Higher long-term interest rates are starting to impact mortgages, potentially helping offset increased deposit costs for U.S. banks while presenting a headwind for refinancing volume.
Mortgage rates for 30-year loans did not respond to the Federal Reserve rate hikes that started in late 2015, inching up just 2 basis points in about two years. Many of the 20 biggest U.S. banks actually reduced their mortgage rates during that period. But over the last four months, rates have spiked an average of 44 basis points nationwide.
For banks that hold residential mortgages, the 2018 jump in mortgage rates can help offset the increasingly competitive deposit market. Investors and analysts have been increasingly concerned about deposit betas, a measure of what portion of the Fed's rate hikes are passed on to depositors. But those costs were more than offset by higher rates on assets, with the median net interest margin at regional banks up 19 basis points in the first quarter compared to a year ago.
"It's important to focus not only on deposit betas, but also on the asset betas and total funding cost," said Ram Shankar, CFO at UMB Financial Corp., during an earnings call. For UMB, a Kansas City, Mo.-based bank with $21.0 billion in assets, the asset beta since the 2015 third quarter has been 64%, compared to a deposit beta of just 24%.
On the other hand, banks and nonbanks that rely on revenue from originating mortgages, as opposed to holding them, will likely see lower volume due to increased rates. Higher mortgage rates tend to depress refinancing activity by reducing or eliminating the borrower's savings from refinancing. In the 2017 fourth quarter, refinancing volume was 42.5% lower than a year earlier.
Looking ahead, the Mortgage Bankers Association expects that refinancing activity for 2018 will be 26% lower than in 2017. That will translate to less total origination volume despite a small predicted increase in the volume of purchase mortgages. The industry group forecasts that mortgage rates will continue increasing throughout 2018, reaching 4.9% by the end of the year.
Further, the yield curve flattened in the first quarter, complicating banks' ability to benefit from rising rates. Mortgages have historically followed the 10-year Treasury market. While the 10-year Treasury jumped in the first four months of the year, the 2-year yield increased even more. That put the spread between 10-year and 2-year Treasurys at just 44 basis points, compared to 125 basis points when the Fed started raising rates.
For consumers, the increase in mortgage rates exacerbates affordability challenges for first-time homebuyers in many large metro areas. Still, the impact has been relatively modest so far. Mark Fleming, chief economist for title insurance and real estate services company First American Financial Corp., wrote May 7 that the historical average for 30-year mortgage rates is 8%, so current conditions remain relatively favorable for homebuyers. The expected jump in mortgage rates this year will decrease "house-buying power," or the amount of home the typical household can afford, by just 2% since wage increases will partially offset the affordability impact of higher rates, Fleming wrote.
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