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Many banks seem to be exiting the mortgage industry at its bottom which, in my opinion, is a grave mistake. Several banks will regret such decisions while those that continue to weather the storm and even expand mortgage operations will prosper significantly. This article will first review recent real estate and mortgage origination trends. Then it will highlight some notable actions of key banks and lending institutions. It will become clear that some banks are clearly "selling low," while others are "buying low." Those in the former category are shedding assets at below book value and thus eroding shareholder value. Those in the latter category are more long-term minded and are capitalizing on relatively cheap opportunities to expand and ultimately offer much more return on investment to shareholders. Investors may consider a long/short strategy whereby they purchase shares of those that are expanding while shorting those that are selling out.

Real Estate Trends

According to the National Association of Realtors (NAR), real estate agent sentiment improvement accelerated in December and the NAR sales metrics have been flat over the last two months. The key data pertains to investor activity. Investor share of the purchase market has hit record levels with Investors renting more than they are flipping. This is a sign that the return on real estate has hit very attractive levels relative to those attainable elsewhere in the financial markets, a key sign of a bottom in the Real Estate market. Additionally, cash financing is nearly at the same level as conventional and FHA/VA financing, indicating that investors are making their cash work in the Real Estate market. According to Case-Schiller, distressed sales have a greater share mostly due to a seasonal decline in non-distressed sales. And investors have absorbed most of the increase in short sale activity.

Mortgage Origination Trends

According to LPS, "those loans originated over the last two years have proven to be some of the best quality originations on record. Likely a result of tighter lending requirements, 2010-11 vintage originations showed 90-day default rates below those of all other years going back to 2005. December origination data also shows that recent prepayment activity, a key indicator of mortgage refinances, has remained strong with 2008-09 originations, high credit score borrowers and government-backed loans having benefited the most from recent, historically low interest rates." 4Q11 volume rose 19% from 3Q11 to $400B as record low mortgage rates drove a new wave of refinancing.

Bank Actions

Given the above information, I believe the market is finally nearing the bottom and would look to expand mortgage originations rather than exit the business. Yet, unsurprisingly some beloved banks are doing the opposite:

Bank Of America (NYSE:BAC) - On February 4, 2012, Barbara Desoer announced her retirement from Bank of America which has taken a reduced role in the mortgage market after exiting the correspondent lending and wholesale origination businesses.

Citibank (NYSE:C) - On February 1, 2012, CitiMortgage, the nation's sixth largest residential wholesaler, informed its loan brokers that it will cease table funding loans as it prepares to exit the Wholesale origination channel. The prior week, Citi announced it will no longer purchase "medium or high-risk" loans that could result in buyback requests from Fannie Mae (OTCQB:FNMA) or Freddie Mac (OTCQB:FMCC) in the bank's latest effort to improve the quality of mortgages it buys from correspondent lenders.

Flagstar Bank (NYSE:FBC) - The $13.6 billion-asset company from Troy, Mich., said on January 25, 2012 that it would suspend dividend payments on its trust-preferred securities and its government bailout funds so it could further bankroll its mortgage banking operations and complete its transformation to a more commercial-oriented bank.

Metlife (NYSE:MET) - On January 16, 2012 Metlife decided to shutter its home lending unit after trying to sell it.

Despite the mass exodus of major players in the industry, I believe there are a few who are making the right decisions:

Wells Fargo (NYSE:WFC) - Wells Fargo continues to hold # 1 market share in the industry and exceeded 30% market share, which is a first for the industry. It saw gains in both its retail and correspondent lending divisions.

JPM Chase (NYSE:JPM) - J.P. Morgan Chase & Co. has seen a surge in residential loans refinanced through a flagship government mortgage program. Additionally, CEO Jamie Dimon recently stated he sees a bottom in the housing market.

I believe that investors who are long WFC and JPM while short some of the banks in the former category could earn handsome rewards this year, especially if the housing market has hit bottom. As an investor, I look for management that is proactive rather than reactionary. Those who are exiting the business now are the latter and could be criticized for their slow reactions. Real estate markets historically have had long cycle times, and given that the market has declined for 5 years, the decision to exit the business should have been made years ago, not now.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Source: Real Estate Trends: 2 Banks That Are Buying Low