Wells Fargo Leans on Short-Term Fixes as It Waits on Rates

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Few people would be more pleased about good weather and a solid home-selling season this spring than Wells Fargo Chief Executive John Stumpf.

Wells Fargo's mortgage banking fees grew 2% in the first quarter, to $1.55 billion, from a year earlier. If that growth continues into the second quarter, along with the strength shown in some other business segments, Wells Fargo should be able to weather the storm of tight margins.

It is a challenge repeated throughout the industry, as other banks look for something to tide them over until interest rates rise, perhaps as early as June. For some companies, like Wells Fargo, mortgages are the essential piece of the puzzle. For other banks, commercial or construction lending might be more important.

The first-quarter results from Wells Fargo, which along with JPMorgan Chase kicked off bank-earnings season Tuesday, seem to provide at least a sliver of hope for other banks.

"Their [4% year-over-year] loan growth is pretty encouraging, [as are] the strong mortgage results and what's going on with commercial lending," said Scott Siefers, an analyst at Sandler O'Neill. "It supports what we've seen from [Federal Reserve] data, but to see it on a company level is more encouraging and it augurs well for the industry as a whole."

To be sure, Wells' net income fell 1.5% year over year, but earnings per share of $1.04 exceeded the expectations of analysts surveyed by Bloomberg by six cents. Its shares finished Tuesday at $54.19, down less than 1%.

John Shrewsberry, the chief financial officer at Wells Fargo, downplayed the importance of mortgage banking. The $1.7 trillion-asset company has enough strength in other areas that strong second-quarter results in mortgages won't be necessary for it to report overall profit growth.

"We've got a combination of things, as we have been waiting for a rate rise for several years," Shrewsberry said in an interview. "We've grown trust and investment fees in a material way. There has been more going on in investment banking. All of those things work together to offset what might be missing in another part of the business."

Shrewsberry also cited Wells Fargo's acquisition of $9 billion of commercial real estate loans from GE Capital, as helping counter the effect of low interest rates.

Even so, when asked about the potential for a big second quarter for mortgages, Shrewsberry said: "It will be great if it picks up."

The stage seems to be set. Wells Fargo said it was processing $44 billion of residential mortgage applications as of March 31. A large majority of those applications will close in the second quarter, Shrewsberry said.

The health of Wells Fargo's mortgage business is typically a good indicator for how other banks will perform, said Joe Morford, an analyst at RBC Capital Markets.

"Wells' mortgage banking was solid and that bodes well for other mortgage-heavy banks, like First Republic Bank, SunTrust [Banks] and Fifth Third [Bancorp]," Morford said.

In addition to its 7% increase in core-portfolio, first-lien single-family mortgages to $210 billion, Wells Fargo also reported growth in other lending categories. Commercial-and-industrial loans rose 13% to $271 billion. Construction loans grew 6% to $20 billion.

"Management was upbeat about their demand for C&I lending," Morford said. "That's a good leading indicator for other regional banks that are heavy in commercial lending."

Banks in that category include the $92 billion-asset KeyCorp in Cleveland, the $69 billion-asset Comerica in Dallas and the $16 billion-asset PacWest Bancorp in Los Angeles, Morford said.

Morford said he was also encouraged to hear that Wells Fargo's exposure to the energy industry was not as harmful as some had feared. About 2% of Wells Fargo's total loan portfolio, or $18.5 billion, is tied to energy and the company "realized minimal credit losses tied to energy loans in the first quarter," Shrewsberry said.

Wells Fargo was even able to provide a positive spin on the influx of liquidity that has poured into the bank. Unlike many other banks, Wells Fargo's deposit growth has outpaced its loan growth. That's a good trend for the long term, as it will provide a source of low-cost funding for loans, Siefers said.

In the short-term, however, excess liquidity can hurt profit margins. Wells Fargo's net interest margin declined 25 basis points, to 2.95%, from a year earlier. Compared with the fourth quarter, the margin declined by 9 basis points and the company attributed 5 basis points of that decline to its outsized deposit growth.

Stumpf, who is also Wells Fargo's chairman, said during a conference call with analysts that he is not going to slam the brakes on deposit growth or decrease the size of its retail branch network where many of those deposits are collected.

"When we become the primary account holder with the customer and deposits lead with that, good things happen," Stumpf said. "Our 6,200 stores are still busy. [About] 75% of our customers come into a store once every six months. Even millennials or our most-advanced on the digital side visit our stores."

"We're not trying to drive customers into what's cheaper for us," Stumpf said. "We think about what's best for them and branches still remain an enormously important part in that."

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