Mortgages Are Now a Bank’s Best Friend

Mortgages Are Now a Bank’s Best Friend
By ERIC DASH
Copyright by The New York Times
Published: July 14, 2009
http://www.nytimes.com/2009/07/15/business/15bank.html?th&emc=th


For the last two years, housing has been at the center of the banking industry’s troubles. But for at least one quarter, it will help lift its results.

Even as banks remain cautious about lending and millions of borrowers still risk losing their homes, the mortgage business is returning as one of the most lucrative corners of the financial industry.

The clearest evidence is emerging this week, as the nation’s biggest banks report their second-quarter numbers.

As independent mortgage companies and brokers shut their doors last fall, and major players like Bank of America, JPMorgan Chase and Wells Fargo swallowed up troubled rivals, lending profit margins widened, doubling at big banks amid a refinancing wave during the first half of the year, analysts said.

Mortgage securities prices have rallied, allowing banks to book hefty gains on their investment portfolios. And accounting tactics — like new rules that let banks book lower losses on troubled assets and reductions in reserves for future losses because of mortgage modifications — may further burnish their results.

“It’s the mother of all mortgage quarters,” said Meredith Whitney, a prominent banking analyst. But whether or not those profits are sustainable remains an open question. “You might believe that the environment has stabilized, but looks are sometimes misleading,” she added.

Over all, analysts say that second-quarter bank earnings are likely to be good, if not quite as strong as the first quarter’s. Bank stocks have rallied over the last four months in anticipation of brighter news.

The KBW Bank Index, a popular measure of the financial sector, has nearly doubled from its low in early March.

Goldman Sachs reported strong profits from trading on Tuesday. But the resurgence of the mortgage business should help most of the big commercial banks, from small regional lenders to national players like Bank of America, Citigroup, JPMorgan Chase and Well Fargo, which report this week.

Banks still face a number of threats. Credit card and commercial real estate loan losses continue to climb. And for many, the quarter will be rife with unusual accounting charges.

Even so, the refinancing rebound is providing a lift. As the Federal Reserve cut interest rates to record lows, hundreds of thousands of borrowers were able to take out cheaper loans. Lenders issued an estimated $1 trillion worth of mortgages during the first half of 2009, according to Inside Mortgage Finance.

Meanwhile, mortgage lending margins are at least two to three times higher than a year ago, analysts said, making it an increasingly important force at the biggest banks. Since 2000, mortgage banking has represented about 3 percent of revenue for Bank of America, JPMorgan and Wells Fargo, Ms. Whitney says. In the first quarter, it more than doubled to about a 6.4 percent share.

Banks also stand to book large gains on mortgage bonds as well more obscure instruments called mortgage servicing rights, which rose late in the quarter in anticipation of more borrowers holding onto their existing loans. That extends the number of payments that lenders can collect.

The values of those rights fell sharply in the first quarter and through most of the second quarter, when interest rates were low. But as interest rates climbed toward the end of June, banks got the best of both worlds: a several-week flurry of refinancings and an increase in the value of the servicing rights.

Frederick Cannon, a banking analyst at Keefe Bruyette Woods, estimated that the value of Wells Fargo’s servicing rights could rise by nearly $8 billion, or more than 60 percent, to as much as $20.2 billion.

Other big banks could experience similarly large gains, although some might be reduced by interest-rate hedging.

Aggressive accounting could also pump up the lenders’ results. Most of the big banks took advantage of an 11th-hour rule accounting rule change in the first quarter to book smaller losses on troubled securities. Jack T. Ciesielski of The Analyst’s Accounting Observer estimated that without the change, earnings for the biggest banks in the Standard & Poor’s financial index would have been almost cut in half. In the second quarter, the impact could be even greater.

In addition, the banks may book some early benefits from a subsidy the government gives them for modifying mortgages — gains that are likely to proliferate in coming quarters if the Obama administration’s Making Home Affordable program takes off.

So far, the government has agreed to funnel $18 billion of taxpayer money to lenders, investors and borrowers to keep Americans in their homes.

Under the program, Bank of America could receive as much as $6 billion to offset part of the losses it incurs from lowering monthly loan payments and to defray its costs, according Treasury Department data.

JPMorgan Chase is eligible for $3.5 billion. Wells Fargo could get as much as $2.9 billion. Citigroup and GMAC stand to collect more than $1 billion each. The first checks start arriving this month — although over the long term, industry insiders project that the banks will retain only around one-third of those funds, with the rest going to subsidize borrowers and investors.

While banks are expected to make loan modifications because it is sound business, Treasury officials say they believe the subsidies will encourage lenders to make even more modifications than they otherwise would.

So far, more than 270,000 borrowers have received offers since the program was introduced this spring. The administration hopes to see that number rise to around four million.