Mortgage Revenue Drop Bodes Ill for Wells Fargo, Industry

For a remarkable 15 consecutive quarters, Wells Fargo (WFC) has trumpeted one earnings record after another. On Friday the company touted another record, reporting third-quarter earnings per share of 99 cents, a penny above the last mark.

But this time there were signs the San Francisco bank's earnings power may be fading.

Mortgage banking revenues at Wells fell 43% from a year earlier. A fall-off had been expected after a rise in mortgage rates put an end to the nationwide refinancing boom. But the decline at Wells was steeper than some observers expected. And it could spell bad news for other mortgage lenders that have yet to report their quarterly earnings.

"It is not unsurprising to get some drop-off in mortgage banking, but I think the drop-off is certainly more severe than I had expected," says Erik Oja, an analyst at S&P Capital IQ. "I would say it is a negative for the industry."

Wells Fargo, the largest U.S. originator of mortgages, is widely seen as an industry bellwether. And the company's results brought into sharp relief just how quickly the climb in rates deflated nationwide mortgage sales.

Originations of refinanced mortgages at Wells Fargo were down 48% from the second quarter of this year, while originations of mortgages for home purchases were off 4% during the same period.

Wells Fargo Chief Financial Officer Timothy Sloan said in an interview Friday that the third-quarter decline in mortgage revenue was generally in line with what the company expected. But he said he expects a further decline in mortgage originations this quarter.

"I don't know what the number's going to be, but it's probably going to be down," Sloan said.

Wells' third-quarter earnings growth was powered by a $900 million reserve release, the company's largest such move in nine quarters. That helped compensate for the steep decline in mortgage revenues, but it left some analysts disappointed about the composition and sustainability of the bank's earnings.

During the third quarter, Wells Fargo responded to the new rate environment by axing 5,300 full-time mortgage-related positions. Wells executives said during a conference call Friday that the savings from those job cuts have yet to be fully realized.

With expense cuts failing to keep pace with the decline in mortgage revenue, Wells Fargo's efficiency ratio jumped from 57.3% in the second quarter to 59.1%, just above the 55%-to-59% range company officials have been targeting. On Friday's conference call, analysts pressed Chief Executive Officer John Stumpf about additional steps the company can take to become more efficient.

For example, Mike Mayo, an analyst at CLSA, pressed Stumpf on Well Fargo's plans for mini-branches, a cost-saving measure that the company is currently testing in Washington.

Stumpf declined to elaborate on the bank's plans for the mini-branch concept, but said the company is also looking to shrink the square footage of existing stores. "We are looking at every lease which comes up," he said.

Sloan told American Banker that additional cost savings, beyond the mortgage-related cuts, will not come from any specific initiative. "It's going to be a little bit here, a little bit there," he said.

Wells' earnings report did contain several encouraging nuggets. Earnings from the company's wealth management business continued to grow, and credit quality improved. Wells Fargo cited the latter factor as a key reason why it made such a large reserve release in the third quarter.

The company's earnings of 99 cents per share nudged past the 97-cent average estimate of analysts surveyed by Bloomberg. But some analysts were disappointed with the company's core earnings. Christopher Mutascio of Keefe, Bruyette & Woods wrote in a research note that relative to his expectations, Wells Fargo's revenue growth was "weak."

The company's share price had dipped by less than 1% in mid-afternoon trading Friday.

At one point during Friday's conference call with analysts, Sloan bristled at a question about whether the 15-quarter streak of record earnings per share was affecting how the bank is managed.

"It's an outcome," he responded. "We don't set about trying to get a certain earnings number. We set about trying to serve our customers."

When American Banker asked Sloan about the ramifications of a U.S. government debt default — the likelihood of which appeared to be ebbing Thursday and Friday — he said the potential fallout would be unpredictable.

"I think it would be a horrible, horrible event if it did occur, and there's no reason that it should occur," Sloan said. "But the fact of the matter is since we've never as a country not honored our obligations, nobody has any idea what's going to happen."

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