Loan growth in the fourth quarter was led by credit cards and C&I loans, with loans on 1-4 family mortgages up less than 1%, according to a client note from Kroll Bond Ratings Agency, and consequently KBRA expects that bank lending in the residential mortgage space will continue to wane in the first quarter of 2015 as commercial lenders retreat from the sector due to high compliance costs and other factors.

Earnings for the U.S. banking sector declined under the weight of the zero interest rate policy of the Federal Open Market Committee at the end of the fourth quarter of 2014, and not surprisingly, asset returns for all U.S. banks actually fell below 1% for the first time in two years, KBRA says.

Kroll Bond Rating Agency believes that bank earnings and asset returns are likely to continue to be under pressure through 2015 and beyond as institutions try to offset declining core earnings on assets with efforts to boost fee revenues, realize greater operating efficiencies, asset sales and other expedients. 

“While KBRA does not see any imminent credit issues affecting larger banks – indeed, credit spreads for large banks are tighter now than pre-2008 levels – we expect these institutions will continue to underperform in terms of asset returns, volumes, margins and loan growth, partly due to pressure from regulators to increase capital and liquidity,” the client note says. “We view these greater regulatory requirements positively given the scope of problems at many of the large banks during the financial crisis.”

Laurie Goodman of Urban Institute notes that “the FICO scores required by lenders in making [1-4 family] loans have increased significantly—thereby decreasing the number of loans made to potential buyers with credit scores under 720.”

KBRA says that though this is positive from a bank credit perspective, the decade old decline in mortgage lending volumes is obviously not a positive for the housing sector. 

“Banks continue to take advantage of distortions and discontinuities in the financial markets that are a direct result of the low rate environment. For example, sales of 1-4 mortgages into the agency market surged 31% in Q4 2014 versus Q4 2013 as banks seized upon gain-on-sale opportunities presented by the nearly 1% primary-secondary spread in the agency RMBS market, nearly double the long-tern average for this key measure,” KBRA says. “Several large banks were seen selling seasoned loans from portfolio into the agency market in the second half of 2014 to capture gain on sale opportunities.”

They note that banks also continued to take advantage of spreads on mortgage servicing rights in 2014, selling these valuable negative duration assets to capture short-term profits.

Spreads for conventional MSRs have been holding steady in the 4-5x cash flow range, while MSRs on government guaranteed loans have been trading in the 3-4x cash flow range, this due to the greater cost of financing FHA MSRs.

“Regional and community banks in particular have been using MSR sales to offset tightening net profit margins on mortgage lending and other assets caused by Fed rate policy, but such efforts have limited utility and weaken bank earnings power longer term,” KBRA says. “KBRA finds it quite striking that even though the primary-secondary spread in the mortgage market is at record levels, overall regulation and other costs are making mortgage lending unprofitable for many banks, large and small.”