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Mortgage Competition Dwindles – And Banks Feel Fine

25 October 2012 in Trading Ideas

JPMorgan Chase CEO Jamie Dimon recently declared that the housing market had “turned the corner.”

And he should know – the company’s recently announced quarterly profit surged to $5.7 billion from $4.3 billion, in large part due to the company’s mortgage business. The company said mortgage loan originations were up 29% to $47.3 billion.

It wasn’t alone – Wells Fargo saw its profit jump 22% on the strength of its mortgage business, which has received a boost from ultralow interest rates and a Federal Reserve bond-buying program that tempted homeowners to refinance existing loans or take out new ones.

It’s that kind of surge in profit that has had a hand in the relatively solid performance of bank stocks recently. The KBW Bank Index has been flat over the past month, while the S&P 500 has declined 2%.

Similarly, the Too Big to Fail motif is up 2% in the past month.

As an Oct. 15, article in the Financial Times reports, Wells Fargo now originates about one-third of new US mortgages – a level that is now unprecedented in a sector that, before the financial crisis, was more fragmented.

That sort of market dominance is potentially great for Wells Fargo, JPMorgan and its investors, but for potential homebuyers, the bounty has been a little more underwhelming, according to Bill Dudley, president of the New York Fed. He says the concentration of mortgage originations at just a few key financial institutions has resulted in banks not passing on low interest rates to borrowers.

As Dudley puts it, this has reduced the effect of Fed stimulus, because consumers have less money, and fewer people can afford a house.

In other words, while the housing market may be recovering, it could be doing so at a quicker pace.

Dudley says the Fed’s latest QE3 bond-buying program has driven down the yield on mortgage-backed securities, and in a fully competitive market, the interest rate for new mortgages would track that decline.

Dudley also said mortgage activity was being held down by warranties required by Fannie Mae and Freddie Mac to buy back loans that go bad. As a result, he said, home loans are discouraged – as are refinancings.

This could have the potential to slow home-loan growth, but for now, those left standing in the business are experiencing a huge contribution to the bottom line.

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