Mortgage Gamble Pays Off for Wells
The Wall Street Journal
By: Shayndi Raice and Nick Timiraos
April 2, 2013
The San Francisco-based bank has become the dominant U.S. mortgage lender, grabbing an unprecedented 28.8% share of all home loans issued nationwide last year, up from 11.2% in 2007, the year before it bought Wachovia. Its home-loan production hit $524 billion last year, the largest annual total ever for one lender and greater than the output of the next five largest lenders combined, according to the publication Inside Mortgage Finance.
In the lucrative Manhattan market, Wells issued almost 20% of new home loans--almost equal to the volume of its two biggest competitors together, according to real-estate research firm CoreLogic Inc. In San Francisco, it made 21% of new loans, in Los Angeles, 12%, and in Dallas, 9%.
"They are dominating the retail space because they are huge, and because there is so little competition from other big banks that have pulled back," says Alan Rosenbaum, chief executive of GuardHill Financial Corp., a New York-based mortgage bank.
Less than half a decade after nearly bringing down the U.S. financial system, mortgage lending is again churning out big profits for American banks. The lowest mortgage rates in more than 60 years have sent homeowners on a refinancing binge. Banks, after being burned badly by sloppy lending before the financial crisis, have tightened their credit standards, making their new loans much safer.
The big question now looming for Wells and other mortgage lenders is what will happen when the refinancing boom wanes. Loans to purchase homes accounted for only about 25% of the mortgage industry's production last year. Mortgage refinancing accounted for 75%--business that is likely to decline precipitously when interest rates start rising again. Timothy Sloan, Wells's chief financial officer, told investors last month that he expected mortgage revenues to decline in the first quarter--a sign that a refinancing slowdown may have begun.
The mortgage-banking operations of U.S. banks and thrifts reported profits of $31.9 billion last year, about six times the $5.2 billion notched in 2011 and the largest total in at least a decade, according to Inside Mortgage Finance. Wells recorded income of $11.6 billion from mortgage banking last year, up nearly 50% from 2011. Overall net income was $18.9 billion, more than double the company's profit in 2007, the year before the Wachovia acquisition.
Wells wound up in a commanding position partly because its biggest competitor retreated. Bank of America Corp. briefly became the nation's largest housing lender after its 2008 acquisition of lending giant Countrywide Financial, once the nation's No. 1 originator. But that deal soured quickly as the housing market deteriorated, saddling Bank of America with hundreds of thousands of defaulted loans and billions of dollars in legal expenses.
The mushrooming expenses prompted Bank of America to stop buying mortgages originated by other lenders. Its share of the mortgage market plunged to 4.3% last year, from 21.6% in 2009. Citigroup Inc., and Ally Financial Inc. also have ceded market share by purchasing fewer loans from other lenders.
Wells bought Wachovia, then the third-biggest U.S. bank by domestic deposits, at the peak of the 2008 financial panic, upending a hastily arranged effort by the federal government to sell it to Citigroup Inc. Wachovia was at the brink of failure, thanks to a large portfolio of risky mortgages it got when it acquired a California-based mortgage lender in 2006.
Because many of the Wachovia loans hadn't been bundled into mortgage securities and resold to investors, Wells was eventually able to restructure them. Wells had made its share of subprime loans and risky home-equity loans during the housing boom, but it hadn't loosened credit standards as much as some other large lenders.
The Wachovia deal gave Wells the nation's biggest branch network: 3,400 new retail locations--it now has 6,200 nationwide--and a presence for the first time in nine Southern and Eastern states, including New York. It also left Wells well positioned to take advantage of the surge in mortgage borrowing kicked off when the Federal Reserve lowered interest rates and the Obama administration opened up refinancing to more borrowers whose mortgages were underwater.
The financial crisis reshaped the mortgage market. Investors were no longer interested in buying securities fashioned from pools of mortgages without government guarantees--the kind of loans that led to huge losses during the banking crisis. That meant any loans that lenders didn't want to hold on their own books would have to conform to standards set by government-controlled Fannie Mae and Freddie Mac, which continue to buy mortgages for resale as securities, and the Federal Housing Administration.
Executives at Wells concluded that a private secondary market "wasn't coming back anytime soon," says Franklin Codel, who heads loan production for Wells Fargo Home Mortgage. "And so we needed to get more focused and stronger on portfolio lending"--that is, the old-fashioned business of making loans that are held on the bank's books. The bank began staffing up a new team dedicated to reviewing loans that can't be sold to investors in mortgage securities.
Wells also saw portfolio lending as vital to making inroads with high-net-worth borrowers in expensive markets such as New York and San Francisco, where home loans are frequently too big to qualify for resale to Fannie or Freddie. Wells set about learning the ins-and-outs of individual markets.
"To be good at portfolio lending, you have to really understand the nuances of local markets," says Mr. Codel, who oversees a staff of nearly 30,000 loan officers, processors, underwriters and support staff from the West Des Moines, Iowa, headquarters of the mortgage operations.
In San Francisco, that meant learning how to underwrite loans for newly minted technology-company millionaires. "We have found a lot of younger people who were maybe paying $1,800 in rent, and now they're buying a $2.5 million property and looking at a $30,000 monthly payment," says Mr. Codel. A rigid rule book for approving loans didn't work well for such candidates. The push to improve portfolio lending "really helped us to sharpen our pencils when it comes to underwriting," says Mr. Codel.
