NEW YORK (TheStreet) -- A refinancing boom that buoyed Wells Fargo's (WFC - Get Report) earnings in late 2012 and the first half of 2013 has petered out as rates rose in the second half of the year, sharply cutting at the bank's mortgage origination activity.
Wells Fargo posted an almost 40% sequential drop in mortgage origination activity that surprised few Wall Street analysts. The bank's explanation for its sharp dropoff in mortgage market activity, however, may provide new and comforting investors who are trying to judge the bank's outlook for 2014.
Chief Financial Officer Timothy Sloan said on a conference call with analysts that the bank's record refinancing activity during the first half of the year was disproportionately high and was a direct result of its previous diligence in originating new mortgage loans. Basically, Sloan appeared to make the point that Wells Fargo's tough credit standards, and the quality of the bank's mortgage servicing portfolio, meant that its borrowers were likely candidates to use sharply falling interest rates to refinance their mortgages.
Presumably, that would compare favorably to banks that had made loans at the peak of the market and where borrowers' remained underwater and unable to refinance as rates fell in late 2012 and early 2013.
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Here's Sloan's quote, in full, responding to a line of questioning from FBR Capital Markets analyst Paul Miller.
"We've talked on a number of occasions about how our market share over the last couple of years was disproportionately high, primarily because the biggest driver for origination volume until the last couple of quarters was refinances. And the reason for that, again to remind everybody, is that we are the largest [mortgage] servicer and the quality of our servicing book was the highest in the industry. So we had many more opportunities than most to be able to meet the needs of our customers by refinancing existing customers by refinancing their mortgages. So it's not surprising and something that we had been indicating was going to occur as a percentage of refinance volumes declined, absolute dollars as well as the percentage of the total decline, that our market share would go down."
Sloan is saying Wells Fargo expected the bulk of its origination activity would come from refinancing activity on mortgages it was servicing, i.e., existing customers refinancing out of higher rates.
That activity has now run its course, as mortgage rates are generally expected to keep rising furing 2014. For context, Wells Fargo's $50 billion in fourth quarter mortgage loan originations was 38% lower than the previous quarter, while the bank's pipeline fell by 29%, indicating further pressure, according to Goldman Sachs analysts.
But if those elevated origination numbers sprang from to the quality of Wells Fargo's legacy loans that the bank was servicing, it may not be such a big issue for investors.
Wells Fargo investors like Bill Smead, chief investment officer of Smead Capital Management, are banking on a pickup of new entrants into the housing market as the U.S. economy improves. That scenario that would generally support rising mortgage rates, but could also help Wells Fargo shift its mortgage origination activity away from refinancing.
-- Written by Antoine Gara in New York