Mortgage revenue at the four largest U.S. lenders is surpassing the costs of faulty home loans and foreclosures from the housing boom as Federal Reserve and government policies help fuel the recovery.
Wells Fargo & Co. (WFC), JPMorgan Chase & Co. (JPM), Bank of America Corp. (BAC), and U.S. Bancorp reported $24.4 billion from home lending in 2012 and expenses of more than $21.7 billion for settlements and loan repurchases, according to data compiled by Bloomberg. Lower costs for firms such as Bank of America this year will act as a “tailwind,” as mortgage revenue remains strong, Goldman Sachs Group Inc. analysts said.
For all the money the government is collecting from banks tied to the worst housing slump since the Great Depression, lenders are still making record profits, thanks to policies that are driving the accelerating rebound. Loan originations totaled $1.75 trillion in 2012, the highest since 2009, according to the Mortgage Bankers Association, as homeowners took advantage of borrowing costs pushed down to record lows by the Fed and the White House expanded programs to help refinancing.
“They’ve come out from the self-inflicted gunshot wound to the head and are now starting to recover due to a government- induced set of policies and programs,” said Clifford Rossi, a former risk manager and managing director at Citigroup (C) Inc. who’s now at the University of Maryland’s Robert H. Smith School of Business. Policies intended to assist homeowners serve “to help the banking segment significantly,” he said.
Banks made record earnings from mortgages last year as they were able to lend at rates much higher than the bonds they were packaged into. That disappointed policy makers including New York Fed President William C. Dudley, after the central bank kept its benchmark interest rate near zero since 2008 and bought $40 billion of mortgage bonds a month to push down borrowing costs. The top four banks controlled about half of the origination market at the end of the third quarter, according to Inside Mortgage Finance.
Even with elevated profit margins, mortgage rates fell to 3.4 percent last week from 4.74 percent two years ago.
“The large banks are making a lot of money off of the Fed, and have been basically since it started buying mortgage backed securities,” said Walt Schmidt, a mortgage strategist at FTN Financial. “As long as the Fed continues to buy them in current volumes, there’s no way around it.”
Still, costs probably will come down. Bank of America, which has booked almost $50 billion in costs since 2007 including refunds and litigation tied to defective home loans and improper foreclosures, said last week that it has dealt with most of those expenses.
Faulty mortgages have cost five banks -- Wells Fargo, Bank of America, JPMorgan, Citigroup and Ally Financial Inc. -- at least $84 billion since 2007, according to data compiled by Bloomberg. In the second half, the four largest mortgage lenders reported about $16 billion of added costs.
“Banks with outsized environmental costs are best positioned to see operating leverage in 2013, as these costs decline,” Goldman Sachs analysts led by Richard Ramsden wrote in a Jan. 3 report. They defined those expenses as mortgage foreclosure and legal costs, and loan buybacks. Declines will be coupled with mortgage revenue that should “remain strong throughout 2013, as spreads remain wide and volume remains resilient,” the analysts wrote.
Goldman said that banks in the best position to benefit this year include Atlanta-based SunTrust Banks Inc., Bank of America, Citigroup and Memphis, Tennessee-based First Horizon National Corp. (FHN) The 24-company KBW bank index rose 0.8 percent today in New York trading extending this month’s gain to 5.1 percent.
Wells Fargo has been the biggest beneficiary of a robust mortgage market. The largest U.S. home lender originated nearly 1 in 3 mortgages as of September and reported a 24 percent rise in fourth-quarter profit Jan. 11. Net gains on origination totaled $2.8 billion in the fourth quarter. In all of 2012, the firm recorded about $11.6 billion in mortgage banking income.
Mortgage banking could bring in another $10.9 billion this year, Chris Kotowski, a New York-based bank analyst with Oppenheimer & Co., estimated in a Dec. 20 report. The top four lenders, Wells Fargo, JPMorgan, U.S. Bancorp and Bank of America, will bring in $27.3 billion from mortgages this year, Kotowski projects.
John Stumpf, chief executive officer at the San Francisco- based bank, said this month there’s still “lots of opportunity” in mortgage lending.
“Momentum continues to build in the housing market,” JPMorgan analysts led by John Sim wrote in a report last week. “Builders are reporting the best sales conditions they’ve seen in more than five years.”
Home values climbed by more than $1.3 trillion to $23.7 trillion since the end of 2011, according to Zillow, and prices will rise by 3.3 percent after an estimated 4.5 percent jump last year, based on estimates of 15 economists and housing analysts surveyed by Bloomberg.
Property sales have also been accelerating with 4.65 million homes purchased in 2012, the most since 2007. While transactions in December from the prior month, they’ve increased to a 4.94 million annual rate, figures from the National Association of Realtors showed today in Washington.
The recovering real estate market will further drive profits at the largest banks for up to 18 months, said FBR Capital Markets Corp. analyst Paul Miller.
“Given where rates are, up to $2.5 trillion loans have an incentive to refinance,” Miller said. “We’re only refinancing about $1 trillion to $1.3 trillion loans a year.”
JPMorgan Chief Executive Officer Jamie Dimon said on an October conference call that mortgage production margins are “very high” at well over 2 percent.
While that’s narrowed about 0.4 percentage points in the last quarter, it compares with margins over time of 0.65 percentage points, the bank’s Chief Financial Officer Marianne Lake said last week on the earnings call with analysts. Mortgage fees and related revenue surged to $2.03 billion in the quarter from $723 million a year earlier.
Even Bank of America, whose ill-timed purchase of Countrywide Financial Corp. in 2008 has led to many of its losses, wants to grow the home-loan business, Chief Financial Officer Bruce Thompson said in a media call last week.
“As we look at the mortgage production piece of this, we want it to grow,” Thompson said. “The one piece of mortgage strategy we have is about reducing the legacy mortgages and attacking that cost going forward.”
The Charlotte, North Carolina-based bank earlier this month reached an $11.7 billion agreement with Fannie Mae to resolve most disputes. It’s also responsible for about $2.9 billion of an $8.5 billion settlement agreed with the Office of the Comptroller of the Currency to end reviews of foreclosure-abuse claims.
“We addressed significant legacy issues in 2012 and our strengths are coming through,” Thompson said in a statement last week. The lender still needs to resolve its battle with mortgage bond insurer MBIA Inc., which its Countrywide unit has been locked in litigation with since 2008.
Banks have counted on home lending to bolster earnings as low interest rates undercut net interest margins, a measure of profitability represented by the gap between what banks pay depositors and what’s earned on loans. The margin at the four largest lenders fell an average 0.20 percentage points in the fourth quarter over the year earlier, to 2.97 percent at the end of December, according to data compiled by Bloomberg.
While production may stay elevated in 2013, profits on home loans may shrink as minutes of the Fed’s December meeting, released Jan. 3, showed policy makers may end $85 billion monthly bond purchases this year. That could “spoil the party” for lenders that profited from a more than 20 percent jump in mortgage originations last year, according to Deutsche Bank AG.
“When the day is done you’ll see profitability cut in half, but that’s a four- to six-quarter process,” FBR’s Miller said. “And they are still going to make good money on mortgages.”