About an hour ago, Bank of America served the latest indication that the US housing "recovery" (also known as the fourth consecutive dead cat bounce of the cheap credit policy-driven housing market in the past five years) may be on its last breath. Namely, the bank announced that it will eliminate about 2,100 jobs and shutter 16 mortgage offices as rising interest rates weaken loan demand, said two people with direct knowledge of the plans and reported by Bloomberg. In some ways this may be non-news: previously we reported, using a Goldman analysis, that up to 60% of all home purchases in recent months have been, which of course shows just how hollow the "recovery" has been for the common American for whom the average home has once again become unaffordable. However, judging by an update presentation given earlier today by the CFO of none other than JP "fortress balance sheet" Morgan, things are rapidly going from bad to worse for the banking industry as a result of the souring mortgage market for which, absent prop trading, loan origination is the primary bread and butter.
Among the various stern warnings about the housing, and thus mortgage, market:
- The mortgage market volume reduction has been dramatic and rapid
- Primary and secondary mortgage rates have increased >100 bps since the lows in early 2Q13, driving
- More than 60% reduction in market refinance applications relative to peak in May 2013
- 2H13 U.S. market originations expected to be down 30-40% versus 1H13
How this impacts the company's bottom line:
Medium-term profitability challenged by:
- Lost revenue from volume
- Purchase volume expected to increase but not to replace lost refinance volume
- Compression of revenue margins
- Due to competitive pressures, change in mix and higher secondary rates
- Negative operating leverage
- Adjusting capacity of the business will take time
- Addressing fixed costs may take longer
- Expect 3Q13 and 4Q13 pretax margin to be slightly negative
But while JPM is lucky in that it does have alternative sources of revenue (the CIO prop trading desk which has nearly $500 billion in excess deposits to invest in risky assets) other banks - such as Wells Fargo - are not quite as lucky, and must maintain a Net Interest Margin-driven revenue stream. However, if loan demand for the highest volume loan product, mortgages, evaporates as a result of spiking rates, such banks are out of luck. It is for them that the following warning about the state of the industry is more dire.
- Increase in rates has reduced the remaining refinance opportunity by >50%
Reread that last bullet point because it explains precisely why the recent jump in rates by only 1% has so much convexity. Despite what bullish pundits desperately attempt to talk down, when they say that the rise in rates is "only" 1%, it is the relative change in demand as a result of the move in mortgages higher by that just 1% from 3.5% to 4.5%, that has crushed the "refinancing opportunity" by more than 50%!
And there goes the Net Interest Margin driven renaissance because of refis are done, and if the majority of home purchases are all cash then... what loan demand is there?
In conclusion, JPM was also kind enough to inform investors how much of its earnings will be "vaporware", or as they are better known, reserve reductions and releases:
- Q3 Mortgage reserve releases:
- NCI: expect $500mm+/-
- PCI: expect $750mm+/-
- Q3 Mortgage charge offs:
- 3Q13: expect $200mm+/-
- H2 For Credit Card reserve releases:
- Expect $500mm+/- reserve release
But it won't be all reserve releases. On the call the firm added that "JPMorgan Chase & Co., the biggest U.S. bank, increased its litigation reserve by more than $1.5 billion in the third quarter to help cover a “crescendo” of potential legal claims.
To summarize: artificial Net Income boost from $1.750bn in reserve release for which the firm will take credit, offset by a $1.5 billion "non-recurring, one time" (if recurring and pretty much all the time these days) litigation release addition, which the sell-side will be sure to ignore as they are, of course, non-recurring.
And stepping aside from mortgage-related issues, "3Q13 Markets revenue, excluding DVA, expected to be flat to down 5% YoY." Looks like plunging trading volumes are not exactly helping.
Full presentation below: