Mortgage-Banking Boom Has Legs, FBR's Miller Says

NEW YORK (TheStreet) -- Mortgage banking, among the few sources of growth for banks amid low interest rates, is likely to remain a tailwind to earnings in 2013, FBR Capital analyst Paul Miller said in a report.

Strong origination volumes on the back of a refinancing boom and high margins on sale of newly originated mortgages in the secondary market has boosted profitability for banks with a strong mortgage banking presence, including Wells Fargo (WFC), US Bancorp (USB) and JPMorgan Chase (JPM).

But some analysts have raised concerns about the sustainability of the refinancing boom and "gain-on-sale" margins.

As TheStreet reported last week, the spread between the primary mortgage rate and the rate on mortgage backed securities is beginning to narrow as Treasury yields rise.

Last year was also an unusually strong one for refinancing as the government's expanded Home Affordable Refinance Program, dubbed Harp 2.0, proved to be more successful.

Analysts including Ken Usdin at Jefferies and Richard Staite at Atlantic Equities expect the refinance boom to slow down. Read more about their concerns in Banks to Suffer Big Decline in Mortgage Revenue.

Still, Miller at FBR believes mortgage banking will continue to be highly profitable for banks for three reasons.

One, while gain-on-sale margins is contracting, it remains near record highs. The spreads will remain high due to "robust purchase volumes, the pipeline of possible refinancings, and limited market capacity."

Secondly, while analysts point to the re-entry of Bank of America (BAC) into the mortgage origination business and smaller originators expanding their origination platforms as signs of increasing competition in the market, Miller notes that Wells Fargo, the largest originator, is slowly decreasing its market share.

"Accounting for market share gains almost across the board for smaller players, we estimate that the incremental capacity coming into the market will only make up for what Wells Fargo (and other large originators) is shedding. With this in mind, it is clear to us that capacity will likely remain somewhat constrained, especially as volumes remain elevated," Miller wrote.

Finally, Miller says the refinancing boom is far from over. "Given where mortgage rates are today relative to the average rate on outstanding mortgages, over $2 trillion of loans have a strong economic incentive to refinance," he said. While the Mortgage Bankers Refinance Index has declined in the last few weeks, Miller estimates there is likely $1 trillion of refinances in an estimated $1.7 trillion to $2 trillion market overall this year.

Even if refinancing volumes were to decline, if rates stay where they are, there is likely to be an increase in fresh purchase volumes, the analyst argues.

Miller believes smaller players including Nationstar (NSM), PHH Corporation (PHH) and Flagstar (FBC) who are gaining market share will benefit the most.

-- Written by Shanthi Bharatwaj in New York



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