Wells Fargo Profit Rises as Lender Puts Brakes on Costs

Wells Fargo & Co., the largest U.S. home lender, said second-quarter profit climbed 19 percent as the bank clamped down on expenses. Results beat analysts’ estimates, and the shares rose 2 percent in New York trading.

Net income advanced to a record $5.52 billion, or 98 cents a share, from $4.62 billion, or 82 cents, a year earlier, the San Francisco-based company said today in a statement. The average estimate of 33 analysts surveyed by Bloomberg, excluding some items, was 93 cents a share.

Chief Executive Officer John Stumpf, 59, scrapped his 2011 cost-cutting goal to invest in businesses such as home lending. With interest rates now climbing from record lows, the bank has forecast that new mortgages will slide for the rest of this year, and Stumpf has renewed his focus on expenses.

Wells Fargo has focused “on reducing expenses while investing in our businesses to generate revenue growth,” Chief Financial Officer Timothy Sloan, 53, said on a conference call today. “We’ll continue to see some improvement on expenses.”

Even with a 4 percent increase in staff, noninterest costs dropped 1 percent to $12.3 billion from a year earlier, and the bank’s efficiency ratio improved to 57.3 percent from 58.3 percent in the first quarter. Expenses tied to foreclosures fell 49 percent to $146 million.

The bank added 1,900 branch bankers in the 12 months ending June, with total headcount rising to 274,300.

Core Earnings

“Expenses are probably between $500 million and $1 billion too high,” Marty Mosby, an analyst at Guggenheim Securities LLC, said in an interview before results were disclosed. “That’s a cushion they are whittling down.”

The quarter showed some of the strains Stumpf faces, with revenue little changed at $21.4 billion. Results were helped by a $500 million pretax release from reserves. Profit before taxes and loss provisions, which some analysts use to gauge results without such one-time items, rose 3 percent to $9.12 billion.

The net interest margin, the difference between what the bank pays for funding and makes on lending, fell to 3.46 percent from 3.48 percent in the first quarter.

The bank made $2.8 billion from mortgage banking, down 3 percent from a year earlier. The tally included $2.41 billion gained from originating home loans, a 9 percent increase. Mike Heid runs that business.

“Consumer loss levels have improved rapidly due primarily to the positive momentum in the residential real estate market, with home prices improving faster and in more markets than expected,” Chief Risk Officer Mike Loughlin said in the statement.

Bond Gains

Wells Fargo, which has been expanding the securities unit run by John Shrewsberry after acquiring it in the purchase of Wachovia Corp., took in $538 million in investment-banking fees, an 85 percent increase from a year earlier. Trading revenue rose 26 percent to $331 million.

Under accounting rules, banks can exclude gains and losses from securities categorized as “available-for-sale” from the income statement and instead include them in equity. Unrealized bond gains at Wells Fargo dropped to $5.1 billion in the second quarter from $11.2 billion at the end of March, the bank said.

“When you have a large security portfolio like we do, and most of the portfolio is at a fixed rate, it’s worth less on paper” when interest rates rise, Sloan said in a phone interview. “It’s not as if rising rates make the income coming off those securities any lower. It’s the same income, it’s just the value that’s different.”

Mortgages Slide

Expense reductions could come in employee benefits, as well as foreclosures, regulatory settlements, and mortgage servicing and repurchases, Sloan said at a June investor conference. Those housing-related expenses cost the company about $3.9 billion last year, he said.

Wells Fargo originated almost 1 in 3 U.S. mortgages in 2012, helping the lender post a third straight year of record profit. Yields climbed after Federal Reserve Chairman Ben S. Bernanke indicated May 22 the central bank may slow monthly bond purchases. The average rate on 30-year fixed-rate mortgages jumped more than a percentage point from early May to 4.46 percent at the end of June.

New home loans fell rapidly after Bernanke’s comments and probably slowed Wells Fargo’s mortgage business, Richard Staite, a London-based analyst at Atlantic Equities LLP, wrote in a June 12 report. Mortgages comprised about 14 percent of total revenue last year, a contribution that may plunge by more than a third this year to $7.5 billion, from $12.2 billion last year, and to $4.8 billion in 2014, he wrote.

Stock Reaction

JPMorgan said today that if mortgage rates stay at or above current levels in the second half, refinancings could drop 30 percent to 40 percent and lead to what CEO Jamie Dimon described as a “dramatic” drop in profits.

“The refinance volume is going to come down significantly if rates continue to stay high,” Stumpf said on today’s call.

Nationwide, home-loan originations may fall 10 percent to $1.57 trillion this year from $1.75 trillion last year, the Mortgage Bankers Association forecast in a June 20 report.

Wells Fargo closed at a record $42.83 on July 8, and fell to $41.89 in yesterday’s trading. That left the stock up 23 percent this year, compared with a 24 percent gain for the 24-company KBW Bank Index. The stock traded for $42.74 at 12:41 p.m. in New York.

Berkshire Hathaway Inc., run by billionaire Warren Buffett, is the biggest stakeholder with more than 8 percent of the common stock, according to data compiled by Bloomberg.

Rating Cut

Staite is among at least five analysts who downgraded Wells Fargo in the past month, giving the stock the equivalent of a sell rating. Chris Mutascio, a Baltimore-based analyst at Keefe, Bruyette & Woods Inc., Jack Micenko at Susquehanna Financial Group LLLP and Scott Siefers of Sandler O’Neill & Partners LP cut their ratings to hold this month.

Wells Fargo and New York-based JPMorgan Chase & Co., which reported a 31 percent jump in quarterly profit today, kick off earnings season for U.S. banks. Citigroup Inc., based in New York, will announce July 15 and Charlotte, North Carolina-based Bank of America Corp. reports July 17.

Lenders have turned to firing workers, cleaning up bad loans and settling litigation to cut costs and boost earnings amid weak borrowing by U.S. businesses and consumers. Commercial and industrial loans rose 0.4 percent in May from a year earlier, while real estate debt contracted 3.3 percent, Fed data show.

Holding Pattern

“Economic growth is so tepid and there is enough uncertainty out there that is holding back the small and medium businesses from expanding,” Guggenheim’s Mosby said. “That’s putting everything in a holding pattern.”

The biggest U.S. lenders, after years of building equity and promising higher payouts, may be forced to hoard profits as they face stricter capital rules. Eight of the largest firms would need to retain capital equal to at least 5 percent of assets, while their banking units would have to hold a minimum of 6 percent, U.S. regulators proposed July 9. The banks have until 2018 to fully comply. Wells Fargo already meets both thresholds, Stumpf said on the call.

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