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JPMorgan CFO Expects Mortgage Production Loss, Higher Legal Expenses in Q3

NEW YORK (TheStreet) -- JPMorgan Chase (JPM) expects to make a loss in its mortgage origination business in the second half of 2013, CFO Marianne Lake said in a presentation to investors Monday.

The sharp increase in interest rates since May has resulted in a 60% reduction in refinancing applications relative to the peak.

Sticking to earlier guidance, Lake said the refinance market is likely to shrink by 30% to 40% in the second half of 2013.

While purchase volumes are growing -- Chase's share of the purchase market has increased from 7.2% in 2011 to 10.7% as of the first half of 2013 -- it is unlikely to make up for the revenue loss from the decline in refinancing activity, she said.

And although rising home prices are lifting more borrowers out of water and increasing the pool of borrowers eligible to refinance, that, too, is likely to take time.

Moreover, revenue margins are compressing, due to "competitive pressures, changes in mix and higher secondary market rates." And while banks are slashing mortgage jobs and reining in costs, expenses will adjust with a lag to the changing landscape.

As a result, pretax margins in the third and fourth quarter are likely to be "slightly negative."

Wells Fargo (WFC) CFO Tim Sloan gave a similarly dim outlook for the business in a presentation Monday morning. Mortgage originations at the San Francisco-based bank are expected to come in at about $80 billion in the third quarter, down from $112 billion in the second quarter

Still, while the rate impact on the business has happened "sooner than expected," JPMorgan maintains its long term target of mortgage production pre-tax income at $1.5 billion.

Also, while the mortgage production business is clearly hurting from rising rates, the overall business is poised to benefit.

A normalized rate environment in the backdrop of an improving economy is "what we have been waiting for," the CFO said. Assuming a 200 basis point (100 basis points equals one percentage point) increase across the curve, the bank's net interest income could rise by $3.7 billion, by the bank's estimate.

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