With the recent increase in mortgage rates, which are now considerably higher than the all-time lows we have seen over the past few years, it should not be too much of a surprise that fewer people are refinancing. However, the extent to which the decline in mortgage business is impacting banks' bottom lines remains to be seen.
How worried should investors be? What impact will the lower mortgage business have on regional banking chains such as Regions Financial (NYSE:RF), larger institutions such as U.S. Bancorp (NYSE:USB), and mortgage leader Wells Fargo (NYSE:WFC)?
The roller-coaster ride of mortgage rates
Mortgage rates have been rather volatile lately, after having fallen from an average of 4.45% in 2011 (already low on a historical basis) to a low of just 3.35% at the end of 2012. Since then, rates have risen back to around the 4.5% range, where they currently stand.
While mortgage rates have indeed risen considerably, they haven't affected new mortgages as much as refinancing. It may surprise you to learn that approximately two-thirds of all mortgage activity in the recent past has been due to refinancing, while just one-third is a result of new purchases.
So, why do higher rates affect refinancing more? Let's say you took out a mortgage a few years ago with a 6% interest rate, and that the original loan amount was $200,000. That makes your payment $1,199. Refinancing at 3.5%, when rates were at their lows, would produce a payment of around $898, a significant difference. At 4.5% (around where rates are now), the payment jumps to $1,013.According to Bankrate.com, the average closing costs on a $200,000 refinancing loan are $3,754, so it's easy to see why the savings on the monthly payment aren't worth it once rates climb.
How it affects the banks
Because of the rise in rates, Regions is anticipating its mortgage originations to drop by about 15% in the fourth quarter, with an additional decline in 2014. The company's mortgage income declined by $17 million from the previous quarter as a result, which may not seem significant given the company's total net income for the quarter was $1.32 billion. An extra $17 million in profits per quarter would translate to an additional $0.05 per share in annual earnings, or a 6% increase on expected earnings for 2013.
U.S. Bancorp reported an even greater impact, with the company expecting a quarterly decline of about 30% in its mortgage revenue for the fourth quarter, which had already dropped by 17.2% from the second quarter. A much larger company than Regions, U.S. Bancorp's earnings will suffer even more, as it derives about 6% of its revenue from mortgages (based on third-quarter numbers) as opposed to less than 4% for Regions.
Wells Fargo is the No. 1 mortgage originator in the U.S., so let's see how the refinancing slowdown could affect the company. Wells Fargo's mortgage income dropped 43% year over year to $1.6 billion in the most recent quarter. Even after the drop, mortgage banking still comprises 7.4% of Wells Fargo's revenue, so it stands to reason that Wells should suffer the most if the declines continue. However, if rates dipped again and the mortgage market stabilized, Wells Fargo would stand to benefit more than the other two companies mentioned.
So, what does it all mean?
The good news is the consensus believes these declines won't continue. Wells Fargo has publicly said it expects the mortgage market to stabilize next year, and although refinancing may not entirely recover to last year's levels, mortgages on new purchases should be a primary driver of growth going forward. Several banks (including Wells Fargo) are offering low down payment loans for the first time since before the mortgage meltdown.
The bottom line is that these banks are very well run, and as long as the housing market continues to improve, banks will find a way to meet the mortgage needs of the market. So, any weakness in share price that results from bad mortgage news is likely to be an excellent buying opportunity, taking advantage of what is likely to be a temporary problem.