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.
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)
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)
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.
A Downgrade for SunTrustUsdin on Friday downgraded SunTrust (NYSE:STI)
Jefferies estimates that SunTrust's mortgage gain-on-sale margin will decline to 2.86% in 2013 from 3.29% in 2012, with the margin declining further to 2.61% in 2014. The firm also estimates that the bank's mortgage production revenue will decline to $828 million this year from $1.056 billion in 2012, declining further to $679 million in 2014.
Usdin estimates the company will earn $2.70 per share this year, with 2014 EPS of $2.85.
Taking It a Step FurtherJefferies conducted a "static test," which Usdin described as a "'what if?' scenario in which gain-on-sale margins reverted to 2011 levels overnight." The analyst said "banks in our stress test could see 5% negative EPS revisions for 2013 and 3% revisions in 2014 vs. our published EPS estimates."
SunTrust, along with BB&T (NYSE:BBT)
Under the "2011" scenario, SunTrust's 2013 EPS estimate would decline by $0.27 and his 2014 estimate would decline by $0.16.
For BB&T, Jefferies estimates earnings of $3.05 per share for both 2013 and 2014. Under the scenario of mortgage gain-on-sale margins reverting to 2011 levels, Usdin estimates that the company's earnings would decline by $.23 for 2013 and $.14 for 2014.
Usdin estimates that Fifth Third will earn $1.65 per share this year and in 2014. If gains-on-sale margins declined to 2011 levels, the analyst estimates the company's earnings would be lowered by $0.12 for 2013 and $0.07 for 2014.