Wells Fargo Stores Mortgage Revenue Ahead of Refinancing Boom’s End

Wells Fargo has been a big winner in the mortgage market lately, but the decision to forego third-quarter profits on home loans shows the bank knows the party won’t last.

The country’s largest mortgage banker kept $9.8 billion worth of new conforming mortgages on its books this past quarter rather than selling them to investors. This is uncommon right now because banks can make a lot of money by exploiting historic differences in interest rates. Wells Fargo executives said they could have made an additional $200 million in the third quarter had they sold the mortgages.

Banks do not typically keep mortgages on their books. Instead, they package them into mortgage backed securities and sell them to investors. This not only removes risk from banks’ balance sheets, but creates revenue. Banks profit from the difference between the interest they charge homeowners and the interest they pay out to the investors who buy mortgage backed securities.

Right now that difference — called the spread — is wide, which means more profits for banks. The average 30-year mortgage rate is 3.42 percent right now. The yield on mortgage-backed securities is 1.2 percentage points lower, compared with a median difference of 0.4 percentage points over the last ten years, according to data compiled by Bloomberg.

This situation will not last forever though.

“One thing we know from history in the mortgage business is that when you are at a high level of margin there generally tends to be more pressure down than up,” said Timothy J. Sloan, chief financial officer during the company’s third quarter earnings conference call.

In this case, that is because at a certain point, practically everyone who qualifies to refinance will have done so.

Wells Fargo said it expects spreads to remain high throughout the fourth quarter and perhaps into the next few quarters. Eventually, low mortgage rates will rise, and fewer consumers will refinance. By holding onto the mortgages now, the bank is essentially storing up revenue.

“When interest rates eventually begin to rise, which is when refi come down, you can deploy that at a much more advantageous time and create some positive there.”

In a press release, the Mortgage Bankers Association said it expects refinancing to drop off in the middle of 2013, with refinancing falling from an estimated $1.2 trillion in 2012 to a projected $785 billion in 2013.

“We expect 2013 refinance originations to play out like our original expectations for 2012, with a long tail of refis extending through the first half of the year followed by a rapid drop-off in the second half,” said Jay Brinkmann, MBA’s chief economist.

The MBA also expects mortgage rates to remain below 4 percent, as the Federal Reserve continues to buy mortgage backed securities through a third round of quantitative easing.


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