Mortgage rates are super low, but they could be lower

By AnnaMaria Andriotis

While the yield on the 10-year U.S.Treasury note has been plummeting, mortgage rates haven’t fallen quite so fast.

After plumbing record lows earlier this week, the 10-year yield was around 1.41% on Thursday. The national average for a 30-year, fixed-rate conforming mortgage was 3.41%, according to the latest data from Freddie Mac out Thursday. The difference or spread between the two, at 2 percentage points, has risen in recent weeks and is at its widest since mid- 2012.

In other words, banks aren’t sharing the entire low-rate bounty with borrowers. Indeed, if the difference between the 30-year mortgage rate and the 10-year Treasury yield were at its average level for the previous 10 years, the average mortgage would be 3.17%. Mortgage rates key off the 10-year Treasury because most homeowners tend to move after around 10 years, repaying their loans in the process.

Even so, borrowers are doing well. Rates around 3.5% are historically low. And the fact that the national average has dipped decisively below 3.5% may spur even more borrowing activity. A range of average rates between 3.6% and 4% has occurred many times for 30-year fixed-rate mortgages since 2012, but they fell below 3.5% for only brief periods; the record low of 3.31% was hit in November 2012.

For banks, and their investors, this is all good news, especially going into second-quarter results later this month. Gains in mortgage-origination revenue could help offset pressure elsewhere in banks’ businesses as low rates crimp profits.

Indeed, banks could benefit from mortgages on two fronts. First, lenders are in an improving-volume environment thanks to a pickup in borrower demand for refinances and home purchases as rates have fallen. Total mortgage originations for the year are expected to hit $1.663 trillion, up 2% from 2015, the Mortgage Bankers Association forecast on June 20. That was the fifth time this year the group has raised its guidance; at the onset of 2016 it was forecasting a 15% decline.

Refinance application volume rose 21% last week from the prior week and is at its highest level since January 2015, according to Mortgage Bankers Association data out Wednesday. So-called refis accounted for 62% of total mortgage applications.

“Lenders are going to be busy fielding those inbound calls,” said Mike Fratantoni, chief economist at the MBA. ” Particularly for those focused on refinance business, lenders should benefit from the increases in origination volume.”

The second positive for banks: That mortgage rates haven’t come as far down as they could shows that firms are exercising profit discipline. One proxy for their profits averaged 1.19% on July 1, compared with a year-to-date low of 0.88% in January, according to Bose George, a mortgage analyst at Keefe, Bruyette & Woods Inc. That represents a rolling average of the difference between the average interest rates lenders are charging on 30-year fixed-rate conforming mortgages and the amount of that rate that gets passed on to investors of Fannie Mae mortgage-backed securities.

Spreads will “be up quite meaningfully in the second quarter and more importantly should persist and show even more strength into the third quarter,” Mr. George said. That reverses a trend of declining spreads experienced in much of 2015. Those last peaked at 1.46% in October 2012.

Retail mortgage lenders that lend directly to borrowers and collect most of the profit stand to benefit the most from the current environment, said Paul Miller, an analyst at FBR Capital Markets. One potential winner, he added, is Wells Fargo, the leading U.S. mortgage lender by volume. Around 15% of its noninterest income comes from mortgages, while the contribution is far lower at J.P. Morgan Chase & Co. and Bank of America Corp.

The good times won’t last forever for banks. They could be forced to lower mortgage rates once the latest wave of demand slows, Mr. George said. Assuming Treasury yields remain where they are, borrowers who wait it out could see mortgage rates fall to 3.25% or maybe even lower than that this year, he said.

Write to AnnaMaria Andriotis at annamaria.andriotis@wsj.com

Source: The Wall Street Journal