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Wells rides high on 'mortgage horse,' but run may end soon

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 Peter Rudegeair

(Reuters) - The home loan business came through for Wells Fargo & Co in the second quarter, helping the biggest U.S. mortgage lender beat Wall Street's profit expectations, despite fears that lending volume would drop as rates rose.

Rising mortgage rates, driven by expectations that the U.S. Federal Reserve will eventually cut back its economic stimulus program, are expected to weigh on banks' mortgage business in the coming months.

But Wells, the No. 4 U.S. bank by assets, has some 90 businesses, ranging from credit cards to small business loans, that will benefit as the economy improves, the bank's top executives said on Friday. The mortgage operations contributed just 13 percent of the bank's more than $21 billion of revenues in the latest quarter.

"The mortgage horse has been a big, strong horse. We've got 89 other horses that are going to be able to grow," Chief Financial Officer Tim Sloan told analysts on a conference call, referring to the stagecoach that has long been the symbol for Wells Fargo.

The bank's shares were up 1.5 percent to $42.51 in afternoon trading on the New York Stock Exchange after touching a new 52-week high of $43.05 earlier in the session. The stock has risen 21 percent this year, compared with a 25 percent rise in the KBW index of bank stocks <.BKX>.

"With Wells Fargo, there were a lot of doubts from large institutional investors who were shorting the shares leading into earnings because of the 30-year (mortgage) rate increasing," said Tom Jalics, a senior investment analyst with Key Private Bank. "But it turns out the worry in investors' heads about originations and refinancing falling off a cliff is probably overdone."

Thirty-year mortgage rates rose to 4.58 percent at the end of the second quarter, up 0.82 percentage point from the first quarter.

The rise in mortgage rates since early May did slow down home loan refinancing, which accounted for 56 percent of Wells Fargo's mortgage applications in the second quarter, down from nearly two-thirds in the first quarter.

But the bank's income from making home loans rose 9 percent from a year earlier. Even Wells executives were not expecting the business to hold up that well.

"We have continued to be surprised by how housing has positively impacted our results," Sloan said on the conference call. "Originations in the second quarter were a lot stronger than I think anyone would have imagined."

That may not last long, possibly putting an end to Wells Fargo's streak of seven consecutive quarters of making more than $100 billion in home loans.

Overall, the San Francisco-based bank made $112 billion of home loans in the latest quarter, down from $131 billion a year earlier but up from $109 billion in the first quarter. Income from mortgage lending totaled $2.41 billion.

Wells Fargo had a 22 percent share of the U.S. mortgage market in the first quarter, down from 27.7 percent at the end of the 2012 fourth quarter, according to Inside Mortgage Finance, an industry publication.

JPMorgan Chase & Co , the second-biggest provider of mortgages in the United States with an 11 percent market share, also forecast a decline in the mortgage business in the coming months. JPMorgan, the largest in the United States by assets, reported a higher-than-expected 31 percent rise in quarterly profit on Friday. Trading revenue rebounded and it set aside less to cover bad loans.

PROFIT RISES

The improving economy and recovering housing market helped Wells Fargo in various ways in the second quarter. Profits got a boost as the bank set aside less money to cover bad loans

Net income applicable to common stockholders rose to $5.27 billion, or 98 cents per share, from $4.40 billion, or 82 cents per share, a year earlier.

Analysts' average forecast was 93 cents per share, according to Thomson Reuters I/B/E/S. It was the bank's 14th consecutive quarter of higher earnings per share.

(For a Wells Fargo earnings graphic, click on http://link.reuters.com/zyc69t)

The bank released $500 million in loan loss reserves in the quarter, well above the $200 million released in the first quarter, due to gains in house prices and fewer bad loans. The bank's provision for bad loans fell 64 percent to $652 million.

The increase in rates made it attractive for the bank to add to its investment portfolio by purchasing $21.1 billion in securities in the quarter.

"That's a big increase from what we've done in prior quarters," Sloan told Reuters in an interview, adding the bank has also added $6 billion in securities to its portfolio since the start of the third quarter.

The bank's net interest margin, an indicator of how profitable its loans are, fell to 3.46 percent in the second quarter from 3.91 percent a year earlier and 3.48 percent in the first quarter.

Rising interest rates should ease pressure banks have faced on their margins, but that trend will take time to bear fruit. Wells Fargo's total second-quarter revenue rose marginally, to $21.37 billion from $21.29 billion a year earlier.

Revenue from trust and investment fees, which accounted for one-third of the bank's fee income, jumped to $3.5 billion, up nearly $300 million from the first quarter. Investment banking fees were up 85 percent from a year ago.

Non-interest expenses fell to $12.25 billion from $12.40 billion in the first quarter but were $250 million more than analysts expected. The primary reason expenses did not fall further was because revenue-based compensation was higher, Sloan said.

(Corrects attribution of quote in 4th paragraph to CFO Tim Sloan from CEO John Stumpf)

(Reporting by Peter Rudegeair in New York, additional reporting by Tanya Agrawal in Bangalore; Editing by Ted Kerr, Paritosh Bansal and John Wallace)

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