Mortgage Worries Overshadow Wells Fargo's (WFC) Strong Fourth-Quarter Earnings

Last Friday, San Francisco, California-based Wells Fargo (WFC: Charts, News), the largest mortgage lender in the United States, surprised the market with an astounding earnings beat on both top and bottom lines. For its fourth quarter, the bank reported earned $4.9 billion, or 91 cents per share, before paying dividends on its preferred stock.

This was a 25% improvement from the $3.9 billion, or 73 cents per share, it earned in the prior year quarter. Analysts had forecast Wells Fargo to earn 87 cents per share. Daily Chart
Meanwhile, revenue grew by 7% to $21.9 billion, topping the analyst estimate of $21.3 billion. Wells Fargo, which is the first of the "mega-banks" to report earnings this month, attributed its strong quarter to decreased loan loss reserves, above-average returns on private equity investments and increased loans. Business in its credit card business and wealth management segment also increased, while the bank increased various fees to boost its top line. Despite strong earnings and revenue growth, investors remained concerned regarding the strength of Wells Fargo's mortgage business. Although the bank funded $125 billion in mortgages, up from $120 billion in the prior year quarter, this was a 13.7% decline from the $139 billion it posted in the previous quarter. Mortgage applications also declined from both the previous year and quarter. Wells Fargo relies heavily on its mortgage business, and controls a 30% share in the United States. JPMorgan (JPM: Charts, News) trails in a distant second at 10%. Wells Fargo's strength in mortgages has offset the pressure of a shrinking net interest rate spread that is hurting its rivals. Under Ben Bernanke, the Federal Reserve Bank has kept, and will continue to keep, interest rates at historically low levels to spur lending and economic growth. For most banks, this reduces the spread between the interest gained from loans and its interest payments to account holders. Wells Fargo's interest income slid 2% in the fourth quarter from the prior year quarter. While Wells Fargo's mortgage business has kept it stronger than its rivals, it also remains its Achilles' heel. Although the number of mortgages expected to default declined, the number of troubled loans increased. Wells Fargo is also a popular target for legislators and regulators, many of whom blame the large mortgage lenders for causing the global financial crises by offering subprime loans. Last Monday, Wells Fargo and nine other banks were required to pay a combined settlement of $8.5 billion to the U.S. government to resolve charges of wrongful foreclosures. This was the closing chapter to a saga that began last October, when the U.S. Justice Department accused Wells Fargo of misrepresenting the quality of its mortgages prior to the subprime mortgage crisis of 2007-2008. For its role in the mortgage meltdown, Wells Fargo is required to pay $766 million in cash, and commit $1.2 billion to "foreclosure prevention actions," such as mortgage modifications. These charges caused a $644 million write down in its fourth quarter earnings. Despite these headwinds, CEO John Stumpf reassured investors of the strength of its mortgage business, stating that the housing market "began a steady rebound in 2012." He also noted that a resolution of the foreclosure charges would reduce its expenses by $125 million per quarter, since it had been hiring external staff to help review individual foreclosures during the subprime mortgage crisis. Shares of Wells Fargo trade at 9.7 times forward earnings with a price-to-book ratio of 2.05. This makes it slightly more expensive than its rival JPMorgan, which trades at 8.7 times forward earnings with a price-to-book ratio of 1.8. Wells Fargo pays a quarterly dividend of 22 cents per share, a 2.51% yield at current prices. Other News About WFC Wells Fargo Advisors Ordered to Pay Investors $1.3 Million Wells Fargo pays up for bad advice. Wells Fargo Earnings: The Stage Coach Rolls On Wells Fargo beats on both the top and bottom lines - so why isn't this stock rallying? Other Stocks in the News Three Fast Food Giants That Will Rule the Planet Will these three big names conquer the planet? 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Published on Jan 14, 2013
By Leo Sun
Leo Sun
Leo Sun is a freelance finance writer and position trader. He focuses on a combination of value and momentum investing, with a strong interest in the trading philosophies of Warren Buffett and Peter Lynch. Leo also has experience writing articles to help small business owners acquire loans and manage their finances. He regularly contributes to the Stock of the Day analysis.

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