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Big Banks Shrug Off Mortgage Slump, For Now

17 January 2014 in Trading Ideas

The huge legal fees recently paid out by JPMorgan Chase had one interesting side-effect: They pushed Wells Fargo into the title of America’s Most Profitable Bank.

Earlier this week, Wells Fargo said it earned $21.9 billion in its most recent quarter, despite an industrywide slowdown in mortgages.1

The San Francisco-based bank, which wrote about one-fifth of all US home loans last year, saw growth in businesses outside its mortgage unit.

And while JPMorgan’s profit in its most recent quarter did slide 16% from a year earlier, the bank still did generate $17.9 billion in net income – that’s despite forking over $2.6 billion to settle federal investigations into its role in Bernard Madoff’s Ponzi scheme.

For both banks, however, the improving fortunes of consumers has helped hold up the companies’ bottom lines. As borrowers saw their ability to repay their debts rise, banks have been able to lift their bottom lines by cutting reserves for bad loans.

It also hasn’t hurt the performance of the nation’s largest banks. The Too Big to Fail motif has gained 6% in the past month and is up 38.4% in the past 12 months.

too big to failThe S&P 500 is up 3.6% in the past month and has risen 27.5% in the past 12 months.

That isn’t to say that the recent mortgage slump didn’t have an effect on both companies’ results. Wells Fargo, for example, wrote $50 billion of mortgages in the fourth quarter, down 60% from a year earlier. In addition, its pipeline of home loans plummeted 69%.

As the Los Angeles Times explained, this trend hit Wells hard because it collects payments on more home loans than any other bank. That gave it more chances to sell borrowers lower-rate mortgages, collecting origination fees and profits from the sale of loans. However, in this quarter only one-third of the bank’s home loans were refinancings, compared with two-thirds a year earlier.

Wells was able to offset its mortgage business sluggishness with improvements in automobile lending, investment banking and credit cards.

Still, bank executives are of the mindset that an improving housing recovery can continue to contribute to a sustained economic recovery. Dick Bove, an analyst with Rafferty Capital Markets, said he expects rising interest rates to lead to more lending profits this year, rather than having banks rely on cutting loss reserves to boost profits.

There’s no certainty that Bove’s expectations will follow according to plan but if investors actually believe that the mortgage business for large US banks is getting healthier, the rally in the sector’s stocks could have more room to run.

1Andrew Tangel and E. Scott Reckard, “Wells Fargo eclipses JPMorgan as most profitable US bank,” latimes.com, Jan. 14, 2014, http://www.latimes.com/business/la-fi-bank-earnings-20140115,0,6405403,full.story#axzz2qWsi0Lzd.