Recently Bank of America has been able to show better than expected profits earning $2.5 billion or 19 cents a share, above analysts’ expectations of 14 cents a share. The housing market has still proved problematic for the bank as investors are calling on it to repurchase more risky soured mortgages. The potential cost of something like this is hard to estimate, coming in around $22.7 billion in the previous quarter, up from $16.1 billion.
As the bank looks to expand earnings and grow it has also managed to save money as mortgage related fees are down. This is of course related to the bank’s purchase of Countrywide Financial which was the nation’s largest sub-prime mortgage lender. Bank of America reiterates that existing bad loans are the result of a poor economy, and not the bank’s ability to underwrite or process loans. This contrasts with shareholder views that the bank should purchase soured mortgages. The bank did not have to pay the record $8.8 billion in mortgage fees it paid last year during this time period. It has outlined that mortgages 60 days late have declined significantly.
Wells Fargo (WFC), one of the beneficiaries of increased mortgages at lower rates, has seen profits increase as a result of a stronger concentration of loans being handled by only large banks. Wells Fargo reported $4.8 billion in revenue in the first six months of this year, a 155 percent increase from the same period last year. Wells Fargo has managed to make 31 percent of the loans to lenders.
Mortgage backed securities have been the source of much profit for banks that seek to extend profits. They are sold to investors as a way of adding extra gains along with slightly higher lending rates.
You are most likely wondering how a bank could make this effective giving the current economy. The reason is because while Bank of America or Chase Corporation (CCF) are the originator of the loans, they are actually transferred to Fanny Mae or Freddy Mac, the government-controlled mortgage giants that offer a government guarantee on payments. This allows for Bank of America or another large bank to sell bonds to investors that are both attractive and high paying.
There is an industry term for defining the profit between the lending rate and the bond rate, simply called the spread. By offering a mortgage at 3.6 percent and selling a bond at 2.6 percent that bank has been able to secure capital for the mortgage and profit once the bond is sold.
According to analysts who track the market, that spread is now at a record high, allowing essentially all banks in the mortgage industry to recover larger profits. The technique I just explained has been in practice for some time, but the increase has been tremendous. Previously the spread was around .5 percent from 2000 to 2010, but lately has jumped to 1.1 percent in the first six months of the year, and this month to 1.26 percent.
The move has allowed for profits to increase at banks, but potentially this could draw the ire of bank regulators. The reasoning is that the federal government in the U.S. currently purchases bank bonds in an effort to relieve toxic mortgages from bank hands. Some regulators may view the practice as dishonest considering the bonds have been purchased in mass to lower rates for consumers and improve the American economy.
Still with America in a constant election cycle and plans for their fiscal and regulatory policies in question, the safe answer for today is that these concerns are currently not an issue.