The large bank Wells Fargo (WFC -1.11%) recently announced that it is planning to significantly scale back its mortgage business, a big move when you consider the bank not long ago was the largest mortgage originator in the country.
Wells Fargo plans to continue providing mortgages for existing customers and homebuyers in minority communities. Furthermore, the bank is going to close its third-party mortgage-buying business in which it would purchase mortgages originated by other lenders. The bank is also planning to sell the bulk of its mortgage-servicing business.
The move is a big shift for CEO Charlie Scharf as he continues to transform the bank, but ultimately one that I think is a good move and that will position Wells Fargo more like a modern-day bank.
The mortgage business is difficult
Wells Fargo is one of the few big banks that stayed heavily involved in the mortgage business even after the fallout from the Great Recession and the subprime mortgage crisis.
Image source: Getty Images.
In 2021, Wells Fargo was the second-largest mortgage lender in the country only behind Rocket Companies, having originated more than $228 billion in volume. The refinancing boom in 2021 enabled the bank to garner almost $5 billion in mortgage banking fees, up from just $3.5 billion the year before.
But the mortgage business really hasn't been attractive since the Great Recession. Low interest rates for much of the last decade make for thin margins, but then when rates rise it can depress volume, especially when they move up quickly as we've seen over the last year.
The business is also quite cyclical. When conditions were extremely fruitful for the mortgage industry in 2021, many analysts warned that this could be as good as it gets, which always seems to put a bit of a cloud over the industry.
The mortgage industry is also very fragmented, and it's difficult for even the top lenders in the space to gain enough market share to really create a moat. Many would describe mortgages as a commoditized product, so it's difficult to really stand out, apart from the rate a company offers.
While home lending has always been a staple of the banking industry, most banks today want to invest their resources into serving customers that they can create multiproduct or strong deposit relationships with. Mortgage products really don't accomplish any of these things or create a loyal relationship with the customer.
Why this is a positive move for Wells Fargo
It's no secret that the modern banking model shifted away from the mortgage space to focus more on various types of commercial lending, which are higher-yielding loans, many of which will adjust with the federal funds rate.
Relationships with commercial clients also create stickier, lower-cost deposits because the lender will often tell the customer that to get a loan or line of credit they also need to keep their deposits with the bank.
This model has been more successful over the last decade, and the large banks like JPMorgan Chase and Bank of America that leaned into this were rewarded with higher valuations.
Wells Fargo already has a premier commercial lending franchise, and Scharf is a Jamie Dimon protégé, so it makes sense that he is getting out of mortgage lending and investing more in businesses like credit card lending and investment banking. Ultimately, the strategy should generate better returns.
