Investment Contrarians

Mortgage Rates on the Rise; Repeat of Lead-Up to 2008?

By for Investment Contrarians |

Mortgage Rates on the Rise; Repeat of Lead-Up to 2008One reaction that should not surprise long-term investors is that the market will move far quicker and further than most people expect. Even before the Federal Reserve has made any statement regarding the timing of reducing its asset purchase program, investors have already begun selling their fixed-income investments, which is causing yields to rise.

This is now resulting in higher mortgage rates.

According to the Mortgage Bankers Association, the average for 30-year mortgage rates increased to 4.15% last week, a substantial move from May’s average for 30-year mortgage rates, which was approximately 3.59%. (Source: “Mortgage Rates on Six Week Streak Higher,” Wall Street Journal, June 13, 2013, accessed June 14, 2013.)

Even though long-term mortgage rates at 4.15% are still near historically low levels, this has impacted refinancing, which will in turn affect certain bank stocks that have benefited from the boom of lower mortgage rates.

The Mortgage Bankers Association also reported that applications for mortgage refinancing are down 36% since the beginning of May. This is a direct result of higher mortgage rates.

Many bank stocks have benefited from refinancing revenue brought on through lower mortgage rates. This revenue generation appears to be in jeopardy, at least resulting in lower revenue growth rates, since fewer homeowners will refinance as mortgage rates continue to rise.

However, the positive sloping yield curve is a benefit for bank stocks, as they make the spread between paying short-term rates and lending at long-term rates. The greater the spread, the larger the possibility of profits.

The question regarding bank stocks is: will new lending be large enough to compensate for the decline in refinancing caused by higher mortgage rates?

That’s a difficult question to answer; however, another way to look at the situation is to instead consider this question: what is the current value of bank stocks, and how much future revenue is the market pricing in?

As we all know, bank stocks have made some tremendously strong moves over the past few months, as shown in the chart of the financial sector below. Many of these moves have been fundamentally driven, as both revenues and earnings have grown substantially.

However, as mortgage rates have begun rising, bank stocks now face headwinds from a very large business segment—that of refinancing. Considering the move up in the price of most bank stocks, I would certainly be cautious in forecasting the level of revenue growth as mortgage rates make their upward adjustment.

Financials Select Sector Chart

Chart courtesy of www.StockCharts.com

While bank stocks might generate new business, several have refinancing as a large share of their mortgage business. Just a couple of bank stocks that I would be worried about due to the share of mortgage refinancing are Bank of America Corporation (NYSE/BAC) and Citigroup Inc. (NYSE/C).

Over the next few years, I believe mortgage rates are set to continue rising higher, and this will put significant pressure on many business segments for bank stocks. Considering the strong performance for most bank stocks, I think that it would be prudent to consider taking profits and reducing exposure in one’s portfolio to this sector.

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