Bank Of America: How Bad Is The Mortgage Situation?

May.22.14 | About: Bank of (BAC)


BAC's mortgage origination revenue fell off a cliff in the year's first quarter.

The stock traded down on this and other information following the report.

What is the financial impact of this decline in mortgage revenue?

Bank of America's (NYSE:BAC) earnings report last month sent the stock down, in what was only the beginning of some ugly trading action for BAC shares. In the release, BAC reported some terrible mortgage-related numbers, along with its competitors. This generally weak mortgage environment is industry-wide, but it makes it no less painful to hear about for shareholders. In this article, we'll take a quick look at just how bad the mortgage problem is at BAC and what it means for shareholders.

First off, we need to understand just how detrimental the mortgage problem is at BAC. In the three months that were reported, BAC produced $10.8 billion of first mortgages and refinancing combined. This seems like a lot, until you realize that last year in the same quarter, BAC produced $25 billion in first mortgages and refinancing combined. In other words, mortgage production was more than cut in half in the first quarter of this year. Ouch.

So we know now that the answer to, "How bad is the mortgage situation?" is, "very." Now that we know mortgage production has fallen off a cliff, what does it mean? First, it means that BAC isn't bringing in the production revenue it did last year, and it showed in the earnings release; BAC produced $542 million less in production income than in the prior-year quarter. This was a result of lower volumes and lower margins, due to interest rate spread compression.

Second, it also means that BAC's mortgage portfolio is running off more quickly than it is being replaced, and indeed, in the quarter, BAC's servicing portfolio declined in size from $810 billion to $780 billion. That is still a sizable portfolio of mortgages, to say the least, but we don't own shares for the size of the company to decline. Now, there is something to be said for BAC not simply running out and lending to anyone with a pulse, as was standard operating procedure for many years leading up to the crisis. But we still need to see the bleeding stop on the mortgage front.

So what does this mean for shareholders? I think we can expect to see pretty much the same thing for the second quarter, as I haven't seen any evidence the mortgage picture is improving. Rising housing pricing has resulted in less affordability in many parts of the country, and that will keep some people from wanting to buy. In addition, the refinancing boom that was a 2012 and 2013 story is clearly dead and gone, so that will likely not be a source of strength in 2014.

However, we still need to put this into perspective in terms of its financial impact. The mortgage malaise makes for a very nice story and bear thesis, but what is the real impact? We know that the first quarter saw a decline in production revenue of $542 million from the year prior, and mortgage servicing revenues declined a further $548 million. Make no mistake, this is ugly. That is an enormous amount of revenue to lose in one quarter from one of the largest segments of a business. However, there is hope.

The first quarter of 2013 was part of the refinance and origination boom that carried large banks' results during 2012 and last year. Thus, BAC's results were juiced and higher than one would have otherwise expected. The government's Home Affordable Refinance Program also drove a lot of business for the big banks, and that well has dried up. In short, I think the results of last year's comparable quarter were too high to make an accurate comparison to this year's results. The deck was stacked against BAC for a favorable comp, and it showed.

I'm not trying to cover up how ugly BAC's first quarter was with the mortgage business, but what I am suggesting is that comparing it to the comparable quarter last year isn't exactly a useful exercise. In fact, the ~$1.1 billion in lost revenue in the first quarter will prove to be the top in terms of how bad it gets for BAC. But even if I'm wrong and BAC can't begin to turn it around, the lost revenue represents something like 4% of BAC's total revenue. We are not talking about a disaster here, even with the worst-case scenario occurring in the first quarter. So while the mortgage picture is pretty much as bad as it gets, it really isn't a huge piece of BAC's income statement anymore, and should be treated as such. And in fact, BAC's total revenue decline in the first quarter was smaller than the mortgage-related revenue decline, indicating that BAC is picking up the slack elsewhere. Just something to think about.

Disclosure: I am long BAC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.