New Products, Bank and Non-Bank Lender Earnings, Banks Adjust Asset Mix Due to Fed Moves

By rchrisman@robchrisman.com

At a psychiatrist's office:
- Do you consume alcohol?
- No.
- Do you smoke?
- No.
- Do you use drugs?
- No.
- Do you play cards?
- No.
- Do you run after other women?
- No.

- So why did you come to me?
- You see, doc, I have one little problem... I lie a lot

"It was a Monday, a day like any other day. I left a small town, for the apple in decay" - so sang Foreigner many years ago. But the Big Apple's real estate market is hardly in decay. The number of Manhattan real estate sales (about 2,900) was essentially flat in the first quarter, but the average sale price inched up 2.6 percent to $2.1 million. Median sale prices (half above, half below) fell 3.3 percent to $1.1 million. CNBC suggests, "The big question for the Manhattan market is how it will absorb the tens of thousands of new units coming available over the next few months and years. Already, the number of condos on the market jumped 7 percent in the quarter, reaching a six-month supply." Too bad we can't spread those new units around to some other parts of the nation.

 New products

 Earnings make the world go 'round for some

 Per a Mortgage Bankers Association survey, independent mortgage banks and mortgage subsidiaries of chartered banks made an average profit of $1,346 on each loan they originated in 2016, up from $1,189 per loan in 2015. Of the 280 firms that reported production, 76 percent were independent mortgage companies and 24 percent were subsidiaries and other non-depository institutions. (In 2015, there were 6,913 U.S. financial institutions covered by the Home Mortgage Disclosure Act - HMDA.) For the mortgage industry as whole, the MBA estimated production volume at $1.89 trillion in 2016, from $1.68 trillion in 2015. Estimates for 2017 are in flux, but seem to center around $1.6 trillion.

 If you didn't make money in 2016 you're the minority. Marina Walsh, MBA Vice President of Industry Analysis, reported that, "Including both production and servicing operations, 94 percent of the firms in the study posted overall pre-tax net financial profits in 2016, from 92 percent 2015." Average loan balances rose to a study-high $244,945 for first mortgages in 2016, and revenues reached a study-high $8,555 per loan in 2016. Production expenses, however, also reached a study-high, at $7,209 per loan, and offset a portion of these revenue improvements. The net result was a slight increase in overall net production income.

 In its Annual Mortgage Bankers Performance Report the MBA reported that average production profit (net production income) rose to 58 basis points in 2016, compared to 52 basis points in 2015. In the first half of 2016, net production income averaged 61 basis points, then dropped to 55 basis points in the second half. Since inception of the Annual Performance Report in 2008, net production income by year has averaged 55 bps ($1,127 per loan).

 "Total production revenues (fee income, net secondary marking income and warehouse spread) rose slightly to 366 basis points in 2016, compared to 359 bps in 2015. On a per-loan basis, production revenues rose to $8,555 per loan in 2016, from $8,234 per loan in 2015. Total loan production expenses--commissions, compensation, occupancy, equipment, and other production expenses and corporate allocations--increased to $7,209 per loan in 2016, from $7,046 in 2015."

 And people keep becoming more expensive: personnel expenses averaged $4,801 per loan in 2016, up from $4,699 per loan in 2015. Productivity rose to 2.4 loans originated per production employee per month in 2016, from 2.2 in 2015. Production employees include sales, fulfillment and production support functions.

 Shifting to big bank earnings during the 1^st quarter, it was a mixed bag for Citi, Wells Fargo, JPMorgan Chase, and PNC. Yet, in general, bank's senior management on the earnings calls sound upbeat about the lending environment despite some signs of a slowdown.

 The bank's latest earning reports reveal lower gains on residential mortgage servicing rights and lower mortgage loan revenues, but the banks are optimistic going into the 2017. Overall earnings for JPMorgan Chase and Wells Fargo were down slightly from the previous quarter. Citigroup and JPMorgan Chase reported about a 17% increase in profit for the first quarter, while Wells Fargo reported that its profit was flat. On conference calls with investors, bank executives were optimistic that efforts to revise financial regulations and reduce tax rates would help increase growth.

