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Wells Fargo posts record quarterly profit, revs disappoint

The logo for Wells Fargo bank is pictured in downtown Los Angeles, California July 17, 2012. REUTERS/Fred Prouser
The logo for Wells Fargo bank is pictured in downtown Los Angeles, California July 17, 2012. REUTERS/Fred Prouser

By Rick Rothacker and Jed Horowitz

(Reuters) - Low interest rates both hurt and helped third-quarter earnings at Wells Fargo & Co , boosting mortgage lending but squeezing core profitability more than analysts expected.

Third-quarter net income rose 22 percent from a year ago to a record $4.9 billion, or 88 cents per share, the bank reported on Friday, topping the analysts' consensus estimate of 87 cents, as compiled by Thomson Reuters I/B/E/S.

But total revenue of $21.2 billion missed the $21.47 billion analysts expected.

Net interest margin - the spread between what the bank pays on deposits and makes on loans - fell to 3.66 percent from 3.91 percent in the second quarter, a bigger drop than it warned of last month.

Wells Fargo executives urged investors to focus on its overall profit rather than the shrinking net interest margin. Wall Street didn't appear to listen as the stock fell more than 3 percent at midday.

"We could easily have increased net interest margin by making bad decisions," such as buying high-interest loans that are likely to default, Chief Financial Officer Tim Sloan said on a conference call with analysts. "We don't spend a lot of time focused on managing to that margin."

Chief Executive John Stumpf said the bank, the biggest mortgage lender in the United States, is also rapidly boosting fee income by selling products and services that don't depend on interest rates for loans.

"Overall revenue is up 8 percent this year," Stumpf said, while deposit growth is strong and bad loans and other expenses are declining. "Those are pretty good numbers."

Sloan conceded there "is no question that in this slow rate environment," interest margin is under pressure and the trend could extend through next year.

Shares in the fourth largest U.S. bank were off 3.4 percent at $34 at midday on the New York Stock Exchange. The KBW Bank Index <.BKX> of large banks, which includes Wells Fargo, was off 2.6 percent.

JPMorgan Chase & Co , the largest U.S. bank, also reported results on Friday. It said profits rose 34 percent to a record $5.71 billion.

SHRINKING MARGINS

Banks are experiencing shrinking margins as older loans with higher interest rates are paid down and they find fewer places to invest growing deposits.

"The margin came in much worse than we expected, but mortgage banking was better," Keefe, Bruyette & Woods analyst Frederick Cannon wrote in a note to clients. "Overall, this was a slight beat this quarter, but the margin matters more."

Wells Fargo's mortgage banking revenue jumped more than 50 percent from a year ago to $2.8 billion. The bank said it decided to retain $9.8 billion in mortgages it could have sold to Fannie Mae and Freddie Mac . It said it can make more on them than the potential $200 million of fee income it could have received.

"Holding these mortgages today doesn't preclude us (from) selling them in the future," Sloan said, when asked if having them on the balance sheet could hurt its capital strength.

The executives touted improvements in credit quality. Stumpf said he anticipates regulators will give the bank the go-ahead to continue returning capital to shareholders in the form of share buybacks and dividend payments after they review an annual stress test starting in March.

Stumpf said his first priority for excess capital, however, is to increase loans.

Wells Fargo made $139 billion in mortgages versus $89 billion a year ago, but up only slightly from the second quarter.

TOTAL LOANS UP

Total loans increased by $7.4 billion, or about 1 percent, from June 30 to $782.6 billion.

Wells Fargo also saw increases in auto, credit card, student and commercial loans.

The bank set aside less money for future loan losses than it actually charged off in the third quarter - a sign it believes credit quality is improving. Some of the third-quarter loan losses resulted from new regulations that will not have an effect in future quarters.

Wells Fargo has emerged from the financial crisis as the dominant U.S. mortgage lender, making three times as many loans as its nearest competitor. But it also has had mortgage-related headaches.

The U.S. Attorney in Manhattan this week filed a lawsuit accusing the bank of recklessly underwriting government-insured home loans. The bank has denied the allegations.

The bank also set aside more money to cover investor demands to buy back soured mortgage loans it sold to them during the housing boom. It added $462 million to those reserves in the third quarter, down from $669 million in the second quarter but up from $390 million a year ago.

(Reporting By Rick Rothacker in Charlotte, N.C.; Additional reporting by Jed Horowitz in New York; Editing by Jeffrey Benkoe)

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