Bank Outlook 2013: Lower Mortgage Volumes, Higher Interest Rates

As 2013 begins, the US economy is facing higher taxes and an uncertain outlook in terms of jobs and growth. As one senior GOP staffer told The IRA over drinks in Washington last week, we took a European approach to the crisis - namely bailing out the largest banks, etc. This is why there is no traditional recovery in terms of jobs and capital formation.


"We used to shake out all of the losers and start again," notes the veteran Washington financial services operative. "This time we bailed out everyone and there is no job growth. We may already have seen the 'recovery' in 2012."


The other aspect of the refusal by Washington to impose pain on the stock and bond holders of the TBTF banks, for example, is that the Fed is still entirely focused on fighting deflation. Since the US refused to get the process of restructuring done quickly and painfully, the adjustment is ongoing - now six years since the subprime crisis began -- and the US central bank is still trying to avoid a reset in asset prices.


Thus when we look at the US banking system, the outlook seems to be flat to down earnings and revenue for 2013. Mortgage refinancing volumes are likely to be down significantly, creating a significant negative bias in bank revenue and earnings this year.


The Mortgage Bankers Association is expecting new loan origination volumes to fall from $1.7 trillion in 2012 to $1.3 trillion this year, but few Sell Side analysts on Wall Street have taken notice of this fact as yet. The culprit is a drop in mortgage refinancing volumes. As we have noted in previous missives, the US banking sector is going through a serious structural change in terms of sources of new revenue.

"Reduced expenses for loan losses and rising noninterest income helped lift insured institutions' earnings to $37.6 billion in third quarter 2012," reports the FDIC in the most recent Quarterly Banking Profile. "Net interest income was $746 million (0.7 percent) higher than a year ago, even though the average net interest margin (NIM) fell from 3.56 percent to 3.43 percent. The increase in net interest income was made possible by a 4.6 percent increase in interest-earning assets. Two out of every three insured institutions (67.8 percent) reported year-over-year NIM declines, as average asset yields declined faster than average funding costs."


So the good news from the perspective of the FOMC is that banks are putting on more assets. The bad news for banks is that the earnings per dollar of asset are falling with NIM. This trend is due to the other negative factor for US banks in 2013 besides lower mortgage origination volumes, namely the Fed and its zero rate policy.


As we noted in our last comment, net, net the impact of the Fed's purchases of RMBS and zero rates more generally is decidedly negative for banks. Many observers are focused on the continuing fiscal disarray in Washington as the explanation for economic troubles in the year ahead, but we see the FOMC as perhaps the biggest single negative for both banks and consumers.


The impact of financial repression c/o the Fed has been widely noticed for years now, but the members of the FOMC refuse to change their policies. In 2013, however, we see the negative impact of ZIRP on banks and consumer activity becoming even more pronounced. And we also look for some unexpected surprises from the TBTF banks in terms of legacy mortgage exposures.


Once the FOMC finally relents and allows short-term interest rates to rise, we expect to see asset returns at banks improve. Consumers and savers will also start to see their cash flow rise after years of financial repression. But the adjustment process will take years, so for 2013 we think it is safe to assume that margins at US banks will continue to compress under the pressure of ZIRP and constrained consumer activity. So long as the Fed penalizes savers and subsidizes debtors via zero rate policy, there will be no meaningful recovery in the US economy.


But once the Fed does let US interest rates rise -- perhaps as early as the middle of 2013 -- the pressure on Washington in terms of fiscal reform will start to escalate dramatically. For the past six years, the FOMC has given Congress and President Barack Obama a free ride in terms of fiscal issues. As the Treasury starts to see the cost of borrowing rise and Fed purchases of collateral subside, the true dimensions of the fiscal crisis in Washington will become the central concern for global markets and financial institutions. That's when the fun really begins.

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