US Equity | Financial Services

wfc

bac

jpm

I will be providing a review of the fourth-quarter 2014 bank call reports in a few weeks, but in the meantime there is a situation developing among the top four U.S.-based money centers.

The year-to-date performance of their stocks has been dismal, much of which can be attributed to the pressure being placed in their net interest margins caused by the 40 basis decline in the yield on the 10-year U.S. Treasuries in the past month.

Year to date, Bank of America (BAC) is down almost 14%, JPMorgan Chase (JPM) has lost almost 11% and Citigroup (C) is off by 12%.

Interestingly, Wells Fargo (WFC) is only down about 3%. The stock appears to benefit from the pervasive expectations that declining 10-year yields will drag down mortgage rates, stimulating both refinance and housing purchase activity, and thus mortgage lending.

But there’s a problem with that expectation. Long-end Treasury yields and mortgage rates have been declining for the past 13 months. Throughout this period, home purchase activity has continued to deteriorate for both new and existing properties.

Although this has had a detrimental impact over the past year on the homebuilders stocks, as I discussed last week in the column Homebuilders May Signal a Correction. it has not impacted traders’ and investors’ expectations for the performance of Wells Fargo.

In the past year, even as Treasury yields and mortgage rates declined, the stock prices of Bank of America, JPMorgan and Citigroup have lost 9%, 1% and 2%, respectively, while Wells Fargo has advanced by 15%.

This is nonsensical, with the negative performers being more indicative of real potential for the sector. Additionally, because of the concentration of its business being in the residential mortgage lending space, Wells Fargo’s stock should be even more sensitive to the poor performance in the housing sector than the other three.

The chart below shows the performance of both prices and sales of new and existing homes on a smoothed basis.

The rate of growth in both sales and prices for new and existing homes is decelerating, similar to the situation that occurred during the early part of the last housing crisis.

The most important issues to note are that this is happening even as mortgage rates have fallen dramatically over the past year and the growth in the sale of existing homes is approaching 0%.

Existing home sales are about 80% of the home purchase market and traditionally represent a commensurate percentage in dollar volume of purchase money mortgage originations.

Even as housing activity continues to slow, investors appear to be pricing Wells Fargo’s stock on the assumption that declining mortgage rates will allow for refinance activity to more than offset the decline in purchase activity.

The problem with that, however, is that mortgage rates, even though they’ve come down from the highs set in 2013, are still about .5% on a 30-year fixed conventional conforming basis, above what they were in early 2013.

Because of that, the majority of the potential refinance market available is limited to those having purchased homes between September 2013 and September 2014, which means the recent surge in refinancing requests will be very limited.

In order for refinance activity to increase substantially, the 30-year fixed mortgage rates would need to get to around 3%, which is about .25% below the record lows of early 2013.

That would imply a 10-year Treasury yield falling to sustained record lows of below 1.5%.

Although that’s possible, between the current yield/rate environment and that occurring, the mortgage business available to Wells Fargo, for both purchases and refinances, is much more limited than investors are pricing the stock for currently.

It is probable that investors will awaken to this reality soon, as they have for the homebuilders stocks, and that Wells Fargo’s stock will reflect a performance closer to that of the other three money centers soon, rather than the other three correcting upward to meet the performance of Wells.