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) 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) and Fifth Third Bank ( FITB) as banks that may outperform in quarterly earnings.

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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.

KBW analysts led by Fred Cannon expect Wells Fargo to earn 87 cents in third quarter earnings per share, in line with overall Wall Street consensus, reflecting flat overall sequential EPS growth and a slowing of mortgage origination from the second quarter.

In July, Wells Fargo and JPMorgan reported 30% plus year-over-year mortgage loan growth. Simply, maintaining rebounding loan volumes may do the trick within the financial sector, given headwinds that the industry faces.

" Flat earnings in a difficult interest rate environment should be a good quarter for the company especially relative to other spread-dependent banks," writes Cannon, who gives Wells Fargo shares an outperform rating.

Although Cannon forecasts a drop in origination volume below $100 billion from $126 billion in the second quarter, he notes the estimate may prove low given that overall industry volumes have maintained a torrid pace in the third quarter. "If we were to hold originations flat in 3Q12 from 2Q12 then our EPS estimate would be $0.94 instead of $0.87," writes the Cannon.

Among the nation's four largest lenders, JPMorgan ( JPM), Bank of America ( BAC), Citigroup ( C) and Wells Fargo, KBW estimates overall mortgage revenue will be $7.25 billion.

After a surge in the recent earnings from home-builders like Lennar ( LEN), Toll Brothers ( TOL) and KB Home ( KBH), some like Goldman Sachs, Barclays and homebuilder CEO's have already called a housing bottom.

"Evidence from the field suggests that the 'for sale' housing market has, in fact, bottomed and that we have commenced a slow and steady recovery process," said Lennar CEO Stuart Miller, in a statement released with the company's second quarter earnings in August.

Housing remains one of eternal optimist Buffett's "bets on America," but his annual letter -- and more recent commentary -- have stressed when it comes housing improvement there is still a ways to go.

While a maintenance big mortgage underwriting volumes will play a front and center role in whether Wells Fargo and other mega-banks can grow in the third quarter and earn their way out of Fed induced earnings hits, the bigger question is what it might say about the overall U.S. housing and economic recovery that shareholders like Warren Buffett often opine on. A pickup in the U.S. economy may quickly be inferred by whether banks grow quarter-over-quarter, it seems. Were that to be the case, Buffett may want to return to previous bullish pronunciations.

Buffett is certainly positioned for any durable rebound. Berkshire owns paint retailer Benjamin Moore, Clayton Homes, the largest producer of homes in the country, in addition to other housing-focused businesses like Acme Brick, Shaw in carpets, Johns Manville in insulation and MiTek in roofing. Meanwhile, top Berkshire bank investments like Wells Fargo, U.S. Bancorp ( USB), BB&T ( BBT) and M&T Bank ( MTB) have benefitted from housing activity.

It's that positioning and a possible change in Buffett's tenor on housing, which may best-serve do-it-yourself stock investors and Buffett acolytes.

For more on Berkshire investments, see why Warren Buffet shuns investment banks.

-- Written by Antoine Gara in New York

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