Mortgage Market Slump: Is it Interest Rates or Jobs and Consumer Income?

Over the past week, most of the major banks in the mortgage sector have been issuing guidance to investors regarding the outlook for mortgage lending volumes going forward in 2014 and beyond.  For the past several months, I have been worried about the transition from refinancing to purchase volumes, both for banks and non-banks.  The good news is that the mortgage loan refinance boom lasted longer than many anticipated.  The bad news is that the industry data and operational announcements by financial institutions have a decidedly bearish slant.

William J. Rodgers, CEO of Atlanta-based SunTrust, said his company's mortgage applications were down 40 percent in August and July, Housing Wire reports.  The bank had earlier announced layoffs in their mortgage division.  M&T Bank Corp. on Monday told investors that they should brace for a " significant" decline in mortgage-banking volumes in the third quarter.

Indeed, most major banks going back several months have been guiding down in terms of lending volumes.  In the Q2 2013 earnings call for JPMorgan, the bank warned that it could see a 40% drop in lending volumes.  More recently, JPM reiterated that mortgage volumes and related revenue are falling faster than it can cut costs.  Mortgage market maven Rob Chrisman provided some color on the recent Baclays investor conference:


“Wells Fargo and Chase, regardless of their perceived advantages, both told the industry yesterday that things might become grim in their mortgage divisions. Wells told investors at a conference that it expects mortgage originations to drop nearly 30% in the third quarter to roughly $80 billion, down from $112 billion in the second quarter. (To put things in perspective, that is still roughly a billion a day in production for Wells.) Wells has already cut 3,000 jobs in the mortgage business since July (roughly 1% of the bank's total workforce). Mortgage-banking income dropped 3% at Wells Fargo and 14% at J.P. Morgan in the second quarter from a year earlier. At Bank of America, which announced 2,100 job cuts on 8/29, the decline was 22% from the year-ago period.”

“J.P. Morgan Chase said (during the conference sponsored by Barclays) that it expects to lose money on its mortgage-origination business in the second half of the year. At J.P. Morgan, mortgage originations are on pace to drop as much as 40% from the first half of 2013, said Marianne Lake, J.P. Morgan's chief financial officer, at the conference. She attributed the decline to a drop in refinancings. She said refinance applications are down more than 60% from the peak in May 2013. Chase's share of the purchase market has increased from 7.2% in 2011 to 10.7% as of the first half of 2013 - but it is unlikely to make up for the revenue loss from the decline in refinancing activity, she said.”


Meanwhile, the Mortgage Bankers Association reports that applications for U.S. home loans plunged as mortgage rates matched their high of the year, with refinancing activity falling to its lowest in more than four years.  MBA said its seasonally adjusted index of mortgage application activity, which includes both refinancing and home purchase demand, sank 13.5 percent in the week ended Sept. 6, after rising 1.3 percent the prior week.  In the past three months, there have only been a handful of up weeks for the MBA index.

While many analysts say that the decline in mortgage applications is a result of higher interest rates, my view is that the real issues are structural.  Some lenders are easing lending standards to help grow volumes, but the fact is that there are fewer buyers in the market than prior to the crash.  Bloomberg reports that “As the economy rebounds and home values climb at about the fastest pace since 2006, lenders including the largest, Wells Fargo & Co., JPMorgan, Bank of America Corp., and mortgage insurers are easing the tightest credit conditions in two decades, lifting restrictions put in place after the worst real estate bust since the Great Depression.”

But even with lower credit score targets and other initiatives, it is not clear to me that the first time home buyer is really going to be able to help offset the precipitous drop in refinancing volumes at major lenders.  The chart below shows the major bank portfolio categories (total real estate, first lien 1-4s, and HELOCs) and also includes 1-4 family mortgages securitized and sold.  HELOC securitizations are tiny and many quarters were zero, so I did not bother to include them.  The only real areas of asset growth for US banks in terms of consumer lines are in autos and credit cards.  



Even during the refinancing boom, bank balance sheets have been flat in terms of holding of 1-4 family mortgages.  More important, the flow of securitization and sales has been falling during this period.  How do you think this chart will look this time next year?  

The sharp downward inflection in 1-4 family mortgage loans securitized and sold in 2009 is partly a result of the FASB 166 rule change on off-balance sheet vehicles.  But key take away is that the aggregate bank portfolio of 1-4 mortgage loans is essentially flat and slowly trending lower -- even as home prices have risen.  As we’ve discussed in ZH, if you take distressed sales out of the equation, the Case-Shiller 20 city index is up high single digits YOY.  But the lack of credit growth in the US banking industry is a very disturbing trend.

Securitization of 1-4s is running about 1/2 of pre-2009 levels, which averaged around $1.1 trillion per quarter in 2008-2007 vs ~ $600 billion per quarter today. Obviously banks don't want to show the Street a sharp drop in retained portfolio levels, so the variable is loans securitized and sold. You may recall that WFC retained a large chunk of agency eligible paper earlier in 2013 and Q4 2012 and had to disclose same in the SEC filings.

Bottom line is that investors need to stop listening to the happy talk coming from the economists, and start focusing on what banks and other lenders are saying and doing operationally to adjust for the mortgage market of 2014 and beyond.  To their credit, JPM, WFC and other banks have been pretty forthright in providing forward guidance.  But does anyone want to hear it?

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