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Wells Fargo & Co (WFC): Beating the Odds

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.

However, I believe the results remained an overall disappointment. In contrast to the widely circulated expectations of as much as $2 billion in additional revenue due to higher interest rates, the bank reported revenue that was only $110 million higher than the prior quarter.

Therefore, the bottom line also remained relatively stable compared to the first quarter. The bank also reported a net interest margin that was 31 bps below the linked quarter, confirming that JPMorgan Chase & Co. (NYSE:JPM) did not enjoy the benefits of higher interest rates as imagined by analysts.

The future ahead for JPMorgan is believed to be bright. Better-than-expected loan growth and capital market performance during the second quarter point toward an improving economy. Since, JPMorgan has a diverse business model, the bank is poised to benefit. Analysts at Barclays have raised their 2013 estimates for JPMorgan.

Another US large cap bank, PNC Financial Services (NYSE:PNC) is expected to report its performance on July 17. PNC Financial Services (NYSE:PNC)’s investors should be ready for a disappointing show. As Credit Suisse analysts estimate, PNC Financial Services (NYSE:PNC) is expected to report lower operating revenue for the second quarter including a decline in the net interest income, meaning the bank would not be able to take benefit of the higher interest rates. The bank’s lower operating revenue expectation is driven by a weak mortgage banking performance, which would partially be offset by higher consumer and corporate-banking services.

On the expenses front, the bank is again expected to show some weakness. However, during the second half of the current year, investors can expect some cost cutting.

Conclusion

So far, neither Wells Fargo & Co (NYSE:WFC) nor JPMorgan Chase were able to take full benefit of the rising interest rates environment as their barely visible net interest margins showed no significant improvement. Analysts at Credit Suisse have a similar expectation for PNC Financial. Having said that, Wells Fargo’s results were better-than-expected, compared to JPMorgan’s but the future for both banks will be tough.

Compared to JPMorgan, Wells Fargo’s management surprised analysts by re-balancing the bank’s portfolio and reporting a better-than-expected book value. I believe Wells Fargo’s management is better positioned to cope with the rough future ahead. Therefore, I am bullish on Wells Fargo.

The article Wells Fargo: Beating the Odds originally appeared on Fool.com and is written by Adnan Khan.

Adnan Khan has no position in any stocks mentioned. The Motley Fool recommends Wells Fargo. The Motley Fool owns shares of JPMorgan Chase & Co (NYSE:JPM)., PNC Financial Services, and Wells Fargo. Adnan is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.

Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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