 Wells Fargo said it plans to close 200 branches per year for the next 2 years as it seeks to reduce expenses. (The bank closed 39 branches in Q1.) Wells' mortgage business, generally viewed as #1 in the nation, and therefore the world, in the first quarter of 2017 fell across most its divisions. Wells' management, however, noted the drop was not a surprise. The bank's first-quarter earnings stated, as expected, residential mortgage loan originations declined in the first quarter, down to $44 billion, from $72 billion in the fourth quarter. Mortgage-banking noninterest income decreased to $1.2 billion, compared with $1.4 billion in fourth quarter 2016. Additionally, mortgage servicing income increased to $456 million in the first quarter from $196 million in the fourth quarter, primarily due to lower unreimbursed servicing costs and lower prepayments.

 First quarter mortgage applications dropped, coming in at $59 billion, down from $75 billion in prior quarter, while the application pipeline fell to $28 billion at quarter end, down from $30 billion at Dec. 31, 2016.

 Over at CitiMortgage, it originated $3.8 billion of new originations, a 32.1 percent decline from the fourth quarter. Ouch. Compared to 1Q16, fundings were down 36.3 percent. On top of that, Citi's third-party servicing portfolio plummeted 66% to $48.5 billion. This was expected, however, since a few months ago Citigroup announced its exit from the servicing sector with a complete withdrawal coming by the end of 2018. (The first move in that process was to sell $97 billion in Fannie Mae/Freddie Mac servicing rights to New Residential Mortgage, LLC, a publicly traded REIT.) But the entire banking franchise posted a net profit of $4.09 billion in the first quarter, a 14.2 percent improvement from 4Q16.

 Capital Markets

 Anyone who started in this business in 2008 has seen an unusual time. Namely, following a reduction in short rates (interest rate on excess reserves, IOER or EBA rate) to 0.25% in late 2008, short-term rates were held low until December 2015. At that time, the Fed switched gears and began raising rates (by 25bp) to 0.50%. It then repeated the process in 2016 (+25bp) and took short rates to 0.75%. Then, at its most recent meeting last month, the Fed added another 25bp increase and took short rates to 1.00%. That is where things stand now.

 Now nearly every week a bevy of Fed speakers give their assessment of the U.S. economy, and give their opinions, given current conditions, of the chance for more rate increases. Remember that short-term rates don't determine mortgage rates, but FOMC participants at the latest meeting now project an average midpoint level of appropriate short term rates of about 1.50% for 2017 (+50bp more), 2.25% in 2018 (+75bp) and 3.00% in 2019 (+75bp). Of note, the top 25% highest projections for each year would be about 1.75% for 2017 (+75bp more), 3.00% for 2018 (+125bp) and 3.25% for 2019 (+25bp).

 To some extent bank stocks have rallied on the thought of higher short-term rates. While higher rates are generally seen as good news for banks, it depends. Yes, the NIM (net interest margin) spread will become larger, which allows banks to make more money. This is especially true if banks can raise deposit rates slower than lending rates (deposit beta). Given current projections, however, it appears funding costs will inevitably go up. That issue and the compounding one that the advantage of increased NIM spread is only there for new variable rate loan business must be considered too.

 Steve Brown with PCBB has observed that, "Fixed rate long-term loan structures requested by bank customers (or currently on bank books) would cause NIM to contract. That damages the benefit of a rising interest rate." Steve goes on to point out that, "Luckily, community banks have options. The first of these is to do a loan-for-loan swap for a customer interested in a new long-term fixed rate loan. This is where you put a hedge on your books for a floating rate, in exchange for your customer's fixed rate loan. This can be complicated and there are provisions you will need to check. It is critical in this approach to get the details right. In this instance, most banks typically engage in loan level hedging to mitigate NIM issues and remain competitive on loan rate offerings."

 Turning to the mundane bond markets, they were closed Friday. Late Wednesday and Thursday the yield on the 10-year, as a proxy for U.S. rates in general, chopped around in the low 2.20% range. So they've come down during April - primarily due to influences from overseas (North Korea, Italy, France, Syria) but also inflation data here in the States being very tame.

 And now we have a week full of thrilling government and private economic releases - much of it housing related. Today we've already had April's NY Fed Empire Manufacturing Index (at 5.2%, less than forecast), coming up is the April NAHB Housing Market Index. Tomorrow we'll have March Housing Starts and Building Permits and March Industrial Production & Capacity Utilization. Wednesday is the MBA's Mortgage Index for last week and the release of the April Fed's Beige Book. Thursday are Philadelphia Fed, Initial Jobless Claims, and March Leading Indicators. The only thing out Friday is March Existing Home Sales.

 Rates are slightly better than the last day that the bond market was trading. The 10-year is yielding 2.23% and current-coupon agency MBS prices are a smidge better.