The nation's two largest mortgage originators separately acknowledged this week that mortgage origination volumes are in free-fall thanks to higher long-term interest rates.
"In the second quarter, we told you that if rates remained at these levels, we would expect volumes to be reduced by 30% to 40% in the second half of this year versus the first half on the back of a dramatic reduction in refinance volume," JPMorgan Chase's (JPM +2.16%) chief financial officer Marianne Lake said earlier this week at the Barclays Global Financial Services Conference.
"This is indeed ... what we're experiencing and all of Fannie, Freddie and the [Mortgage Bankers Association] agree that the volume reduction will be 35% flat."
Lake's counterpart at Wells Fargo (WFC +0.69%), CFO Timothy Sloan, sounded a similarly cautious tone in a presentation at the same industry conference. "While our mortgage business continued to generate strong results in the second quarter, we expect mortgage revenue to decline in the third quarter with declines in mortgages and originations."
Sloan went on to note that the bank currently expects mortgage originations in the third quarter to be "about $80 billion." For the record, that would be a reduction of 28.6% from the previous quarter and a staggering 42.5% less than the same three months last year.
You can see the impact of this in the Mortgage Bankers Association's weekly market composite index, which tracks origination volumes from 75% of the domestic mortgage market.
To be clear, divining the bottom-line impact of this trend is an exercise in futility. In Wells Fargo's case, for instance, while it gets 22% of its noninterest income from mortgage banking activities (excluding mortgage servicing) which will suffer from higher rates, it has numerous business lines that thrive in this type of an environment.
"Some of our businesses naturally do better in lower-rate environments and others benefit as rates rise," Sloan said. In the mortgage arena specifically, "while higher rates reduce volume, it does help other parts of the mortgage business, including servicing, which generally benefits from the slowdown in the amortization of mortgage servicing rights."
Beyond this, the impact is felt most intensely at lenders that rely on refinancing mortgages to a greater extent than purchase-money mortgages to fill their origination pipelines. This is because the demand to refinance a mortgage is significantly more sensitive to interest rates than is the demand for a new loan.
The last three months serve as a case in point. Since the beginning of May, refinance application volume is down by 62% while purchase-money application volume is off by 16%.
Source: Mortgage Bankers Association.
Topping the list of affected lenders is Bank of America (BAC +0.07%). In the second quarter of this year, a full 83% of its first mortgage production volume was for refinance originations. At Wells Fargo, the comparable figure was 54%.
PNC Financial (PNC +0.99%), on the other hand, purports to be much better positioned to withstand the rise in rates. Between the second quarter of last year and the same three months this year, its purchase-money mortgage originations grew by 41% and now account for 51% of its overall mortgage activity.
As the Pittsburgh-based lender's CEO said at the same conference, "we've been growing application volume for new purchase loans at more than twice the pace of the industry as a whole. The result is that we're growing purchase volumes both in terms of absolute dollars and as a percentage of all the mortgages that we originate."
The point is that investors should be prepared for dramatically lower origination volumes to be reported in the upcoming round of quarterly earnings, which are slated to begin in the middle of next month. This isn't necessarily bad. And in fact, it may even be read as a positive sign, as rising mortgage rates could be interpreted as an upbeat indication of the ongoing economic recovery.
