Warning Signs for Housing Stocks

Two big banks today with one clear message: Housing bulls beware.

Earnings reports this morning from JPMorgan Chase & Co. (JPM) and Wells Fargo & Company (WFC) revealed significant declines in mortgage activity. JPMorgan originations fell 48 percent compared to the same period last year, while Wells Fargo applications dropped 26 percent. Given that Wells Fargo typically underwrites one quarter of the nation's mortgages during a given quarter, this weakness is significant.

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JPMorgan Chief Financial Officer Marianne Lake said during the earnings conference call that she expects the bank to terminate 1,000 mortgage-related positions during the fourth quarter. This will bring the bank's total mortgage origination layoffs this year to 7,000. Wells Fargo has reported similar figures. So too has Bank of America Corp. (BAC).

Overall mortgage activity in the U.S. has declined significantly for several quarters, based on data collected by Inside Mortgage Finance. During the most recent period for which data is available (the second quarter of this year), U.S. originations totaled $295 billion, representing a decline of 48 percent compared to the same period a year ago.

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The data serve as a warning to housing bulls, especially those equity investors who own homebuilders and regional banks. Falling demand for mortgage financing implies lower demand for housing-related businesses, which in turn suggests headwinds to earnings.

We note at least five analysts have cut earnings estimates during the past four weeks on the following seven companies: Fifth Third Bancorp (FITB); KB Home (KBH); Keycorp (KEY); Lennar Corporation (LEN); M&T Bank Corporation (MTB); PNC Financial Services Group, Inc. (PNC); Regions Financial Corporation (RF).

Downward-sloping trend lines for two key exchange traded funds illustrate the fundamental erosion in their underlying busineses: SPDR S&P Regional Banking ETF (KRE) and SPDR S&P Homebuilders ETF (XHB). Returns for each are negative this year, and we believe today's data suggest they are vulnerable to further declines.

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