Wells Fargo mortgage bonanza leads to questions of what's next

Wells Fargo & Co. smashed through another profit record, posting double-digit income growth Friday as the bank reaps the benefits of the country's mortgage boom.

Profits shot up 22 percent from a year ago to $4.9 billion, or 88 cents per share, beating Wall Street's consensus estimate of 87 cents by a penny. It was the lender's sixth straight quarter of record profits.

But the rock-bottom interest rates helping fuel a surge of mortgage making and refinancing are also squeezing the bank's profit margin. The question on everyone's mind is what the lender will do when the mortgage rodeo leaves town.

The San Francisco-based bank, the nation's No. 1 mortgage maker originating one-third of the country's home loans, said confidently Friday that it expects the boom to last "a few more quarters."

Record mortgage banking production revenue also helped lift rival JPMorgan Chase & Co., the No. 2 mortgage lender in the United States, to record profits as the two banks kicked off bank earnings season. JPMorgan Chase posted record third quarter profits Friday of $5.7 billion.

Investors were skeptical. Wells Fargo shares, which have been trading at highs recently, immediately dropped 3 percent and investors punished bank stocks in general. Wells Fargo shares closed Friday at $34.25, down 93 cents.

The mortgage bonanza has been muting the revenue problems banks face with generally weak loan demand and ultra low interest rates, analysts say. Although Wells Fargo's sales rose 8 percent from a year ago to $21.21 billion, they fell short of the consensus estimate of $21.47 billion and actually fell from the previous quarter.

The bank's all-important net interest margin (NIM) -- a key number that measures the difference between what a bank makes on loans and what it must pay out in interest -- also shrank a bit more than anticipated, dropping a quarter percentage point from the previous quarter to 3.66 percent. Some of that was due to strong growth in deposits with proceeds invested in short-term investments with low yields.

In a conference call Friday, bank executives told industry analysts that low interest rates will continue squeezing the bank's net interest margin, but that they don't expect it to continue shrinking at that rate.

"NIM was definitely a disappointment," said Jennifer Thompson, a bank analyst at Portales Partners in New York. However, Wells Fargo remains above average since the average margin for large cap banks in the second quarter was 3.48, she said.

The two sides of the business tell the story.

Net interest income from old-fashioned lending and securities available for sale was largely flat, up 1 percent from a year ago to $10.66 billion.

The bank also saw strong trading gains from higher deferred compensation plan investment income and better results on trading for clients. Trust and investment fees and service charges on deposit accounts were both up 6 percent from a year ago.

The bank's current mortgage pipeline is "still very strong," Wells Fargo's chief financial officer, Timothy Sloane, told analysts. He said he expects the boom to last "for a few more quarters."

Analysts hammered away with questions about where the lender will generate revenue to offset the drop when mortgage banking slows down, beyond such things as improved mortgage servicing and cost cutting.

"The important thing is we've been through this before," Sloane said. "We'll adjust to it."

Thompson, at Portales Partners, said she was surprised by the bank's confidence that the mortgage wave will last a few more quarters.

Lenders have been getting a big hand from government policies aimed at strengthening the economy by boosting mortgage lending. They will get an additional boost from the Federal Reserve's decision last month to buy more mortgage-backed securities at a pace of $40 billion per month.

Suit pending

Even as Wells Fargo cashes in on current home lending, it remains challenged by its past. The U.S. attorney in New York sued Wells Fargo on Tuesday for civil fraud, accusing it of reckless and fraudulent mortgage lending over many years that cost the government hundreds of millions of dollars in insurance claims when borrowers defaulted.

The bank has denied the allegations and said it will vigorously defend itself.

Wells Fargo Home Mortgage is based in Des Moines, but the bank has a major mortgage operation in Minnesota that employs about 8,500 mortgage team members involved in originating, processing and servicing mortgages, among other things.