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Wells Fargo & Co (WFC): Beating the Odds

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Wells Fargo & Co (NYSE:WFC)In an environment of volatile interest rates, the largest US home lender, Wells Fargo & Co (NYSE:WFC) became one of the first money-center banks to report second-quarter performance. The bank left investors and analysts surprised after it disclosed its performance for the recent quarter. Let’s look at some of the reasons why.

Expectations

Before we find out why analysts were left surprised, we must understand what analysts and investors were expecting from Wells Fargo & Co (NYSE:WFC) during the second quarter.

Given the higher interest-rate environment, analysts at Citigroup Inc (NYSE:C) considered Wells Fargo & Co (NYSE:WFC) to be one of the banks that was positioned to beat its consensus earnings estimates on a greater-than-expected decline in expenses. However, at the same time, analysts at Credit Suisse estimated Wells Fargo to be one the most equity-sensitive banks. That’s because Wells Fargo’s available-for-sale portfolio durations were the highest among other large-cap banks.

With Credit Suisse’s estimated duration of 3.5 years, Wells Fargo & Co (NYSE:WFC) was expected to experience the highest decline of approximately 0.4% in its tangible common equity, while its net interest income was not expected to move significantly.

The beat

The bank was able to surprise analysts and beat its earning-per-share (EPS) and revenue estimates. Wells Fargo posted EPS of $0.98 per share, beating estimates by $0.04, while revenue of approximately $21.4 billion exceeded estimates by $170 million. The second-quarter results were boosted by a better-than-expected net interest margin and mortgage originations.

Highlights

Among other second-quarter highlights include better-than-expected mortgage-banking revenue and net interest margins. Wells Fargo reported a net interest margin of approximately 3.5%, down only 2 bps over the linked quarter, while mortgage originations of $112 billion were up 2.7% over the year-ago period. This is in sharp contrast to the widely circulated expectations that Wells Fargo & Co (NYSE:WFC) would not be able to grow its mortgage-banking results because of the slowdown in overall refinancing activity. Besides reporting 2.7% increase in mortgage originations, the bank also reported 4.3% increase in its mortgage applications.

Book value concerns irrelevant

While Wells Fargo is considered one of the most equity-sensitive banks by analysts at Citigroup Inc (NYSE:C), it reported a relatively stable book value compared to the prior quarter. This means Wells Fargo’s management conducted some successful re-balancing efforts for the bank’s fixed income portfolio in order to reduce durations. Lesser duration of the fixed-income portfolio makes the book value of the bank less exposed to interest rate moves.

At the end of the second quarter, Wells Fargo reported a book value of $28.26 per share compared to $28.27 per share in the first quarter.

The future

Despite leaving analysts and investors positively surprised, the future for Wells Fargo is rough. The bank is the largest home lender in the US and has relied heavily on refinance applications in the past. However, with rising mortgage rates, refinance activity will see a slowdown, which will hurt the bank’s future performance. Besides, the bank’s new mortgage production application pipeline decreased 15% over the prior quarter, meaning you should expect the bank to report lower mortgage originations during the third quarter.

Competition

Let’s look at how some of Wells Fargo & Co (NYSE:WFC)’s competitors are coping in the prevailing macroeconomic situation.

JPMorgan Chase & Co. (NYSE:JPM), the second-largest home lender in the US, also disclosed its second-quarter performance. Like, Wells Fargo, JPMorgan Chase & Co. (NYSE:JPM) was also able to beat its EPS and revenue estimates.

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