Banks to Suffer Big Decline in Mortgage Revenue in 2013

Regional banks enjoyed a blowout 2012 for mortgage revenue. But that may all come to an end this year.

That means investors can no longer count on a steady stream of glowing earnings-season headlines for mortgage growth or upward earnings-estimate revisions.

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President Obama early last year expanded the Home Affordable Refinance Program, or HARP, to allow qualified borrowers with mortgage loans held by Fannie Mae (OTC:FNMA) or Freddie Mac (OTC:FMCC) to refinance at record-low interest rates, no matter how much the market value of the underlying home had declined.

The expanded HARP, along with record-low interest rates, led to a 39% year-over-year increase in US mortgage loan origination volume to $1.75 trillion during 2012, according to the Mortgage Bankers Association (MBA). The low-rate environment also generated unusually high gains on the sale of newly originated loans to government-sponsored enterprises, including Fannie Mae and Freddie Mac.

Many of the large regional mortgage lenders saw continual increases in mortgage lending volume and profit last year, but gain-on-sale margins were already beginning to soften during the fourth quarter.

Projecting Declines in Margins and Volume

The MBA estimates that total US mortgage origination volume will decline by 19% to $1.41 trillion this year, and drop another 25% to $1.061 trillion in 2014.

The Federal Reserve has kept the short-term federal funds rate in a record-low range of between zero and 0.25% since late 2008, and the Federal Open Market Committee  has said this "highly accommodative" policy is likely to continue until the US unemployment rate declines to 6.5%. But investors are always looking ahead, and the market yield for 10-year US Treasury bonds has increased by 42 basis points over the past three months to around 2%.

Atlantic Equities analyst Richard Staite said in a January 29 report that a concurrent increase in yields on mortgage-backed securities (MBS) led to a contraction in the primary secondary mortgage spread to 82 basis points from an average of 123 during the fourth quarter.

Jefferies analyst Ken Usdin said in a report Friday that the median gain-on-sale margin for eight large-cap banks covered by his firm expanded to 3.16% in 2012 from 1.94% in 2011. Usdin also estimated that the median gain-on-sale margin would decline to 2.75% in 2013 and 2.33% in 2014. These combined figures exclude Regions Financial (NYSE:RF) of Birmingham, Ala., because "it does not offer the same granularity" as other large-cap regional banks covered by Jefferies, according to Usdin.

Jefferies also said mortgage production revenue for the group of eight large-cap banks more than doubled in 2012. The firm estimates that their mortgage production revenue will decline by 19% during 2013 and by another 24% in 2014.

Usdin says Wells Fargo (NYSE:WFC) will take the biggest hit on gain-on-sale margins during 2013, with the margin declining by 43 basis points to 1.92%, dropping further to 1.55% in 2014. Jefferies also estimates that Wells Fargo's mortgage production revenue will decline to $8.79 billion in 2013 from $12.2 billion. For 2013, Usdin estimates Wells Fargo's mortgage production revenue will total $6.63 billion.

Usdin rates Wells Fargo "buy," with a $39 price target, estimating the company will earn $3.55 per share this year, with EPS increasing to $3.65 in 2014.

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