Banks continue to receive the benefits of government monetary and housing policies support, as various stimulus programs have led to an onslaught of mortgage refinance loans. Earnings announcements by J.P. Morgan Chase and Wells Fargo shows that big lenders earned record profits in the third quarter of 2012.
Furthermore, according to Barclays banking analyst Jason Goldberg, the industry anticipates that revenues earned from mortgage refinancing and loan originations will continue through Q4 2012 on into next year.
Inside Mortgage Finance estimates that lenders completed as much as $450 billion in mortgages in the third quarter. In the second quarter, lenders approved $405 billion in mortgage applications. Approximately $275.4 billion or 68% of the volume of mortgages approved consisted of mortgage refinances.
Banks Benefit from Government Guarantees
When the financial markets crashed in late 2008, the government bailed out the banks to the tune of $700 billion plus. Since then, many of the largest banks have used the funds to put themselves in a position to make significant profits as housing and mortgage markets have improved.
In fact, loan originations and mortgage refinancing has resulted in hefty profits even at a time of low interest rates, which have cut profits in another revenue streams.
In their role as middlemen in the mortgage industry, banks make loans but do not have to keep most of the mortgages on their books. Instead, they package the loans into mortgage-backed securities (MBSs) and sell them to investors.
Fannie Mae guarantees a significant percentage of the mortgages. If homeowners default, investors who purchase the securities know that the bonds have the backing of U.S. taxpayers.
Federal Polices Benefit Banks
Repackaging mortgages and selling them as bonds bring in hefty profits for lenders. Policies initiated by the Treasury Department and Federal Reserve, which the entities designed to help the housing industry, has enabled lenders to make even larger profits.
For example, the Federal Reserve's announcement in September that it will purchase $40 billion a month in MBSs increases the price of the instruments and makes them more attractive to investors. Consequently, banks earn higher profits when they sell the bonds.
In addition, recent revisions to the Home Affordable Refinance Program (HARP) have also been instrumental in helping banks make more money. A few months ago, the Federal Housing Finance Agency eliminated the 125% loan-to-value ratio and other impediments that prevented many homeowners with underwater mortgages from refinancing.
With interest rates dropping to one record low after another and policies stated above, mortgage refinancing levels have zoomed.
More Profits Ahead
At the end of last year, the 30-year fixed rate mortgage averaged 3.9% compared to the current average rate of 3.36%. Based on the present level of rates, banking analyst Paul Miller said nearly half of the homeowners with outstanding mortgages have the economic incentive to refinance to a low-interest rate loan.
According to Miller, the current economic environment could mean a consistent stream of mortgage refinancing over the next few quarters. However, a shortage of staff at the banks caps the volume of mortgage refinancing application lenders can process.
Banks also have a concern about put-backs, which can cut into their substantial profits. Put-backs refer to loans sold to Fannie Mae or Freddie Mac that the government returns to lenders because of questionable underwriting.
If the economy weakens, it could lead to an increase in homeowner defaults. Similar to the last crisis, Fannie and Freddie would take a closer look at purchase mortgages and mortgage refinances they bought or insured.