Mortgage Lenders Opt for Cruise Control

Banks seem to be imitating Detroit—and that's not necessarily a bad thing.

Just as car makers discovered profits trump sales volume, banks are showing pricing and lending discipline on mortgages. The result: In the first quarter, banks saw big gains in mortgage-banking revenue and profit on the back of strong refinancing activity.

At Wells Fargo, WFC +2.47% net gains on mortgage-loan origination and sales activities of $2.6 billion were more than double the prior year's level. Bank of America BAC +2.65% said its mortgage production was the lowest in five quarters, yet income of $115 million, excluding certain charges, was the highest in that period. Smaller banks, too, shared in the bounty.

Not everyone will be thrilled by this. Strong mortgage-banking results partly reflect the spread between the yield on mortgage-backed securities and mortgage rates currently being more than twice the norm. For borrowers that's not so good. They would prefer if already low mortgage rates of around 4% fell even further. Meanwhile, tighter lending criteria are in some cases making it more difficult for borrowers to get mortgages.

Yet better results may signal changes benefiting both bank investors and the wider financial system. Namely, that banks are resisting the temptation to repeat mistakes that led to the housing bust. And tougher criteria, while a drag right now on lending, may ultimately help the mortgage market reduce its dependency on government guarantees.

A refinancing wave early last decade led mortgage players to expand rapidly and drive loan margins down. When refinancing slowed, many firms were desperate to keep volumes growing to support their bigger operations. So they cut pricing further while giving loans out with little regard to borrowers' financial condition. In that, they resembled car makers trying to maintain market share at all costs.

This time, banks are acting differently so far. While some are expanding, they "have lower expectations and are saying, 'We'll charge more and do less'," says Guy Cecala, chief executive of Inside Mortgage Finance. "Historically, lenders would compete on price or underwriting and the surprising thing is we have seen neither today."

At the same time, the structure of the mortgage market is changing. BofA has trimmed its sails after suffering huge losses due to demands that it repurchase mortgages originated by Countrywide Financial, which it bought in 2008. Last year, the bank shut down its correspondent-mortgage unit, which purchased mortgages from other lenders.

That has taken capacity out of the market, reducing pressure on other lenders to reduce loan pricing. BofA in the first quarter originated $15 billion of mortgages, compared with $56 billion a year earlier. At the same time, lenders are keeping loan conditions tight.




The result has been higher loan-sale margins for banks. At Fifth Third Bancorp, FITB +2.04% for example, this margin was 2.7% in the first quarter, compared with 1.6% a year earlier.

It is debatable whether the higher margins will stick, especially when interest rates eventually rise. Fifth Third, for one, expects margins to decline in the second quarter, while J.P. Morgan JPM +2.63% executives said on the bank's latest earnings call that they think current levels aren't sustainable long term.

Still, even if margins don't stay at first-quarter levels, they are likely to run higher than in the past, says Paul Miller, analyst with FBR Capital Markets. He believes margins should hold up relatively well throughout 2012, especially as banks enjoy the benefit of an increase in activity from the government's latest refinance initiative.

That should give bank investors some cheer, even as overall loan growth remains lackluster. More broadly, the absence of a gold-rush mentality among lenders should benefit the housing and mortgage markets in the long run.

Source: http://online.wsj.com/article/SB10001424052702304723304577370313759609308.html?mod=WSJ_Heard_LEFTTopNews