Wells Fargo’s Record Profits Show Housing on the Mend

by Dan Burrows | July 13, 2012 1:01 pm

Wells Fargo’s Record Profits Show Housing on the Mend

A gradually stabilizing housing market is good news for the nation’s homeowners — and it’s great news for Wells Fargo (NYSE:WFC[1]).

With mortgage rates notching fresh record lows seemingly every other week and house prices no longer in free fall, the country’s No. 1 mortgage lender and fourth-largest bank┬áposted all-time high quarterly profits Friday.

Yes, the bank still has some messes on its hands. The day before its second-quarter earnings release, WFC reached a $175 million settlement with the U.S. government for ripping off African-American and Latino borrowers on mortgage loans. And, true, WFC set aside another $670 million to cover the cost of selling garbage loans it sold to Fannie Mae and Freddie Mac.

But when it comes to traditional lending, WFC’s results were stronger than expected, thanks to better results in mortgages and retail banking.

The company said second-quarter profit rose 17% to hit a record $4.62 billion, beating Wall Street’s earnings estimate by a penny a share. Profits from mortgage lending led the way, jumping nearly 80% to $2.9 billion.

Once-in-a-lifetime low rates have homeowners refinancing in droves, the bank said. That could bode well for future consumer spending. After all, the less money people pay on mortgage debt, the more they have for other purchases.

And, wouldn’t you know it, WFC said customers and businesses alike borrowed more money last quarter. Commercial loans ticked up, as did credit card usage and auto loans.

Wells Fargo has a couple of distinct advantages in the current macroeconomic environment. Its investment banking business is comparatively small, so the drop in trading volumes, dearth of deal activity and drop in share prices doesn’t hurt the bank’s results to the same degree as, say, Bank of America (NYSE:BAC[2]) or JPMorgan Chase (NYSE:JPM[3]), which reported its own better-than-expected results[4] Friday.

Additionally, and probably more important, WFC doesn’t do much business in Europe, which has helped insulate the bank from the credit crisis and lack of economic growth on the continent.

But the fact remains that bread-and-butter mortgage lending was strong and, yes, credit quality improved, too. Although the bank had to set aside that giant refund to Fannie Mae and Freddie Mac, it also was able to boost its balance sheet by releasing about $400 million in reserves to cover losses on loans.

WFC said it expects “continued but more modest improvement” in credit quality for the remainder of the year, and continues to expect future reserve releases in 2012. Sounds like someone’s balance sheet is getting stronger.

And although the jump in mortgage lending and broader improvement in retail banking hardly sounds the all-clear on the housing market or state of the consumer, it does show signs of incremental recovery.

As for the investor’s perspective, WFC’s profit beat was just what the market needed. Everyone knew it was going to be a bad second-quarter earnings season, and it still got off to a surprisingly poor start[5]. Just witness the market’s six-session slump before Friday’s rally.

If stocks are to maintain any momentum to the upside, we’ll need a slew of more reports like the one WFC delivered at the end of the week.

As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.

Endnotes:
  1. WFC: http://studio-5.financialcontent.com/investplace/quote?Symbol=WFC
  2. BAC: http://studio-5.financialcontent.com/investplace/quote?Symbol=BAC
  3. JPM: http://studio-5.financialcontent.com/investplace/quote?Symbol=JPM
  4. reported its own better-than-expected results: http://investorplace.com/2012/07/jpmorgan-has-a-cold-not-pneumonia/
  5. a surprisingly poor start: http://investorplace.com/2012/07/wall-street-earning-warnings-bloodbath/

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