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Short-Term Mortgage Pain Is Long-Term Gain for Banks

NEW YORK ( TheStreet) -- Rising long-term interest rates will hurt banks' gains on the sale of new mortgages, but the improving housing market will offset any pain.

The yield on 10-year Treasury bonds climbed to 2% on Monday for the first time since April 25. The increase will eventually bode well for banks' profitability, as yields on other long-term assets rise.

Atlantic Equities analyst Richard Staite on Tuesday said the recent rise in mortgage-backed securities (MBS) yields has led to a contraction in the primary secondary mortgage spread to 82 basis points from an average of 123 last quarter. That means smaller profits on the sale of newly originated mortgage loans to Fannie Mae (FNMA) and Freddie Mac (FMCC).

Staite said lower secondary market mortgage spreads is of major concern for Wells Fargo (WFC - Get Report), since the company "is most exposed to a contraction with over 14% of revenue from mortgage production and potentially as much as 20% of profits."

Wells Fargo's fourth-quarter mortgage revenue grew 9% sequentially and 30% year-over-year, totaling $3.1 billion. The company has been the strongest and steadiest earnings performer among the "big four" U.S. banks, also including Bank of America (BAC - Get Report), JPMorgan Chase (JPM) and Citigroup (C), all through the credit crisis and its aftermath.

Wells Fargo's 2012 operating return on average assets (ROA) was 1.41%, according to Thomson Reuters Bank Insight, compared with 0.94% for JPMorgan, 0.33% for Citigroup and 0.13% for Bank of America.

According to Staite, the spread between mortgage loan rates charged to customers and the rates charged when the government-sponsored giants package loans into securities has averaged 50 basis points historically. But the spread widened to 122 basis points during the second half of last year. The main factor was the Federal Reserve's decision in September to increases its purchase of agency MBS by $40 billion per month.

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