In 2012, fueled by historically low interest rates and stabilizing home prices, Wells Fargo's (WFC +0.52%) mortgage banking unit churned out an industry-leading $524 billion of mortgage loans and boosted the unit's revenue 49% compared to 2011. To put this $524 billion in perspective, not even the infamous Countrywide Financial, now owned by Bank of America (BAC +0.62%), eclipsed the $500 billion mark in the boom years of 2005 or 2006.
While banks like B of A and smaller lenders scaled back mortgage operations, Wells Fargo remained steadfast in its position in the market and was able to take full advantage of the recent refinancing boom. The simple thought that Wells Fargo's current mortgage business is even bigger than Countrywide's in its heyday may cause Wells Fargo shareholders to cringe.
Source: Wells Fargo 10-Ks.
However, it is important to remember that not all mortgages are created equally. The vast majority of mortgage loans in the United States fall into two categories: Conforming and nonconforming.
Conforming mortgages are loans that have a specified limited loan amount ranging between $417,000 and $625,000, depending on the area, and meet certain debt-to-income ratio standards. These limits are set by the Federal Housing Finance Agency and determine which mortgage institutions like Fannie Mae and Freddie Mac can purchase from lenders and securitize. Naturally, nonconforming mortgage loans do not meet these standards and must either be kept on the lender's books or securitized in the private market, a market that has since dried up since the financial crisis.
The main difference between Wells Fargo's mortgage volume today and Countrywide's in 2006 is a shift in mortgage type. A staggering 46% of Countrywide's loans were non-conforming loans. Before investors became almost completely opposed to private-label mortgage-backed securities, Countrywide was able to profitably market these mortgages into securities. Once the credit crisis hit, Countrywide (then part of B of A) had no way to keep its origination engine churning in the absence of private-label liquidity.
Source: Countrywide Financial's 2006 10-K.
Unlike 2006, conforming mortgages are now driving the increase in origination volume. Due to the Federal Reserve's presence in the market and absence of credit risk associated with agency mortgaged-backed securities, liquidity has been flowing through Wells Fargo and other originators as loan supply has kept pace with the enormous refinancing demand. Refinancing demand may taper off as interest rates eventually creep higher, and Wells Fargo's revenue from its mortgage banking operation will probably decline from current levels. Despite experiencing enormous volume, given the nature of its originations, Wells Fargo's shareholders should not be concerned about becoming the second-coming of Countrywide.
