Fifth Third Shielded from Mortgage Decline: UBS

NEW YORK ( TheStreet) - Mortgage lending is expected to decline this year as the refinancing wave subsides, but Fifth Third Bancorp ( FITB) has plenty of offsets to preserve earnings, according to UBS analyst Stephen Scinicariello.

Fifth Third Bancorp of Cincinnati originated $25.2 billion in residential mortgage loans during 2012, increasing from $18.6 billion in 2011. The company's revenue from mortgage origination fees and the sale of loans totaled $821 million in 2012, more than doubling from $396 million the previous year.

The company also booked $250 million in loan servicing fees last year, however this was mostly offset by $186 million in servicing rights amortization and $40 million in valuation adjustments on servicing rights. These adjustments are typical during a period of heavy refinancing activity, because banks must reflect the anticipated decline in servicing revenue from the loan payoffs, in their earnings and on their balance sheets.

A Major Decline for 2013

Mortgage volume was given a great boost last year after President Obama expanded the Home Affordable Refinance Program (Harp). HARP 2.0 allows qualified borrowers with mortgage loans held by government-sponsored enterprises -- including Fannie Mae and Freddie Mac -- to refinance their loans at today's historically low interest rates, no matter how much the value of the collateral home as dropped.

Mortgage lenders in 2012 also enjoyed very wide gain-on-sale spreads, which are expected to drop significantly in 2013, in part because the rising yield on 10-year U.S. Treasury bonds is causing a corresponding increase in mortgage-backed securities yields. Scinicariello late on Thursday said in a report that mortgage gain-on-sale spreads had declined by 30 basis points since the end of last year.

The Mortgage Bankers Association expects total mortgage loan originations in the United States to decline by 20% in 2013 to $1.396 trillion from $1.750 trillion in 2012. The MBA expects mortgage volume to decline by another 24% in 2014, to $1.055 trillion.

What This Might Mean for Fifth Third

Fifth Third's $845 million in mortgage banking net revenue made up 13% of the company's total revenue during 2012, increasing from 10% in 2011. In light of the MBA forecasts and the declining mortgage gain-on-sale spreads, UBS conducted "a scenario analysis to assess the EPS effect of a 50% decline in mortgage origination revenues; taking into account several revenue and expense offsets."

"In our scenario analysis, a 50% decline in origination and gain on sale revenues translates into a $0.31 hit to EPS (17%); however, taking several offsets into account, we estimate only a potential net reduction to operating EPS of $0.13 or 7%," Scinicariello wrote.

The offsets include a 40% efficiency ratio for Fifth Third's mortgage operations. The efficiency ratio is, essentially, the number of pennies of expense incurred for each dollar of revenue. An efficiency ratio below 50% is generally considered quite good for most banking businesses.

Other offsets in the scenario of a 50% mortgage volume decline for Fifth Third include "a 15% increase in servicing fees, reinvestment of MBS cash flow at higher yield (45bps), and higher mortgage spreads of 40bps on incremental/repricing volume," according to Scinicariello.

UBS's earnings forecasts for Fifth Third assume a 32% decline in quarterly mortgage loan origination volume through the first quarter of 2014. When factoring in "the potential revaluation of $77.3B of mortgage servicing rights," which will increase in value as refinancing activity slows, Scinicariello estimated that Fifth Third's GAAP earnings per share would be "more modestly impacted by only 2%."

Scinicariello rates Fifth Third a "buy," with a 12-month price target of $19.00, estimating the company will earn $1.78 a share this year, with EPS rising to $2.29 in 2014.

Fifth Thirds shares closed at $15.84 Thursday, returning 4% this year, following a 11.5% return during 2012. The shares trade for 1.3 times tangible book value, and for 9.4 times the consensus 2014 EPS estimate of $1.69, among analysts polled by Thomson Reuters. The consensus 2013 EPS estimate is $1.64.

Based on a quarterly payout of 10 cents, the shares have a divided yield of 2.53%.

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-- Written by Philip van Doorn in Jupiter, Fla.

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Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.