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We believe the U.S. housing sector has bottomed. We further believe this improvement in the U.S. housing sector will have a favorable impact on U.S. mortgage originations, which will result in the outperformance of the U.S. banks that have exposed their operations to the housing sector. We have identified four such banks (Wells Fargo (NYSE:WFC), JPMorgan (NYSE:JPM), U.S. Bancorp (NYSE:USB) and Regions Financial (NYSE:RF)) that will benefit the most from this recovery. The remainder of the article aims to discuss the recent favorable activity in the U.S. housing sector, its impact on the U.S. mortgage market and each bank's exposure to the housing sector.

Recent Developments in the US Housing Sector

In one of our previous reports on the U.S. housing sector, we noted that the sector had bottomed and was now recovering. We noted the increase in both new-home and existing-home sales, supported by a healthy trend in the S&P Case-Shiller National Price Indices. We also noted how share prices of home builders had appreciated by about 50% since the beginning of the year.

One of the leading indicators of the U.S. Housing sector, the Case-Shiller Home Price Index, increased 1.14% in the month of June over the previous quarter of the same year. Case-Shiller Home Price Index Composite 10 and Case-Shiller Home Price Index Composite 20 demonstrated a similar trend, increasing 1.01% and 0.94%, respectively. These activities in the U.S. Housing markets coupled with record low mortgage rates (30-year mortgage rate at 3.55% and 15-year mortgage rate at 2.86%) have favored the U.S. mortgage markets.

Activity in the U.S. mortgage Markets

Favorable activity in the U.S. mortgage markets can be seen in the upward trend in U.S. mortgage applications and U.S. mortgage originations. Mortgage applications increased, as demonstrated in the table below. The purchase index increased 12% YoY, while the refinance index appreciated approximately 25% over the same time.

The graph below depicts the inverse relationship between the 30-year fixed mortgage rate and the refinance index. It clearly demonstrates that refinancing is driven by low mortgage rates.

Source: Mortgagenewsdaily

U.S. mortgage originations, at $372 billion for the second quarter of the current year, are up 2.5% from the prior quarter's $363 billion. These healthy activities will have a positive impact on U.S. banks that have a large exposure to the U.S. Housing sector. Earlier in a report, we noted that Wells Fargo, Bank of American (NYSE:BAC) and Regions Financials were good investment opportunities if an investor wanted to play the recovery of the U.S. Housing sector. We add to the list JPMorgan and U.S. Bancorp. The remainder of this report aims to look at their exposure towards the U.S. mortgage sector.

Wells Fargo

Among the money center banks, Wells Fargo is considered to have the largest exposure to the U.S. Housing sector. It has established itself as the largest residential home mortgage originator in the U.S., with one out of every three new mortgages in the U.S. in the first two quarters of the current year being made by the bank. Compared to this, the bank originated one out of ten new mortgages in the year 2004. During the second quarter of the current year, the bank made home originations worth $131 billion, up 155bps. Taking into account the current mortgage originations level of $372 billion, if the bank continues to make the same mortgage originations of $131 billion, it will continue to make approximately 1 out of every 3 new mortgages.

We believe WFC will continue to rule as the new mortgage originator in the coming quarter. $208 billion worth of mortgage applications were received by the bank during the second quarter of the current year. This is approximately 11% more than the applications received by the bank during the previous quarter. Overall, around 28% of the bank's non-interest income accrues from mortgage-related activities. Most of the mortgages originated by the bank are not kept on its balance sheet, which is why only 4% of the interest income comes from mortgages. Another reason to favor the bank is its scarce presence in debt-stricken Europe. At the end of the second quarter, the bank had a Tier 1 capital ratio of 11.7%.

Wells Fargo posted strong second quarter results, and we believe it will continue to ride the recovering U.S. housing markets in the future. Therefore, it is our most favored bank to play on the U.S. housing recovery.

JPMorgan Chase

JPMorgan, the largest U.S. bank, is considered to have the second largest share in U.S. mortgage originations. It has a Tier 1 capital ratio of 11.3%. For the second quarter of the current year, the bank originated mortgages worth $44 billion, against $34 billion in the same quarter of the previous year. This is a surge of 29% in one year. JPMorgan's mortgage origination, as a percentage of the total U.S. mortgage originations for the second quarter of the current year, comes out to be 12%. Total volumes of mortgage originations improved 37% over the previous year to $66.9 billion.

Amidst reports of a $2 billion trading loss that swelled to $5.8 billion, we recommended our investors to stay away from the stock until the bank gave a clear picture on its risk management systems, and the steps it is taking to improve its internal controls. However, the bank will be one of the major beneficiaries in the event of the anticipated U.S. housing recovery. Therefore, investors looking to play the U.S. housing recovery are recommended to buy the stock.

U.S. Bancorp

U.S. Bancorp operates as a regional U.S. bank and caters mostly to the Midwestern U.S. population. The bank reported strong second quarter results. Much of the improvement in the second quarter results was associated with the increase in mortgage originations. Mortgage originations and retails loans for the bank totaled $28.1 billion. Non-interest income increased by 8.4% in the second quarter, largely due to income from mortgage-related activities. We believe the bank, with a Tier 1 capital ratio of 10.7%, will benefit from the encouraging activity in the U.S. housing sector, which is why we reiterate our bullish stance on the stock.

Regions Financial Corporation

Regions Financials operates as a regional bank in the U.S., which means it does not have any operations in Europe. The bank has a lower Tier 1 capital ratio of 11.02% as compared to WFC. Mortgage originations for the second quarter of the current year totaled $2.1 billion, as compared to $1.4 billion in the linked quarter. Earlier, we concluded that the bank will benefit from the growth in its low cost deposit base. Combined with that advantage, we believe Regions Financial will outperform most of its regional peers on the U.S. housing recovery.

Valuations

The stocks of the two money center banks, Wells Fargo and JPMorgan, trade at a premium of 35% and a discount of 20% to their respective book values. The stocks of the two regional banks, U.S. Bancorp and RF, trade at a premium of 94% and a discount of 29% to their respective book values.

Source: 4 Banks To Buy On The U.S. Housing Recovery