Mortgage Headwinds to Hit Banks in First Quarter

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Strong mortgage originations have propped up earnings for banks over the last several quarters, but the trend may have weakened in the first quarter, according to FBR Capital analyst Paul Miller.

In a note Friday, Miller recommended avoiding "origination-reliant" names, specifically those trading above book value.

"We now believe that 1Q13 stands to be lower than we expected from an industry origination standpoint, largely driven by seasonal weakness with the most significant impact at larger originators and potentially driving near-term weakness across the group," he wrote.

While the Mortgage Bankers Association estimates first-quarter originations totaled $482 billion, Miller said that based on conversations within the industry, originations were likely lower than expected, closer to $400 billion.

The analyst lowered his earnings estimates for Bank of America, Fifth Third Bancorp, Flagstar Bancorp, U.S. Bancorp, SunTrust and Wells Fargo to reflect reduced originations.

Low interest rates and an expanded government refinance program have boosted refinance volumes while fresh mortgage originations are starting to slowly creep higher. Banks have also raked in profits from gain-on-sale margins—the profits they earn on selling the refinanced loans to investors.

Many analysts fear that the refinance boom will peter out, ending the winning streak for banks that have ridden the wave, especially Wells Fargo.

Still, FBR remains positive on mortgage banking for the rest of the year as low interest rates and government initiatives to expand mortgage credit continue to fuel volume growth.

"We continue to believe the perceived 'refinance cliff' will happen later rather than sooner, with the hopes that refinance volumes will remain elevated long enough for the purchase market to continue to gain traction," Miller wrote. "Though gains on the purchase side have been incremental thus far, housing supply improvements and mortgages for additional credit tranches provide meaningful tailwinds to volumes even as gain-on-sale margins continue to contract."

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