Federal stimulus has ignited a boom in mortgage refinancing, benefiting both homeowners and banks. And the good times could continue as the government steps up its support of the broad housing market.
The proof will be in the profits.
On Friday, Wells Fargo and JPMorgan Chase, the top two mortgage lenders in the country, are scheduled to report quarterly earnings. Their results - and the wave of other bank reports that follow - will offer clues as to whether the current mortgage boom is sustainable or set to fizzle.
“We expect mortgage revenue to continue to be elevated in the third quarter and possibly into next year,†said Jason Goldberg, a banking analyst at Barclays.
In the third quarter, banks probably originated as much as $450 billion of home loans, according to estimates by Inside Mortgage Finance, a publication that tracks the industry. That figure, which includes both refinances of existing mortgages and new loans to purchase a house, would be a considerable jump from the previous period. In the second quarter, banks originated $405 billion, with 68 percent as refinancings.
Since the financial crisis of 2008, some large banks have found themselves well positioned to make money when the mortgage market gets hot.
It comes down to the advantageous role banks play as the middlemen in the mortgage machine. Instead of holding on to new mortgages that earn interest over a number of years, banks sell nearly all of them to investors after packaging them into bonds. The federal government, through entities like Fannie Mae, attaches a guarantee of repayment on the loans, making the bonds even more attractive to the investors.
When the banks sell the mortgages as bonds, they do so at a profit. This markup has gotten even bigger after the recent moves by the Federal Reserve and the Treasury Department to help the housing sector.
In September, the Fed announced plans to buy large amounts of mor tgage-backed bonds. The proposal has driven the price of such securities higher, allowing banks to earn an even bigger financial gain when they sell their mortgages into the market.
A Treasury program makes it easier for homeowners who are underwater, meaning their properties are worth less than their loans, to refinance. This initiative - coupled with the ultralow interest rates - has generated a flurry of refinancing activity, producing a windfall for banks.
Some analysts expect banks to keep churning out profits on mortgages. They think it unlikely that there will be a letup in refinancing anytime soon, given that rates are expected to stay low for a while. The average rate on a 30-year fixed rate mortgage has dropped to 3.36 percent, from 3.95 percent at the end of 2011, according to Freddie Mac figures.
“I estimate that close to half of mortgages have an economic incentive to refinance,†said Paul Miller, a banking analyst at FBR Capital Markets.
Mr. Miller believes the steady stream of refinancings will last for multiple quarters. Banks are reluctant to expand their mortgage operations, meaning the market can handle only a limited volume of loans at a time.
These banks fear that entities like Fannie Mae, which guarantee the loans, have become a lot more demanding when asking banks to take back troubled loans. The so-called put-backs can quickly prompt losses that can surpass the income that banks originally made on the loans. And though the quality of loans written since the crisis has been high, banks fear they could be swamped with put-backs if the economy slows.
“There's a lot of uncertainty at the moment, and it does weigh,†said Mr. Goldberg, the Barclays analyst.
If some banks remain nervous about increasing the amount of mortgages they originate, it only tightens the grip of the few dominant lenders, making it easier for them to determine the interest rates ordinary borrowers pay an d generate strong profits. Those rates could be well under 3 percent, if the gains banks make when they sell the mortgages were at historical levels, according to a New York Times analysis earlier this year.
Some of the top banks benefited from the wave of consolidation that occurred during the financial crisis. In the first half of 2012, for instance, Wells Fargo, which acquired Wachovia, and JPMorgan Chase, which consumed Washington Mutual, accounted 44 percent of all mortgages, according to figures from Inside Mortgage Finance.
In first half of 2012, Wells Fargo reported gains of $4.83 billion when originating mortgages, a 155 percent increase from $1.89 billion in the first half of 2011. JPMorgan's mortgage production revenue was up 70 percent.
Still, some analysts are less certain about the strength of the refinancing boom. If Mitt Romney wins the presidential election, he could move quickly to overhaul housing finance in ways that could, at least temp orarily, unsettle the mortgage market.
There are more immediate concerns, though.
“The biggest threat is a rise in interest rates,†said Guy Cecala, publisher of Inside Mortgage Finance. For many borrowers, refinancing would no longer make sense if mortgage rates went back up to, say, 3.75 percent.
Even if mortgage rates stay low, the big banks might finally start to see more competition. The temptation of bigger mortgage gains may come to outweigh the fears that some banks have.
“If this lasts longer than expected, you will see banks re-enter the game,†said Todd Hagerman, banking analyst at Sterne Agee & Leach.
