Fattened Margins Seen Shrinking 40% at Banks: Mortgages

Record mortgage profits that drove earnings at Wells Fargo & Co. and JPMorgan Chase & Co. are fading as increased competition keeps the rates banks are offering on new loans near all-time lows.

The amount that lenders make from packaging each loan into securities and selling them to investors may be down as much as 40 percent from last quarter, Compass Point Research and Trading LLC estimates, as banks absorb most of the costs of tumbling bond prices.

After the four biggest bank lenders reported more than $24 billion of revenue from originations last year as refinancing soared, mortgage firms are accepting narrower margins as they seek to sustain demand from a shrinking pool of borrowers. Bond prices have slumped as the U.S. housing recovery contributes to optimism about the economy and investors start to brace for the end of the Federal Reserve’s debt purchases.

“Gain-on-sale margins are definitely getting squeezed,” said Rob Hirt, chief executive officer of Walnut Creek, California-based RPM Mortgage Inc., whose margins are down about 10 percent to 15 percent. “It can depend on the type of mortgage company you are,” he said. RPM for instance only grants loans directly to consumers, rather than through brokers or correspondents.

While the average rate for a 30-year fixed mortgage tracked by Freddie Mac has risen 0.25 percentage point from a record low in November to 3.56 percent this week, that’s less than half of the 0.54 percentage point-increase to 2.64 percent in a Bloomberg index of yields on the government-backed securities into which lenders package new loans.

Record Spread

The difference between the two rates, known as the primary-secondary spread, is a gauge of the profitability of originations. It reached an all-time high of 1.8 percentage point in September.

Increases in the annual fees that taxpayer-supported Fannie Mae and Freddie Mac charge to guarantee mortgage bonds of 0.1 percentage point mean the drop in lenders’ margins is even larger than the narrowing gap alone suggests, according to a report yesterday by Compass Point.

“The profits from mortgage origination will be pressured,” Kevin Barker, an analyst at the Washington-based firm, said in a telephone interview.

Firms that may be most damaged by the change include Flagstar Bancorp Inc., Nationstar Mortgage Holdings Inc. PennyMac Mortgage Investment Trust, EverBank Financial Corp. and PHH Corp., according to the report.

Historical Levels

Wells Fargo rose 1 percent to $35.82 at 4:15 p.m. in New York extending the gain this year to 4.8 percent. EverBank fell

0.6 percent and has declined 2.1 percent since 2012.

Spokesmen for the companies and JPMorgan and Wells Fargo, the two largest home lenders last year, declined to comment or didn’t return messages yesterday. Some of their executives have said they’ve been anticipating a drop in profitability.

“Margins in the fourth quarter remained wide compared to historical levels,” PennyMac Chief Financial Officer Anne McCallion said during a Feb. 8 earnings call. “That margin will begin to normalize this year as new competitors enter the market and refinance activity begins to decline.”

Competition for mortgage originations could take market share from Wells Fargo and JPMorgan. San Francisco-based Wells Fargo expanded its operations staff by at least 25 percent in 2012, the company said in November. JPMorgan, the biggest U.S. bank by assets, said last year it had transferred 3,500 people from servicing to mortgage originations.

‘Hiring Spree’

The industry was on a “hiring spree” in 2012 as companies tried to take advantage of the “surprising increase in refinance volumes,” Barker said in the report.

That jump last year created wider margins as lenders restrained how much they decreased the rates they offered to consumers as the firms slowly built up staff to handle the demand, while the Fed helped drive down bond yields by announcing in September it would buy $40 billion of mortgage securities each month. Obama administration programs also made it easier for some borrowers to qualify.

Resistance by banks to dropping rates frustrated U.S. central bankers including New York Fed President William Dudley, who said in a speech that its efforts to bolster the economy “had been impeded.” His bank held a special workshop in December to examine why the primary-secondary spread was so wide. Since then, the gap has shrunk as bonds tumbled amid signs the economic recovery is strengthening. A survey of primary dealers conducted by the New York Fed shows a majority anticipate an end to mortgage-bond purchases by January.

Converging Rates

A Credit Suisse Group AG measure of the gap that takes into account increases in Fannie Mae and Freddie Mac guarantee fees has since fallen to within 0.15 percentage point of its “long-term pre-crisis average,” the bank’s analysts led by Mahesh Swaminathan said yesterday in a report.

The two rates have “converged, but perhaps not as the Fed intended,” they said. The central bank was aiming for lower loan rates, not to have them remain “sticky” as bond yields climbed.

While PHH CEO Glen A. Messina described the primary-secondary spread as a “good indication” of gain-on-sale margins on a Feb. 7 conference call, it can be imperfect. For instance, lenders can sell bonds backed by certain mortgages for more.

Even with margins contracting, they’re “not collapsing,” and volumes should remain strong, Paul Miller, an analyst at FBR Capital Markets Corp., said in a Feb. 20 report.

Refinancing Applications

A Mortgage Bankers Association index of weekly refinancing applications, for instance, is down 27.9 percent from a more than three-year high in September. The current levels of that measure and one for home-purchase loans suggest originations can surpass the 2012 total of $1.8 trillion, he said.

FBR estimates there are between $2 trillion and $2.5 trillion in mortgages left to refinance, based on their current rates.

“We continue to recommend the mortgage banking space and believe that profitability will remain elevated in 2013,” he wrote.

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