Wells cashes in on mortgage boom
The big bank's fat first quarter is the result of a federally backed mortgage-refinancing surge. Still, some say banks aren't out of the woods yet.
NEW YORK (Fortune) -- Wells Fargo's numbers show how the big banks hope to muddle through the deepest economic downturn in decades - with some help from their friends in Washington.
San Francisco-based Wells (WFC, Fortune 500) surprised Wall Street Thursday by saying it expects to make $3 billion, or 55 cents a share, in the first quarter ended last month -- almost double the analyst consensus estimate.
Shares of Wells surged 30% to their highest level since January on the news, and the beaten-down shares of rivals followed.
Thursday's events don't erase the worries about the big banks, which center on the scope of loan losses as real estate prices plunge.
Still, Wells' numbers show that with competition having collapsed, plain vanilla banking - even mortgage banking - can be enormously profitable right now.
Wells said it posted a first-quarter net interest margin -- reflecting the difference between the rate it pays on its own borrowings and the rate it collects on its loans -- of 4.1%. That's down from the 4.9% Wells reported in the fourth quarter, excluding its acquisition of Wachovia, but above the 3.9% Wall Street expectation for the combined company in the first quarter.
Wells, which has portrayed itself as an unwilling recipient of aid from Washington and has criticized government intervention in the financial sector, also was helped in the first quarter by federal efforts to contain the damage from the housing bust.
Wells is the nation's biggest mortgage servicer and a big home loan originator, so it was a big beneficiary of a refinancing boom driven in part by ultra-low short-term interest rates and the government's purchases of mortgage bonds.
Wells said mortgage originations doubled from fourth-quarter levels to $100 billion, with three-quarters of those covering refinancing transactions.
While the refinancing boom won't last forever, it is clear that holding down mortgage rates has emerged as a top priority in Washington. The hope is that low rates can help the economy by reducing borrowers' monthly payments and could also lead to a rebound in home sales.
The gains won't be limited to the first quarter, either. Mortgage activity should remain strong in the second quarter, Wells said, judging by its own origination pipeline.
Though Wells took $25 billion in federal aid in October, it hasn't been a happy relationship. Chairman Dick Kovacevich recently called the government's stress tests "asinine" and blamed the changing terms of federal support for a steep dividend cut last month.
Thursday's news alone won't quell investors' fears about the pain that lies ahead for banks with big mortgage portfolios. Wells and rivals such as Bank of America (BAC, Fortune 500), Citigroup (C, Fortune 500) and JPMorgan Chase (JPM, Fortune 500) remain perilously exposed to declining asset prices, particularly for commercial and residential real estate.
Indeed, some analysts questioned the quality of Wells' first-quarter profit numbers, saying the bank should be saving more for the rainy days ahead.
"We believe that credit quality materially deteriorated in the first quarter and that Wells Fargo is under-reserving for expected future losses," FBR Capital Markets analyst Paul Miller wrote in a note to clients Thursday. "We remain cautious based on what we don't know."
Wells said it added $1.3 billion to its loan loss reserve in the first quarter, bringing its total cushion against credit losses to $23 billion. Wells Fargo chief financial officer Howard Atkins called that "a very big number" in an interview on Bloomberg television Thursday, and called Wells' provision against loan losses "adequate."
Still, Wells' loan loss allowance as a percentage of total loans at the end of the first quarter was just 2.7%, going by FBR estimates -- compared with 3.62% at the end of the fourth quarter at JPMorgan Chase, the best-reserved big bank.
Even analysts who like the stock say the road ahead may not be smooth. Andrew Marquardt, an analyst at Fox Pitt Kelton who rates Wells an "outperform", wrote in a note to clients Thursday that he remains "cautious" on the state of the bank's commercial real estate, credit card and home equity loan portfolios, among others.