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Mortgage rate spike could spur M&A wave

A spike in mortgage rates since the November 2016 election could spur deal activity among nonbank mortgage originators.

Among banks reporting earnings, several companies showed declines in mortgage banking revenue during the 2016 fourth quarter as refinance volume tumbled following the rate hike. Mortgages were also in the news this week as President Donald Trump took office and suspended a premium cut for loans insured by the Federal Housing Administration. However, industry observers said the move would not have a large impact on operations for mortgage originators, instead pointing to the rate move since Trump's election as the more meaningful development.

The Mortgage Bankers Association reported Jan. 25 that refinance share fell to 50% of total applications for the week ended Jan. 20, the lowest level since July 2015. The drying up of refinancing activity could put some mortgage origination shops in trouble and create opportunities for more stable players.

"Our expectation is that as volume drops, profit margins will get even tighter, and we shouldn't be surprised to see some consolidation," said Michael Fratantoni, chief economist for the Mortgage Bankers Association. The industry group projects a 50% decline in refinance volume this year relative to 2016.

Even in 2016, a banner year for mortgage volume, profit margins shrunk due to higher expenses from additional regulation, Fratantoni said. That had some industry observers thinking consolidation among mortgage shops would be imminent, but the deal activity never materialized.

"There was a disconnect between what people thought their company was worth and what somebody would pay for it," said Guy Cecala, CEO of Inside Mortgage Finance. "This year, if someone has significantly lower volume, there's no arguing about what it's worth — and it's going to be less."

Cecala said small, nonbank mortgage originators, particularly those more dependent on refinance volume, will be the most likely to sell. And he said the buyers will be slightly larger nonbanks but that banks are likely to stay on the sidelines as they focus on highly profitable jumbo mortgage originations rather than seeking greater volume of all mortgages.

Bank earnings season for year-end results has been pockmarked by reports of weaker mortgage banking revenue due to the spike in rates. Freddie Mac reports mortgage rates on a weekly basis. For the week ended Nov. 10, 2016, the week of the election, average rates for 30-year fixed-rate mortgages stood at 3.57%. By year-end, rates had spiked nearly 80 basis points to 4.32% for the week ended Dec. 29, 2016.

At Wells Fargo & Co., the nation's top mortgage originator per most recent data, the bank reported a $250 million quarter-over-quarter decline in mortgage banking as servicing income fell and costs rose. It should be noted the bank is still dealing with the fallout from a massive fake-accounts scandal. But many other banks also reported declines in mortgage banking revenue.

SunTrust Banks Inc. executives reported a $40 million decline in mortgage production income, attributing the drop-off to lower refinancing activity following the rate spike. JPMorgan Chase & Co. reported a linked-quarter decrease of $184 million in mortgage banking revenue under its consumer and community banking segment. The weaker results have some executives thinking about acquisition opportunities.

"We are the sixth-largest bank originator in the nation and are well-positioned to benefit from any market dislocation as interest rates rise and the refinance boom goes away," said Lee Smith, COO for Flagstar Bancorp Inc., during the company's earnings call.

On Capitol Hill, certain politicians and news organizations were more focused on President Trump's decision to suspend a cut to the premiums charged for loans insured by the Federal Housing Administration. Former President Barack Obama had approved a 25-basis-point cut in upfront premiums for the loans, which are generally targeted toward first-time homebuyers.

The cut would have made FHA loans more attractive than conventional loans for a greater number of borrowers, said Dan Green, CEO of Growella, a personal finance publisher. However, the suspension of the cut simply means those borrowers will find a loan backed by Fannie Mae or Freddie Mac more financially attractive. For originators, the difference will be minimal, he said.