Lower Rates Have a Downside for Banks
July 22 2019 - 8:29AM
Dow Jones News
By Ben Eisen
Lower interest rates generally help banks' mortgage businesses.
Except when they don't.
The value of mortgage-servicing rights, which are a key part of
banks' mortgage businesses, got hit by falling rates in the second
quarter at Wells Fargo & Co., JPMorgan Chase & Co. and
other lenders, weighing on what was otherwise a strong period for
home-lending operations.
Mortgage servicing involves collecting payments and performing
other administrative duties on home loans, but the value of the
rights to service those mortgages usually drops when interest rates
fall.
Wells Fargo, the largest bank holder of servicing rights, said
the value of its mortgage-servicing rights dropped 9% from the end
of the first quarter to $12.1 billion at the end of the second
quarter. JPMorgan, the second-largest, said the value of its
mortgage-servicing rights fell 15% over the quarter to $5.1
billion.
The moves show the flip side of falling rates, which generally
spur borrowers to take out home loans or refinance. The average
30-year fixed mortgage ended the second quarter with a rate of
3.73%, down from 4.08% at the beginning of the period, according to
Freddie Mac data. The Federal Reserve has signaled it is ready to
cut rates after several years of raising them, in turn pulling down
the cost of borrowing for mortgages and other debt.
But while lower rates can fuel mortgage making, they usually
hurt the paper value of servicing rights. That is because lower
rates make homeowners more likely to refinance their mortgages or
otherwise pay them off early, which means the servicer loses that
future income stream.
It might be a humdrum business, but it is important to many
lenders. Lenders can service mortgages they have made or buy the
rights to service mortgages made by other lenders. Some do so
because they provide a steady source of income. Citizens Financial
Group Inc., for example, doubled the amount of mortgages it
services when it bought a lender last year, leading to a jump in
mortgage-banking revenue.
In their second-quarter earnings reports last week, banks
disclosed steep declines in the value of these assets. The banks
that have reported earnings so far generally lost between 7% and
10% of fair value in their mortgage-servicing-rights portfolios,
according to Mark Garland, managing director at SitusAMC, which
advises on servicing transactions.
For servicing portfolios, it was the speed of the drop that
caught many executives off guard.
"Mortgage companies do best when rates move steadily in a
direction as opposed to rapidly in a direction," said Stephen
Lynch, a credit analyst at S&P Global Ratings, whose coverage
includes mortgage firms. "We definitely saw a dislocation."
Banks typically use derivatives to protect against volatility in
the value of their servicing rights, a practice known as hedging.
But that becomes more difficult when rates fall quickly. Some
lenders disclosed getting wrong-footed by their hedges. "It was a
tough quarter to hedge," Mr. Garland said.
When banks service a mortgage, they can collect a small cut of
the mortgage payment. Many banks take this job because it allows
them to develop a relationship with the borrower and try to sell
them other bank products, while also collecting income.
Banks serviced some $3.6 trillion of mortgages that have been
packaged into Fannie Mae or Freddie Mac securities or otherwise
sold on to other investors, according to data from the end of March
by industry-research group Inside Mortgage Finance.
The business of buying and selling servicing rights became a hot
trade last year as mortgage rates hit multiyear highs. Those trades
have cooled as rates dropped this year. In the first quarter as
rates were falling, $135.7 billion of Fannie, Freddie and Ginnie
Mae servicing rights changed hands, down about $40 billion from the
prior quarter, according to Inside Mortgage Finance.
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Write to Ben Eisen at ben.eisen@wsj.com
(END) Dow Jones Newswires
July 22, 2019 08:14 ET (12:14 GMT)
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