Projecting Declines in Margins and Volume
The MBA estimates that total U.S. mortgage origination volume will decline by 19% to $1.41 trillion this year, and drop another 25% to $1.061 trillion in 2014. The Federal Reserve has kept the short-term federal funds rate in a record-low range of between zero and 0.25% since late 2008, and the Federal Open Market Committee has said this "highly accommodative" policy is likely to continue until the U.S. unemployment rate declines to 6.5%. But investors are always looking ahead, and the market yield for 10-year U.S. Treasury bonds has increased by 42 basis points over the past three months to around 2%. Atlantic Equities analyst Richard Staite said in a Jan. 29 report that a concurrent increase in yields on mortgage-backed securities (MBS) led to a contraction in the primary secondary mortgage spread to 82 basis points from an average of 123 during the fourth quarter. Jefferies analyst Ken Usdin said in a report Friday that the median gain-on-sale margin for eight large-cap banks covered by his firm expanded to 3.16% in 2012 from 1.94% in 2011. Usdin also estimated that the median gain-on-sale margin would decline to 2.75% in 2013 and 2.33% in 2014. These combined figures exclude Regions Financial of Birmingham, Ala., because "it does not offer the same granularity" as other large-cap regional banks covered by Jefferies, according to Usdin.
A Downgrade for SunTrust
Usdin on Friday downgraded SunTrust ( STI) of Atlanta to "hold" from "buy," while lowering his price target for the shares to $30 from $32. "We are more concerned about the revenue transition gap that could emerge with the likely refi slowdown and gain-on-sale margin normalization." Jefferies estimates that SunTrust's mortgage gain-on-sale margin will decline to 2.86% in 2013 from 3.29% in 2012, with the margin declining further to 2.61% in 2014. The firm also estimates that the bank's mortgage production revenue will decline to $828 million this year from $1.056 billion in 2012, declining further to $679 million in 2014. Usdin estimates the company will earn $2.70 a share this year, with 2014 EPS of $2.85.
Taking It a Step Further
Jefferies conducted a "static test," which Usdin described as a "'what if?' scenario in which gain-on-sale margins reverted to 2011 levels overnight." The analyst said "banks in our stress test could see 5% negative EPS revisions for 2013 and 3% revisions in 2014 vs. our published EPS estimates." SunTrust, along with BB&T ( BBT) of Winston-Salem, N.C., and Fifth Third Bancorp ( FITB) of Cincinnati "screen the worst in our simple exercise, relatively speaking, given the size of their underlying mortgage businesses and above-average gain-on-sale margin expansion seen over the last year, Usdin said. Under the "2011" scenario, SunTrust's 2013 EPS estimate would decline by $0.27 and his 2014 estimate would decline by $0.16.