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Wells Fargo Will Prove Warren Buffett's Housing Call

NEW YORK ( TheStreet) -- Amid recent data on rising home prices, falling foreclosure rates and expected gains in overall mortgage refinancing and lending activity, watch for Wells Fargo's (WFC - Get Report) third-quarter earnings to propel the company's largest shareholder - Warren Buffett of Berkshire Hathaway (BRK.A) - to sing a housing recovery tune.

After a weaker than expected housing rebound in 2011 tempered Buffett's talk on the mortgage market, strong loan growth volumes at the investment conglomerate's largest bank holdings may stand as a an early barometer of a true rebound play after previous false starts.

Housing, a laggard through the U.S. recovery, gave Buffett reason to apologize for a 2011 forecast in Berkshire's annual letter that the market was in a full-blown recovery. "I was dead wrong," wrote Buffett, in this year's letter. Still, the 'Oracle of Omaha' maintained optimism on housing, stating in a July 12 CNBC interview, "[In] residential housing, we're seeing a pickup. It's noticeable. It's from a very low base."

In what's expected to be another relatively weak quarter for large-cap bank underwriting, trading and advisory revenue, many analysts on Wall Street now point to a pickup in mortgage lending and refinancing as a key driver of industry wide earnings. Wells Fargo, the nation's largest mortgage lender is most levered to a pickup in housing market activity and its shares have gained nearly 30% year-to-date on strong overall loan growth.

The question for Wells Fargo and the overall banking sector headed into the third quarter is whether a housing pickup is still to accelerate and whether it will be enough of offset negatives like falling interest rate-based earnings.

On the heels of the Federal Reserve's September plan to begin a third easing effort - known as QE3 -- by buying $40 billion in mortgage bonds a month for the foreseeable future and keeping interest rates near zero through mid-2015, followers of the banking sector warned that the program could be a big hit to 2013 bank sector earnings

"[We] need to deter mine the relationship between the expected (and rather substantial) net interest margin compression and the strength in mortgage banking income," writes Stifel Financial analyst Christopher Mutascio, in a third-quarter earnings preview. "Does the strength in mortgage banking activity more than offset a net interest margin that is expected to compress roughly 15 basis points during the quarter?," the analyst notes.

Were Wells Fargo to guide for further drops interest rate-based earnings in 2013, Mutascio argues the bank's impressive earnings growth could stall.

Heading into earnings, Deutsche Bank analyst Matt O'Connor downgraded Wells Fargo and PNC Financial (PNC), another fast growing lender, from 'Buy' to 'Hold' on concerns over year-to-date stock gains, interest rate pressures and whether the respective banks can maintain strong mortgage lending growth.

"We believe WFC is best positioned for mortgage activity remaining stronger than expected given its market share of about one-third... However, both of these are well known and we believe already reflected in the stock," writes O'Connor. The analyst recommends Goldman Sachs (GS - Get Report) and Fifth Third Bank (FITB) as banks that may outperform in quarterly earnings.

>>View Warren Buffett's Portfolio

Some question whether strong overall third quarter housing and loan origination data may outweigh concerns of an earnings stall at Wells Fargo or other lenders.
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