Wells Stays Upbeat as Rising Rates Cut into Refi Business

Wells Fargo — the nation's top home lender — is predicting a sharp decline in mortgage originations this quarter, but Chief Executive Officer John Stumpf says he's not worried.

On a conference call with analysts Friday, Stumpf made the case that shrinking refinancing activity — the result of a recent spike in interest rates — will be largely offset by improvements in the economy that will drive growth in other business lines.

He said its loan servicing business, for example, is benefiting from an overall decline in loan defaults and delinquencies. He argued, too, that rising home prices will generate more sales of loans to home buyers and encourage consumers to take out more loans for cars and other products.

"As housing improves, people feel better," Stumpf told analysts during a conference call announcing the company's second-quarter earnings. "It improves confidence. People spend more."

The San Francisco bank announced quarterly net income of $5.5 billion, up 19% from the same quarter a year earlier. Earnings per share climbed 20%, to 98 cents, beating by a nickel the estimates of analysts polled by Bloomberg. The company's stock price was up about 2% in midday trading.

Wells attributed the results in to improved credit quality — its loan-loss provision was down nearly 50% from the previous quarter — as well as to $123 million in cuts to non-interest expenses.

Analysts, however, cautioned that the results would be hard to duplicate the next quarter. In a research note, Sandler O'Neill & Partners said that to sustain earnings, "future credit performance will have to replicate this quarter's low provision number, and other pre-provision drivers will have to hold firm (which could be difficult should mortgage continue to slow)."

Wells wasn't making any short-term promises, instead emphasizing its long-term growth potential. "I sure do like our chances to continue to grow earnings over time," Chief Financial Officer Timothy Sloan told analysts.

During Friday's conference call, analysts mostly wanted to talk about Wells' mortgage business — so much so that Nancy Bush of NAB Research jokingly promised that she wouldn't ask a question on the subject.

Wells Fargo originated almost one-third of all U.S. mortgages last year, propelled in large part by the flood of existing home owners refinancing at bargain-basement interest rates. But in the second quarter, Wells Fargo originated $112 billion in mortgages, down from $131 billion in the same period a year ago. Refinances made up 56% of the mortgage volume, which was down from 69% in the first quarter of this year.

Sloan acknowledged that much of the impact of the rise in interest rates has yet to be felt — since the spike in borrowing costs happened only a few weeks ago, and Wells Fargo had lots of mortgage applications in the pipeline at that time. He predicted that the company's originations will fall to below $100 billion in the third quarter.

But Wells executives argued that the rising interest rates are a sign of an improving U.S. economy, which is good news for the company overall. They also emphasized that they've long been planning for a rate hike.

Wells Fargo plans to help compensate for the decline in refinances by redoubling its efforts to sell mortgages to home buyers, executives said. They added that higher prices should lead to fewer delinquencies and foreclosures, which will aid mortgage servicing.

Wells Fargo's upbeat take on the mortgage business came in contrast to remarks Friday by JPMorgan Chase (JPM) executives, who warned analysts that mortgage production could drop by 30% to 40% in the second half. Chase is the nation's No. 2 mortgage originator behind Wells.

One reason for Chase's pessimism could be that it relies more heavily on refinancing activity than Wells does. In the second quarter, 64% of its mortgages were refis, compared to 56% for Wells Fargo

In an interview Friday with CNBC's Jim Cramer, Chase CEO Jamie Dimon acknowledged that Wells Fargo is doing a better job than Chase in the mortgage business.

"You admit that someone is doing better than you?" Cramer asked. "Absolutely. They have been doing better for a long time," Dimon responded.

For their part, Wells executives said that other parts of their business, outside of the mortgage realm, will have to pick up the slack to compensate for the decline of the refinance business. Mortgage originations accounted for 22% of the company's first quarter noninterest income.

"We have 89 other businesses in this company that are continuing to grow," Sloan said.

When pressed by Mike Mayo, an analyst with CSLA, about which specific businesses would make up for the lost mortgage income, Sloan refused to be pinned down, saying: "All of them."

Stumpf did mention Wells Fargo's credit card operation, which is an area where the company has lagged behind other big retail banks, as one business line with growth potential.