Will Wells Fargo Earnings Defy the Mortgage Slowdown?
Wells Fargo will release its quarterly report on Friday, and the bank's investors are bracing themselves for what could be a dramatic slowdown in the number of mortgages the bank originated in the third quarter. Yet, even as Wells and rivals JPMorgan Chase and Bank of America make job cuts in their mortgage departments, will the rise in mortgage rates really hurt Wells Fargo's earnings as much as some shareholders fear?
Banks have enjoyed huge gains in recent years, as their recoveries from the financial crisis went better than most people would have expected. Now, though, the Federal Reserve's threat to remove the stimulus that quantitative easing has provided has caused a big rise in interest rates, and that, in turn, has sent the mortgage market into turmoil. Wells was one of the first to say it would cut jobs in response, but Citigroup , B of A, and JPMorgan quickly followed suit. The question is whether Wells can move forward with its other business lines to make up for any reduction in income from mortgage operations. Let's take an early look at what's been happening with Wells Fargo over the past quarter, and what we're likely to see in its report.
Stats on Wells Fargo
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Earnings Beats in Past 4 Quarters
Source: Yahoo! Finance.
Can you bank on Wells Fargo earnings growth?
Surprisingly, analysts have gotten more optimistic about Wells Fargo's earnings in recent months. They've boosted their views for the third quarter by $0.05 per share, and added more than double that amount to their full-year 2013 projections. The stock, however, has stalled out, falling 5% since early July.
We got a taste of what higher interest rates could do to Wells Fargo when it released its second-quarter report in July. Wells posted a big profit increase of 19%, but most of the increase came from the bank reducing its provisions for loan losses. Higher rates caused a $6.1 billion net unrealized loss on its securities portfolio, and mortgage originations fell almost 15% from year-ago levels. Moreover, the industry's expectations are even worse for this quarter, as Wells expects a 30% decline in mortgage activity, while JPMorgan sees mortgage volume falling an even more dramatic 40%.
Yet, the thing investors are forgetting about Wells is that it does a lot more than just make mortgage loans. With commercial loans making up about half of Wells' total loan portfolio, the bank will be in a better position to earn increasing interest income from commercial loans that tend to be more immediately sensitive to rate increases. Moreover, with mortgages making up only about a quarter of Wells' total fee income, even substantial mortgage-income drops won't have as large an impact on its overall non-interest income as some fear. Wells' return on equity has jumped to impressive levels, with its 13.5% ROE beating out JPMorgan's 12.2%, and dwarfing B of A's 2.8% figure over the past 12 months.
Another forgotten point among many bank investors is that competition among banks is still important. For instance, Bank of America has a huge lead in deposit market share in Wells' backyard of San Francisco, although Wells has grown deposits faster than B of A over the past year. Despite its Western emphasis, Wells also faces residential-loan competition from Citigroup in the Las Vegas market, and Midwest-regional powerhouse U.S. Bancorp throughout California. Yet cross-selling is the big advantage Wells Fargo has over its competitors, as it has demonstrated an uncanny ability to get existing customers to add new products and expand their relationships with the bank.
In the Wells Fargo earnings report, look beyond the headline numbers to see what's driving results from specific units within the bank. The mix of income and revenue could tell a lot, not just about Wells Fargo, but about the banking industry in general for the remainder of 2013.
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The article Will Wells Fargo Earnings Defy the Mortgage Slowdown? originally appeared on Fool.com.Fool contributor Dan Caplinger owns warrants on Wells Fargo, Bank of America, and JPMorgan Chase. You can follow him on Twitter @DanCaplinger. The Motley Fool recommends Bank of America and Wells Fargo. The Motley Fool owns shares of Bank of America, Citigroup, JPMorgan Chase, and Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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