Wells Fargo Gets a Housing Bump

Updated to reflect Stifel Financial comments and updated share prices

NEW YORK ( TheStreet) - Wells Fargo ( WFC), the nation's largest mortgage lender, released earnings Friday that beat expectations and give new data into a widespread housing rebound.

However, a larger than expected drop in the bank's interest rate-based earnings pushed shares sharply lower in early trading and cloud the bank's outlook.

While mortgage lending continued to add loans, adding $11.9 billion in core loans during the quarter, the bank reported new pressure to interest rate-based earnings, which fell as margins were pressured. Interest margins fell by 25 basis points, a larger amount than the 17 basis point drop chief financial officer Tim Sloan forecast in September.

Overall, the San Francisco- based lender reported third quarter earnings of $4.94 billion or 88 cents a share, beating estimates of 87 cents, according to analyst forecasts compiled by Bloomberg. Revenue came in at 21.2 billion, slightly beating estimates of $20.9 billion.

For Wells Fargo investors, falling interest margins may prove a worrying sign for the bank's 2013 earnings; however, onlookers reading into a housing market rebound may take solace in the bank's continued loan growth.

"In the third quarter, core loans grew by $11.9 billion and we saw continued strength in our mortgage and deposit businesses," John Stumpf, chief executive of Wells Fargo said in a statement released with earnings. The bank's commentary was mixed between positive language on the housing market and banking industry specific headwinds like falling interest rates.

"While the economic and interest rate environments continue to present challenges for us and our industry, our diversified model and focus on our customers continued to produce strong quarterly results," noted CFO Sloan, in the earnings release.

In early Friday trading Wells Fargo shares fell over 3% to $33.98, on concerns over a bigger than expected drop in interest margins.

Still, the bank's earnings add new insight into the health of a housing market rebound. In earnings also released on Friday, JPMorgan ( JPM), the largest bank in the U.S. beat estimates on record third quarter earnings of $5.7 billion, or $1.40 a share, beating the consensus estimate of $1.24, among analysts polled by Thomson Reuters. In earnings, JPMorgan chief executive Jamie Dimon said a housing has turned the quarter.

Some analysts downplayed Wells Fargo's earnings beat and honed in on what could be a troubling dynamic between slowing mortgage origination growth and falling interest rates. "The beat relative to our expectations was entirely driven by lower loan loss provisioning - rather than higher mortgage banking income," wrote Stifel Nicolaus analyst Christopher Mutascio in a Friday note to clients.

The analyst stressed the importance of continued loan growth on Wells Fargo's earnings outlook. "More importantly, mortgage banking income is not offsetting the impact of net interest margin compression," wrote Mutascio.

Heading into third quarter earnings, many bank analysts on Wall Street pointed to a pickup in mortgage lending and refinancing as a key driver of industry wide profits. As the nation's largest mortgage lender, Wells Fargo 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 was whether a housing pickup 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

In total, the bank's revenue rose 8.1% from a year earlier and held steady compared with the second quarter. Mortgage banking income rose to $2.81 billion, up 53% from 2011 levels, but posted a $86 million drop from the prior quarter

Better than expected earnings per share and revenue numbers in the third quarter signal that, for now, Wells Fargo continues to outperform expectations. However, headed into 2013, falling interest earnings are a worrying sign.

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.

Some questioned 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 expected Wells Fargo to report flat overall sequential EPS growth and a slowing of mortgage origination from the second quarter.

" Flat earnings in a difficult interest rate environment should be a good quarter for the company especially relative to other spread-dependent banks," wrote Cannon, who gives Wells Fargo shares an outperform rating. Overall, revenue at Wells Fargo held steady, while earnings per share rose by 6 cents.

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.

On Wednesday, the U.S. government is suing Wells Fargo for hundreds of millions of dollars in a civil fraud lawsuit targeted at the lender's underwriting of Federal Housing Administration-backed (FHA) mortgages issued over a decade that eventually defaulted.

The U.S. Attorney for the Southern District of New York's filed a civil fraud suit in Manhattan Tuesday arguing that the U.S. government paid hundreds of millions of dollars in insurance on FHA-backed loans Wells Fargo improperly underwrote. The U.S. Attorney and the U.S. Department of Housing and Urban Development are seeking to prove Wells Fargo fell short in its underwriting standards and should refund provide taxpayers with a refund.

-- Written by Antoine Gara in New York

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