Cost-cutting and trading in investment banking helped drive strong growth in US bank earnings in the second quarter, but a slowdown in the mortgage business is beginning to hit revenues.
Earnings year on year were up 20% at Wells Fargo, 26% at Citi (excluding an accounting gain), 32% at JPMorgan and 63% at Bank of America Merrill Lynch. Revenues, however, were not the biggest driver. Wells Fargo’s revenues were largely flat, BAML’s were up 3%, Citi’s 8% and JPMorgan’s 14%.
Cost-cutting, releasing money held aside for bad loans and trading in investment banking were behind the rise in earnings, but the muted growth in revenues is making analysts nervous.
The refinancing of mortgages has driven banking revenues over the past few quarters, but now that source is waning as rates rise, potentially adversely affecting the five banks that command half of the US mortgage market – Wells Fargo, JPMorgan, Citi, BAML and US Bancorp. US Bancorp’s earnings were up just 5% year on year while revenues were down 2.4%.
In a report published on July 11, Fitch Ratings warned of revenue declines for the US banks in light of decreased mortgage origination.
"For some banks, mortgage banking has accounted for as much as 20% of non-interest income and nearly 8% to 10% of net revenue. A mortgage banking decline of as much as 50% due to higher interest rates and refinancing burnout could represent a 4% revenue decline for regional banks, a significant drop that we believe would need to be offset to keep revenue at least level," says Fitch Ratings’ Justin Fuller.
Housing starts – an economic indicator that reflects the number of privately owned new houses under construction – dropped almost 10% in July to the lowest levels since August 2012, according to the US Department of Commerce. New loan applications are trending lower.
The Mortgage Bankers Association (MBA) Index has been trending lower for several months. In the week ending July 19, the index was down 1.2%. Its Refinance Index for that week was the lowest since July 2011.
Total mortgage originations are forecast to decline 26.5% in 2014 to $1.053 trillion, according to the MBA.
"The decrease will likely be attributable to a significant drop in refinance originations outweighing a substantial increase in purchase originations. For perspective, there were $2,430 billion in mortgage originations in 2007," says Fitch.
This slowdown is already taking its toll.
JPMorgan’s net income from mortgage banking was down 14% in the second quarter on a year earlier, while Wells Fargo’s mortgage banking net income fell 3% year on year and the number of mortgage applications dropped 30%. At BAML, sales of mortgages increased, but earnings still declined as a result of lower margins. Citi reported lower mortgage origination and servicing levels. US Bancorp’s mortgage banking income fell 19% year on year.
The banks seem to be preparing the market for even lower revenues from mortgage divisions.
In a second-quarter earnings call, JPMorgan’s chief financial officer, Marianne Lake, said: "Despite a strong start in April, the environment in late May and June drove mortgage rates up significantly, around 100 basis points. This pressure has continued into July and we expect it could have a significant impact on the refinance market side in the second half of the year. So if mortgage rates stay at or above current levels, the market could be reduced for an estimated 30% to 40%."
Lake added: "We’re trying to be clear with you that this would be a significant event." US Bancorp’s CFO, Andrew Cecere, said of his firm’s results: "In June we expected mortgage banking revenue to be higher in the second quarter than the first quarter. However, since the time we made that statement to the end of the quarter, rates moved up by about 60 basis points and refinance activity slowed significantly."
At Wells Fargo, refinancings were 56% of originations in the second quarter, down from 69% in the first quarter.
"We’ve managed through many refi cycles in the past and we will adjust the size of our business based on production volumes through this cycle," said Tim Sloan, Well Fargo’s CFO, during an earnings call. "Gain on sale margins declined to 2.21% and with the increase in mortgage rates, we would expect further declines in our margins and originations."
Some analysts argue, however, that both JPMorgan and Wells Fargo have diversified enough business streams to weather any slump in mortgages.
Indeed, Wells Fargo’s chief executive, John Stumpf, added in the earnings call that declines in originations would be balanced out with other business streams. Servicing, in particular, is often cited as a smoother to decreases in refinancing. As rates increase and fewer homeowners refinance their mortgages, banks earn more from collecting payments on existing loans.
But servicing revenues are much smaller than mortgage-lending revenues at most banks. Servicing at Wells Fargo, for example, contributed 4% of fee income in the second quarter compared with 22% in mortgage lending.
