US banks squeezed as mortgage profits hit

US banks are suffering a squeeze on mortgage profits after a bumper two years, adding to pressure on the earnings of Wells Fargo, Bank of America and the other large lenders.

Mortgage rates rose from an average 3.42 per cent to 3.53 per cent on Thursday, the sharpest increase in 10 months, according to the weekly survey of 30-year mortgages by Freddie Mac, the government-backed mortgage company.

But the rate rise is not swelling the profits of lenders. In fact, the spread between what it costs them to fund mortgages and what they charge borrowers has halved since a record set in September.

At the same time, bankers say, demand has fallen as the surge in refinancings has tailed off. “What we’ve seen is a significant reduction in the market size, particularly recently,” said an executive at a large lender. “I know our applications are down.”

The downturn comes after the biggest banks sharply increased their capacity, hiring new loan officers to deal with a flood of homeowners wanting to refinance.

The mortgage rate is also influenced by the secondary market of mortgage-backed securities, where yields have increased significantly recently in line with US Treasuries.

Although rates that lenders charge borrowers have risen as a result, they have not increased in line with bond yields, leading to a tightening of the spread between what lenders receive from bond investors and what they charge borrowers.

The tightening may ease concerns about potential profiteering. Federal Reserve officials have been worried about banks making profits on the back of the central bank’s own quantitative easing programme, known as QE3, in which it is buying $40bn a month of MBS, pushing prices up and yields down.

“Mortgage originators have been big beneficiaries of QE3,” said Richard Staite, analyst at Atlantic Equities. “They didn’t pass on all of the decline in MBS yields to the end customers, allowing them to generate abnormal profits. That’s now coming to an end.”

The primary-secondary spread, typically around 50 basis points, spiked to more than 150 basis points in September. However, it has recently fallen to below 100 basis points, mainly because the yield on new mortgage bonds has risen quickly, in part due to the improving outlook on the US economy.

David Stevens, head of the Mortgage Bankers Association, said the spread was likely to be permanently higher because of increased costs, such as guarantee fees paid by banks for government-backed insurance on their loans. But he said the emergence of final regulations this month was reducing uncertainty and the tailing off of the wave of refinancing was reducing demand: both should reduce the spread.

“When the market contracts . . . we’re going to have increased competition,” he said. “Competition on its own is going to drive spreads tighter. That’s not always a healthy outcome because some institutions may reduce margins below healthy levels.”