $25 million that the securities would outperform yield benchmarks in a trade suggested by Barclays would have made $6.7 million between Sept. 7 and Sept. 20. The wager involved using 20 times leverage, a typical amount for a hedge fund on such bets.

Consumer Consequences

For consumers the payoff hasn’t been as quick.

“With each successive round of easing, the Fed appears to be getting less ’bang for its printed buck,’ ” Richard Eckert, an analyst in San Francisco at securities firm B. Riley & Co., wrote yesterday in a report. Along with lenders “finding they can maintain or increase their margins while still remaining competitive,” fewer borrowers are refinancing after previously lowering their rates.

The Mortgage Bankers Association made minimal changes to its forecasts for lending volumes between Sept. 18 and Aug. 20, even as the Fed acted, he noted. The group estimated this month that lending will total $1.47 trillion this year, compared with a prediction of $1.41 trillion last month, and $1.04 trillion in 2013, the same as its previous forecast. In 2011, originations totaled $1.26 trillion.

Abrahams of Deutsche Bank, says that while the Fed’s debt buying can only work through “the slow and noisy filter of mortgage lenders,” it will ultimately assist homeowners.

“As lenders work through their current backlog of loan applications, they will eventually lower rates to keep production at full capacity,” he wrote in a Sept. 19 report. “Borrowers will eventually benefit.”

To contact the reporter on this story: Jody Shenn in New York at jshenn@bloomberg.net

To contact the editors responsible for this story: Rob Urban in New York at robprag@bloomberg.net; Alan Goldstein at agoldstein5@bloomberg.net

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