JPMorgan Chase & Co. CEO Jamie Dimon told investors last week that rising interest rates could trigger a “dramatic reduction” in the bank’s mortgage profits. According to its own analysts, the U.S. housing market will extend its recovery regardless.
The rate for 30-year home loans jumped to 4.51% last week from a near record-low of 3.35% in early May after Federal Reserve Chairman Ben Bernanke indicated the central bank may slow its purchases of government and mortgage bonds. Refinancing, which has slumped to the lowest in two years, may drop by as much as 40% in the second half of this year, JPMorgan chief financial officer Marianne Lake said July 12.
Home prices rising at the fastest pace since 2006 can withstand higher rates as lenders ease underwriting standards, job growth fuels demand and the supply of distressed properties dwindles, JPMorgan analysts led by John Sim wrote in a July 10 report. The New York-based researchers increased their forecast for price appreciation to 10.1% this year from 7% in March.
“There has been widespread concern that rising rates may hurt the housing recovery,” the analysts said. “We do not think that the recent market move will change the broader story of increased homebuyer activity.”
Bernanke said last month that rates have risen in part because of optimism about the economy and “perceptions of the Federal Reserve.” Home prices rose 12.1% in April from the prior year, according to the S&P/Case-Shiller Index, with increases in each of the 20 cities in the measure.
“People are more optimistic about housing. They expect house prices to continue to rise,” he said. That “compensates to some extent for a slightly higher mortgage rate.”
Growth has been driven by a lack of housing stock coupled with demand from institutional investors, including private equity firm Blackstone Group LP, which has purchased more than 30,000 single-family homes to rent. The number of homes for sale fell 5% to 1.74 million in January from the year-earlier period, the fewest since December 1999, according to the National Association of Realtors.
For banks, including Wells Fargo & Co., the nation’s largest home-loan lender, and No. 2 JPMorgan, rising rates may be more detrimental after the lenders benefited from record profit margins in the mortgage business in 2012. Refinancing accounted for 76% of last year’s $1.75 trillion in loan originations. Originations may fall 10% this year, the Mortgage Bankers Association forecast in a June 20 report.
“For most mortgages outstanding now, the rate does not provide an incentive for refinancing,” said Walt Schmidt, a mortgage strategist at FTN Financial. “These margins have remained relatively robust for the banks and they’re not going to be making that money anymore.”
Wells Fargo, one of the biggest beneficiaries of the housing recovery, originated almost one in three mortgages in 2012, helping it post a third straight year of record profit. The firm said last week that it made $2.8 billion from mortgage banking in the second quarter, 3% less than a year earlier.
New home loans fell rapidly after Bernanke’s comments and probably slowed Wells Fargo’s mortgage business, Richard Staite, a London-based analyst at Atlantic Equities LLP, wrote in a June 12 report. Mortgages comprised about 14% of total revenue last year, a contribution that may plunge by more than a third this year to $7.5 billion, from $12.2 billion last year, and to $4.8 billion in 2014, he wrote.
“You’re going to see a big change in mortgage profits in the second half of this year compared to what you’ve seen in 2012 and the first half of this year,” said Kevin Barker, an analyst at Washington-based Compass Point Research & Trading LLC.
Dimon, 57, has led JPMorgan to record earnings over the past three years as the Fed’s stimulus boosted the economy and bank profits. Mortgage fees and related revenue at the bank dropped 20% to $1.82 billion in the second quarter, compared with $2.27 billion a year earlier.
If the recent increase in interest rates holds, homeowner refinancing could be reduced by 30% to 40% in the second half of this year, Lake said.
“We’re trying to be clear with you that this would be a significant event,” she said on the conference call.
“It definitely could be that severe,” Barker said. “2012 and the first half of this year have been historically good quarters for mortgage banking so I would argue that the market was already generous for mortgage banks.”
JPMorgan may accelerate a job-cut program announced earlier in the year. The bank said in February it’s eliminating as many as 19,000 jobs in its mortgage and community-banking divisions through 2014 as Dimon trims expenses.
The company reported a 31% increase in second- quarter net income to $6.5 billion, or $1.60 a share, as a 10% jump in trading and investment banking revenue outweighed a 3% drop at the consumer and community banking unit. Its shares have gained 52% in the last year.
Rising rates and a decline in refinancing could expand credit availability that’s been restricted following the housing crash by forcing lenders to compete more aggressively for homebuyers, said Doug Duncan, chief economist at Fannie Mae.
Banks, “if they want to stay in business, they’re going to compete,” he said last month.
Mortgage costs are also still near historic lows, with the rate down from 6.8% in 2006, more than 10% in 1990 and 18.63% in 1981. Housing affordability in January reached its highest level in records dating to 1989, according to the National Association of Realtors, and prices are still 26 percent below their peak seven years ago.
U.S. homebuilders have rallied 4.8% this month and are up 30% in the last 12 months.
As long as home price appreciation, job growth and easing of lending standards “continue to move in a positive direction as expected,” most of the negative effect on housing demand would be offset, the JPMorgan analysts wrote. Under those circumstances, homes sales would stay above 4.8 million even with a 2 percentage point rise in mortgage rates from 2012 levels, creating the highest level of net demand since 2006, they said.
“The next two months of existing and new home sales will be critical to see if higher rates will affect the economy,” said Schmidt. “The current standard view of affordability is still pretty high and it will take more than 100 basis points to change that.”