How refinancing helps the likes of Bank of America and Wells Fargo
Earlier today I posted an article about how accounting was favourable to banks in that it could help them weather the storm and appear well-capitalized until a recovery is underway. Afterwards, a buoyant economy would increase earnings enough to allow the massive writedowns that need to flow through the income statement to be taken in stride. As an addendum to the previous post, I added a note regarding how this turn-of-events can take place even though the housing market is considerably worse than most pundits felt it would be.
Calculated Risk has a story out (Revisiting the JPMorgan / WaMu Acquisition) which suggests that JPMorgan, if anything, under-provisioned for the eventual WaMu losses. That would suggest a lot of writedowns over the life of the WaMu loans. This is an account that I would tend to believe as the housing market is worse than the baseline case JPMorgan presented after the acquisition (see my post "JP Morgan Chase buys WaMu out"). Again, I see WaMu as a bankrupt organization that was destined to fail. Nevertheless, over the short-term, accounting from the transaction can be favourable to JPMorgan’s earnings – and I see that as a net positive for JPM.
I have another tack regarding bank earnings to share. Feel free to express your agreement or doubt in the comments regarding this line of argument. As a result of the securitization model of mortgage finance having replaced the traditional model, banks with large retail customer bases are geared to transactions and volume as a way of making money. This means banks like high mortgage transaction volumes, whether through actual purchases or refinancing. Some of the the banks geared in that direction include Wells Fargo and Wachovia, Bank of America and Countrywide Financial, and JPMorgan and Washington Mutual. All of these banks will benefit from having bought other bankrupt organizations with large mortgage operations.
For example, say you buy a house in 2004 that is not underwater. Having seen your 5-year ARM reach the end of the ARM period, you are looking to refinance now in 2009. Using some of the homeowner-oriented bailout schemes, your bank can lower your monthly payment but in return they get an incentive payment:
- A straight out cash incentive payment of say $1000 for doing a loan modification on a still current loan as the lender (say Wells Fargo) AND another cash payment as a servicer (say, Countrywide, now BofA).
- A amortized payment equal to half of the savings you just received (as long as you stay current, which 40% of loan-mods are not doing). So you save $100, but the bank gets $50 a month for the next five years as a lender. The servicer will get annual payments here as well.
Nice, huh? Well read this from the Mortgage Bankers Association from last week’s Weekly Mortgage Applications Survey. I have highlighted the points you should pay attention to.
The Mortgage Bankers Association (MBA) today released its Weekly Mortgage Applications Survey for the week ending May 15, 2009. The Market Composite Index, a measure of mortgage loan application volume, was 915.9, an increase of 2.3 percent on a seasonally adjusted basis from 895.6 one week earlier. On an unadjusted basis, the Index increased 2.0 percent compared with the previous week and increased 42.0 percent compared with the same week one year earlier.
The Refinance Index increased 4.5 percent to 4794.4 from 4588.6 the previous week and the seasonally adjusted Purchase Index decreased 4.4 percent to 254.0 from 265.7 one week earlier.
The four week moving average for the seasonally adjusted Market Index is down 6.4 percent. The four week moving average is up 0.1 percent for the seasonally adjusted Purchase Index, while this average is down 8.2 percent for the Refinance Index.
The refinance share of mortgage activity increased to 73.6 percent of total applications from 71.9 percent the previous week. The adjustable-rate mortgage (ARM) share of activity increased to 2.4 percent from 2.3 percent of total applications from the previous week.
The fact is bankers are looking to get A LOT of refinancing volume because both servicers and lenders stand to increase current net income significantly if refinancing volumes are high. An increased refinancing transaction volume is a backdoor way of re-capitalizing banks. Now, just in case you are interested, here is what the same MBA Weekly report looked like on Oct 8th, just after Lehman filed for bankruptcy.
The Mortgage Bankers Association (MBA) today released its Weekly Mortgage Applications Survey for the week ending October 3, 2008. The Market Composite Index, a measure of mortgage loan application volume, was 465.5, an increase of 2.2 percent on a seasonally adjusted basis from 455.4 one week earlier. On an unadjusted basis, the Index increased 2.2 percent compared with the previous week and was down 28.6 percent compared with the same week one year earlier.
The Refinance Index increased 0.9 percent to 1345.8 from the previous week and the seasonally adjusted Purchase Index increased 3.2 percent to 314.5 from one week earlier. The Conventional Purchase Index increased 0.7 percent while the Government Purchase Index (largely FHA) increased 9.9 percent.
The four week moving average for the seasonally adjusted Market Index is down 1.4 percent. The four week moving average for the seasonally adjusted Purchase Index is down 4.1 percent, while this average is up 1.8 percent for the Refinance Index.The refinance share of mortgage activity decreased to 43.4 percent of total applications from 44.0 percent the previous week. The adjustable-rate mortgage (ARM) share of activity decreased to 2.3 percent from 2.5 percent of total applications from the previous week.
Clearly refinancing volume is through the roof as zero percent interest rates are an incentive for all mortgage-holders to refinance. This increased volume of transactions will be very helpful to banks’ earnings over the near-term. Notice that I haven’t mentioned Citigroup anywhere here because they lost out in the Wachovia transaction and they have a fairly small retail operation domestically.
Source
Mortgage Applications Increase in Latest MBA Weekly Survey: 20 May 2009 – MBA website
Mortgage Applications Increase Slightly In Latest MBA Weekly Survey: 8 Oct 2008 – MBA website
100% agree Ed. My question/fear (long-term) is that securitization markets will never come back in their previous form. So if we get a tepid recovery, even a minor rise in rates to still low levels (let’s say 6-8%) would be what drops us into the W. Refi’s slow, the banks earnings get doubly hammered as the refi-driven revenue drops and the cost of capital rises (again, even slightly). If the Case Shiller keeps going the way its going, presumably even people wanting to refi just to extend would have problems, which would like lead us back to more foreclosures, more write downs, etc. etc. Its a ridiculously viscous cycle, and I honestly have no idea how we get out of it outside of a ZIRP environment like Japan, or a black swan-type positive economic discovery (alt energy or what have you). Scary, really.
All this refinancing will also degrade the quality of existing MBS significantly. Guess who will end up owning all those “legacy assets”?
This is for both Adam and Kyle. I was just listening to Whitney Tilson and he brings home my own fears about a double dip. They are much like yours here Kyle, that the reflation play brings risk back and the unwind process is arrested temporarily to the detriment of everyone involved when economic weakness re-appears.
40% of those getting loan mods are defaulting, suggesting this whole nonsense is just another opaque way of transferring wealth from taxpayers to banks in order to recapitalize them.
For the survivors: probably WFC and JPM, great. But, there are going to be some major casualties down the line. I tend to see that time period as later rather than sooner, but we are still not out of the woods in this crisis.
In the meantime, investors are buying the financials.
I forgot where, but somewhere today there was a post about a report by S&P about expecting up to 75% (!) of mods to fail over the next year. It really just comes back to the same idea of sustainability. I think I’m close to your feeling on this Ed, that the stimulus and general worldwide govt reflation moves will buoy the global economy starting soon, which will be reflected in gdp and trade balances, but once they run dry, we hit a wall. Do we end up in meltdown mode again? Probably not, but it’s not like you’re going to see 4% gdp growth either.