Wells now has 600 loan salespeople working in San Francisco, up from fewer than 150 in 2001. It has worked to cultivate relationships with real-estate agents, forming a joint venture with Alain Pinel Realtors, a luxury real-estate brokerage.
"Wells Fargo has been much more focused on doing new business. They want to make loans," says Jeff Sposito, the president of J. Rockcliff Realtors, in San Francisco's East Bay.
Bankers have long viewed the New York City market as a plum, thanks to its concentration of high-net-worth customers who buy private-wealth management services, insurance and other financial-services products.
But success in New York has proved elusive for large national mortgage lenders because of the city's unique mix of expensive condominiums and co-op apartments, and wealthy borrowers who have unusual business partnerships, are self-employed or have more assets than income. Mortgages on co-ops and condos are more complex because they require the lender to assess the financial strength of the building, not just the borrower.
Wells aggressively courted local real-estate brokers and developers. It struck deals to become the preferred lender for two of the city's big brokerages, Brown Harris Stevens and Halstead Property. It formed DE Capital, a mortgage-lending operation jointly owned with Douglas Elliman, New York's largest brokerage. Dorothy Herman, chief executive of Douglas Elliman, says Wells agreed to terms that other banks wouldn't, such as allowing her in some circumstances to send clients to outside mortgage brokers.
Ms. Herman says she initially was skeptical about whether a West Coast bank could conquer the anomalous New York market. Today, about 50% of her clients take out a mortgage through Wells Fargo, she says.
The preferred-lender arrangements give Wells "first crack at a lot more loans," says Mr. Rosenbaum of GuardHill Financial, the New York mortgage bank.
Wells helped build a clearinghouse of information to help New York loan officers figure out whether loans in particular real-estate developments would qualify for backing from Fannie, Freddie or the Federal Housing Administration. "It's tedious, tedious work," says Jackie Teplitzky, a Douglas Elliman real-estate agent. "You have to have people that the only thing they do is update that database."
Wells paid thousands of dollars for new condo developments to become "warranted" by the mortgage giants, accelerating the process by which buyers could purchase units with loans eligible for federal backing.
Developments boosted by that money include the BellTel Lofts in downtown Brooklyn, the Tempo in Manhattan's Gramercy neighborhood and Azure on Manhattan's Upper East Side.
With tight credit standards now the norm in the mortgage-lending business, most customers pick lenders strictly based on price and quality of service, brokers say.
"I don't think you care who is giving you the money," says Michael Kafka, a real-estate agent who refinanced his co-op on Manhattan's Upper West Side at 3.85% in October with Wells Fargo. "For me, it was rate driven. That was the bottom line."
Although loan pricing varies day to day and market to market, Wells has a reputation for being competitive, brokers say.
Mr. Codel says one challenge in Manhattan has been learning to underwrite loans for a "different clientele," including the self-employed.
Ronald Simons spent several months last year working with Wells Fargo to arrange a $1 million adjustable-rate loan to buy a condominium in Manhattan's Hell's Kitchen neighborhood before giving up and taking the business to a local brokerage. Mr. Simons, who has owned several other properties, says his experience with Wells was "the most stressful, inefficient process of trying to get a loan that I have ever had."
Although Mr. Simons was making a sizable down payment, he ran into problems because he runs his own business, a film and theater production company that had operating losses in its first two years. He says Wells wanted him to move money into the bank's private-wealth business.
A Wells spokeswoman declined to discuss individual customers, saying only that the bank has a responsibility "to take the time necessary to assure that we're making a loan that the customer can responsibly sustain."
Wells is already bracing for the end of the refinancing boom. It hopes that building relationships with real-estate brokers and developers, as it has done in New York, will soften the blow. About 35% of Wells's mortgage production last year came from home-purchase lending, 10 percentage points above the industry average.
Regulators have expressed some unease about the concentration of the mortgage industry.
While the top five lenders account for the same share of the market as they did before the financial crisis, Wells Fargo's current share eclipses that of Countrywide, the top lender in 2007.
"We have seen a great deal of concentration" in the mortgage industry, Edward DeMarco, acting director of the Federal Housing Finance Agency, said last May. Policy makers need to "think hard," he said, about how regulation has promoted concentration "and what might be done to reverse this." He didn't refer specifically to any bank.
To some, Wells's market dominance isn't a bad thing. Scott Simon, a managing director at bond giant Pacific Investment Management Co., or Pimco, a unit of Allianz SE, contends that if Wells followed its larger rivals in retreating, "credit would be more expensive."
Wells's Mr. Codel notes that half of the bank's mortgage business comes from loans that Wells purchases from smaller companies. "I talk to regulators regularly and remind them that," he says. "It's really important to remember 85 of 100 customers are going to a competitor of ours."
Mr. Sloan, the bank's chief financial officer, told investors last month that Wells continues to see good opportunities in mortgage lending despite the fact that its huge market share likely won't last. "We're not assuming that we're going to continue in this environment forever," he said, "because it's really mathematically impossible."
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