Posted on: Sunday, December 28, 2003
Banks seeing demand fall off for refinancing
| • | Banks foresee major economic growth |
By Mark Skertic
Chicago Tribune
CHICAGO — About a year ago, Richard DeKaser, National City Bank's chief economist, knew one thing: There was no way the mortgage refinancing boom would continue through 2003.
Other economists also forecasted a slowdown when interest rates inevitably rose. The revenue that banks and mortgage companies were earning from application fees would shrink, analysts warned.
Their forecasts were correct, but about a year premature. Rates are slowly rising, prompting DeKaser and others to warn of a significant falloff in mortgage activity in 2004. That will hurt the bottom line for some banks that have made millions from mortgage application fees.
In July, mortgage interest rates hit their lowest levels since the 1950s, at an average rate of 5.2 percent for a 30-year mortgage. The rate has climbed about a percentage point since, and is expected to rise further in 2004.
"It's pretty clear to us that you won't see a repeat in 2004 of what we saw in 2003," said Jim Russell, Fifth Third Bank's director of core equity strategy. "That's just crystal clear."
In terms of recent history, a rate of less than 7 percent is still a good deal. But people who needed to be enticed to refinance by the chance for a lower rate probably have already done so. Gone are the days when homeowners refinanced again and again as rates dropped.
Some banks already feel the pinch. Washington Mutual, one of the largest mortgage lenders in the nation, recently announced that its fourth-quarter mortgage volume would be off about 50 percent from the third quarter.
The drop is forcing the company to "take steps to substantially reduce operating costs, and streamline and improve operations to drive efficiency," said chairman and chief executive Kerry Killinger.
"A lot of banks generated these lower-rate loans and then lived off the fees they generated," said John McCune, research manager of the banking group for SNL Financial, a financial news and research firm.
"What happened is there is a glut — a massive amount of low-interest loans out there after people refinanced three, four, five times.
"What was propping up earnings wasn't the loans, it was the fees. Fee income has dried up, and they're stuck with these loans."
For some banks, a slowdown in mortgage business won't even register on the bottom line. At Chicago-based Bank One Corp., for example, about a third of earnings comes from retail operations, and mortgages are a fraction of that.
"We didn't have the feast that some others had, but we won't have the hangover, either," said Bank One spokesman Tom Kelly.
In August, there were 435,000 U.S. workers handling mortgage applications, the Mortgage Bankers Association estimates. It expects that number to decline by 68,000 by the end of 2004.
Mortgage applications are down 40 percent to 50 percent from last summer, "a historic period," according to Doug Duncan, the association's senior vice president and chief economist.
For banks and thrifts, that period meant a healthy boost to the bottom line. The gains recorded from making loans accounted for 13.1 percent of pretax profits for federally insured commercial banks during the third quarter, up from 5.4 percent last year, according to an analysis of mortgage banking exposure done this month by investment firm Legg Mason.
Although the number of refinancing applications has shrunk, the millions of loans closed in the last year have left an important legacy, said Fifth Third's Russell.
"There's improved credit quality on the corporate side and for consumers who refinanced," he said. Millions of consumers now have loans at lower rates, he said.
That means banks don't have to set aside as much money to cover bad loans. Assuming the economy continues to improve, "we see a better credit picture going into 2005 and 2006 as well," Russell said. "Banks benefited in 2003 from a fee standpoint, but going forward they benefit from a lower loss profile."
The other legacy of the refinancing boom is that banks have millions of loans locked in at low rates. Many banks sell loans to other banks or mortgage companies soon after closing on a mortgage, so they benefit from the fees the customer paid but aren't left with the loan on the books when interest rates begin moving upward.
Those that haven't will be "trying to get them off their books, selling them and getting higher-rate loans in," McCune said. In some cases, banks may sell the loans at a loss.
Knowing that rates may rise, banks hedge current loans with other investments that produce income in an environment of rising interest rates. It's a balancing act intended to produce a healthy bottom line.
"The people who run the banking sector are very, very smart people, and you'd hope they know how to handle these kinds of things," McCune said. "But rates have never been this low for this long, so it's uncharted territory."
