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NEW YORK (TheStreet) -- For once, banks with exposure to mortgages can actually look forward to some earnings upside.

Nomura analyst Brian Foran expects the latest version of the government's

Home Affordable Refinance Program

-- dubbed HARP 2.0 -- to offer a major revenue tailwind to banks in the mortgage origination business , much bigger than the market is currently anticipating.

Refinancing volume is likely to rise with HARP now accounting for 20% to 40% of bank applications. Banks also stand to benefit from gain on sale of HARP loans, which command a stronger premium in the market.

In all, HARP could offer as much as $12 billion in mortgage banking revenue upside to the industry, according to Nomura, offsetting the negative impact of lower interest rates on interest income.

In October last year, the government revised guidelines to the HARP program. Borrowers with loans backed by

Fannie Mae



Freddie Mac


with a current loan-to-value ratio of 80% and above can get their loans refinanced, widening access to underwater borrowers who owe substantially more than their homes were worth.

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In the previous version, the program had a ceiling on the loan-to-value ratio at 125%.

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The loan must have been sold before May 2009, the borrower must be current on their mortgage and must have made no late payments in the past six months.

Banks have reported a pickup in activity since the launch of the program, although the real surge in refinancing has kicked in only in March, when the industry moved to automated underwriting on these loans. HARP is particularly active in states where there are significant number of homes underwater including Arizona, Nevada and Florida. Refi volumes in these states are up 61%, 71% and 49% respectively in February over January, according to the report.

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Foran believes that the latest version of HARP could target as much as 1.5 million home loans in a base case scenario or even 2 million in a high case and that the government's estimate of 1 million loans might be conservative.

Wells Fargo

(WFC) - Get Wells Fargo & Company Report


JPMorgan Chase

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Bank of America

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are the three biggest mortgage originators, although only Wells has really maintained and in fact grown its presence in the mortgage origination business.

Both Bank of America and JPMorgan have reduced their presence in this space. Bank of America's share of mortgage originations has declined from 25% in 2007 to 5% by the end of the fourth quarter of 2011.

Besides Wells Fargo, banks with an exposure to underwater states like Florida such as


(STI) - Get SunTrust Banks, Inc. Report


Fifth Third Bancorp

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also stand to gain. Mortgage banking also accounts for a higher share of revenues at these three banks at 11%, 7% and 10% respectively compared to the industry average of 4%.

Not all of the revenue upside will flow to the bottomline, however. The analyst expects Wells Fargo to use the upside from mortgage revenues to accelerate its cost savings programs while SunTrust will likely channel the higher revenues towards meeting its higher mortgage repurchase claims.

Also, banks holding mortgage-backed securities will see a downside from lower yields on their balance sheet. But the analyst notes that "banks make more of the origination fees and lose less of the net interest income," given that they originate 70% of the mortgages but hold only 20% of agency-backed securities.

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Also while the rising Treasury yields could result in mortgage yields creeping higher, Nomura does not anticipate a significant dip in refinancing activity under HARP. "HARP provides a fairly interest rate insensitive stream of income to the banks. Most borrowers going through HARP have interest rates of 5-6% on their loans. They would certainly prefer a 3.75% mortgage, but they will happily take a 4%, 4.25% or even a 4.50% loan as well."

--Written by Shanthi Bharatwaj in New York

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