Mortgages returned from the dead (again) at several big banks last quarter, but it wasn't enough to lift their spirits about the future.
Home lending soared 20% to 30% from the first quarter to the second at Wells Fargo (WFC), Bank of America (BAC) and Citigroup (NYSE:C) and fell slightly at JPMorgan Chase (JPM). Still, it was way down year over year, and bankers remain anxious about revenue and profit growth for the rest of 2014.
Why? Even after shedding thousands of mortgage employees, the question hanging over the banks is how to keep a lid on expenses now that the market has shifted to home loans—which are far more expensive to originate—and away from refinances.
John Shrewsberry, Wells Fargo's chief financial officer, summed up big banks' cautious sentiments about the mortgage market on a conference call with analysts this month.
"We're not seeing breakout returns to precrisis levels of enthusiasm around homeownership," Shrewsberry said. "We're glad the results were good. They're certainly up seasonally quarter over quarter. But we might have imagined a little bit more going into the [end of the] year."
JPMorgan Chase CEO Jamie Dimon was downright pessimistic in widely reported harsh comments about the profitability, or lack thereof, in Federal Housing Administration loans.
"The big weak spot which we all acknowledge is mortgage," Dimon said.
All of the top banks are looking for ways to stem the decline in mortgage volumes, which have plunged 60%, on average from a year ago. The large banks have all slashed their employee headcounts, which are down 5,000 to 6,000 from last year, because refinance volumes have dried up.
Wells Fargo is used to rolling with the punches, CEO John Stumpf assured analysts.
"Ramping up and ramping down is a core competency here," Stumpf said. "If you're going to be in this business, you have to be good at that."
Scott Buchta, head of fixed-income strategy for Brean Capital, said the massive job cuts that began last year will help the big banks' profitability.
"When volumes dropped sharply after rates rose last year, lenders had to adjust their pipelines accordingly to cut their fixed costs and rightsize their headcounts," Buchta said. "I think they have been able to keep their margins at a level where they can remain profitable."
The big problem is that cost to originate a home loan has skyrocketed, according to the Mortgage Bankers Association.
Expenses for compensation and other costs minus all fee income hit a record of $8,025 per loan in the first quarter, up from roughly $7,000 in the fourth quarter, the MBA found.
Marianne Lake, the CFO at JPMorgan Chase, told analysts that expenses in mortgages continue to be "a tailwind."
"When you have a very, very small market, which I think you would agree a $1.1 trillionor lower market is very small, then it is hard with the fixed cost structure to make a lot of money in the mortgage business, particularly if you are taking a hard line, which we are, on the types of mortgage product that we want to participate in," Lake said.
(The MBA cut its 2014 loan origination forecast to $1.05 trillion because home purchase loan application volume is well behind where it was this time last year.)
Franklin Codel, Wells Fargo's head of mortgage production, agreed with the premise that job cuts have gone a long way toward boosting profits but acknowledged that costs remain a challenge.
"All else being equal, if reductions hadn't taken place, profitability would be worse," Codel said in an interview. "There is some validity to the point that the cost to originate a mortgage today is higher than it was in 2005. The amount of work that goes into taking a file from application to funding is different, [and] the amount of documentation and the steps that we do from appraisal to verification is higher."
It is hard to predict mortgage volume in the second half because if mortgage rates drop further, refinances could jump.
Buchta estimates that if mortgage rates drop 25 basis points or more, banks could see their margins widen and earnings increase accordingly. For example, if mortgage rates were to fall below 4%, then roughly $525 billion of conventional loans could potentially refinance, unleashing another wave of refi activity.
"A 25 [basis point] move in rates could be very profitable for the banks," Buchta said.
Mortgage revenue is important to the big companies' financial performances, but less important than it used to be.
Origination revenue as a percentage of total revenue has fallen to 2% for banks, on average, from a peak of 9% in mid-2012, said Brian Foran, a partner at Autonomous Research. Mortgage originations make up just 4% of total revenue at Wells Fargo, the largest lender, Foran said.
Perhaps the most astonishing statistics in mortgages these days are gain-on-sale margins, which are averaging 2.2%, a level that in past periods would have been considered "super profitable," Foran said. (Of course, some banks share their gain-on-sale profits with correspondent lenders, so there are differences among lenders.)
The problem is that compliance costs, audits by the Consumer Financial Protection Bureau, licensing and oversight are so much higher that originating a home loan has become very expensive.
"We're at 2% gain-on-sale and lenders are struggling to make money because the cost structure of the business has gone ballistic," Foran said. "It just speaks to how much costs and legal risk have skyrocketed in the business."