Could Higher Rates Kill the Housing Recovery?

source: http://www.flickr.com/photos/wwworks/

source: http://www.flickr.com/photos/wwworks/

Wells Fargo (NYSE:WFC) is the largest mortgage lender in the U.S. The bank was reportedly responsible for one in four home loans in the first half of 2013, down from as many as one in three in the first half of 2012, but still at the head of the industry. In the second quarter, the bank reported that net income climbed 19 percent on the year, with $112 billion in residential mortgage originations. Boosting profits was the fact that losses related to mortgage loan repurchases have been on the decline — just $65 million in the second quarter compared to $305 million in the first quarter.

All told, it’s been a pretty good year for Wells Fargo. Fueled in part by the recent boom in the housing market — buyers can’t seem to resist historically low rates — shares have climbed more than 19 percent this year to date. Through August, the stock had climbed as much as 24 percent YTD, but shares have slid about 3.5 percent over the past month.

Part of the reason for the recent decline is a perception that rising interest rates will negatively impact the bank’s mortgage origination business, which is a critical component of its success. The bank’s chief financial officer, Tim Sloan, said at the Barclays investor conference this week that originations could decline as much as 29 percent in the current quarter thanks primarily to rising rates.

So have far have rates come? Since dipping below 3.5 percent in May, the average commitment rate on a 30-year fixed-rate mortgage has climbed rapidly to about 4.5 percent. The reason? By and large, the specter of asset tapering by the U.S. Federal Reserve, which has spooked yields higher. The benchmark 10-year Treasury has skyrocketed over the past few months, climbing from nearly 2.1 percent in June to more than 2.9 percent in September.

As a result of climbing rates, mortgage applications have generally been on the decline. The latest report from the Mortgage Bankers Association showed that for the week ended August 30, applications increased 1.3 percent on a seasonally adjusted basis, the first increase in 17 weeks. The industry group’s refinance index increased 2 percent while the seasonally adjusted purchase index fell by 0.4 percent. Overall, the refinance share of mortgage activity accounted for 61 percent of total applications, up 1 percent from its lowest level in over two years. In fact, the refinance index has crashed more than 60 percent from its peak during the week of May 3.

30-year

While the increase in rates may become a headwind for Wells Fargo, Sloan does not expect it to kill the housing recovery. According to Bloomberg, Sloan said: “We don’t believe that the recent increases in mortgage rates are going to in any way, shape or form snuff out the housing recovery. When you look at any sort of statistics in the demographics in terms of household creation as well as household affordability, they are still very attractive and should drive a continued recovery in the housing business.”

Sloan echoed comments made by Lawrence Yun, the National Association of Realtors’s chief economist, who believes that a pullback in pending home sales is nothing to panic about. He said in a press release, “The modest decline in sales is not yet concerning, and contract activity remains elevated, with the South and Midwest showing no measurable slowdown.”

The Pending Home Sales Index, a forward-looking indicator based on contract signings, fell 1.3 percent to 109.5 in July compared to 110.9 in June, according to the National Association of Realtors. After posting its strongest pace since 2006 in May, the index has now declined for two consecutive months.

Don’t Miss: Don’t Worry: The NSA Is Monitoring the Global Economy for Us.

More from The Cheat Sheet