Mortgage-heavy banks advised to redeploy cash to boost earnings

While mortgage-heavy banks may see an impact on their earnings due to decreased originations, they can mitigate that by strategically redeploying excess cash, a Keefe, Bruyette & Woods report said.

The improved U.S. economy and growing vaccination rates have contributed to rising mortgage rates in recent weeks.

"And while [rates are] still very low by historical standards, we believe this will begin to have a dampening impact on mortgage banking results in the coming quarters for many banks," said KBW Head of U.S. Bank Research Chris McGratty. "Looking ahead, however, we expect mortgage banking revenues to begin to moderate in 2021 [down -18% from 2020 for all banks] and further in 2022 [down -10% from 2021 all banks], and this pressure is more pronounced for mortgage-heavy banks."

Among those on his list of mortgage-heavy banks are Hilltop Holdings (the parent of PlainsCapital Bank and PrimeLending), Flagstar, MVB Financial, FB Financial, Ameris Bancorp, National Bank Holdings and First Western Financial.

Flagstar is also on McGratty’s list of 10 mortgage warehouse heavy banks that are expected to see reduced revenue as nonbank mortgage lenders have less need for these short-term loans.

Mortgage banking revenue increased to 4% of total revenue in 2020 from 2% in 2019, according to an analysis of the banks KBW follows. By 2022, KBW expects revenue to slip to 3%.

However, for the mortgage-heavy banks, that line of business represented 21% of total 2020 revenues, up from 10% in 2019. That revenue is expected to shrink to 15% in 2021 and 13% in 2022.

KBW's model determined that the seven banks listed above are looking at a median 41% decline in mortgage banking revenues over the next two years. While gain on sale margins are likely to contract, servicing returns should increase because mortgage servicing rights will remain on the books longer with fewer refinancings.

For investors, that means the potential revenue headwinds from slowing mortgage banking activity is largely captured in earnings per share estimates, McGratty said. Still, the narrative around EPS revisions should also include the potential for positive revenue adjustments from excess cash deployment.

"Said another way, single-variable EPS sensitivity analysis (mortgage) is incomplete without also assessing the EPS upside potential from what we believe is a far more meaningful earnings lever over time (excess cash deployment)," he said.

He writes that the most attractive remixing opportunity would involve putting 50% into securities, including mortgage-backed securities, and 50% into other forms of loans.